Are There Differences Among Investment Advisor E&O Policies?
By Bayard Bigelow III MBA CPA
We have been managing the same E&O professional liability program for RIA’s for more than ten years. That’s ten years of phone calls, letters, requests for clarification and, in general, a significant amount of misunderstanding and confusion about what E&O insurance is all about. We also speak a lot, and will typically field a wide variety of questions from the audience. Whether by phone, in person, through correspondence, or from an audience, the questions don’t vary a lot — they underscore just how broad the level of misunderstanding really is. Lacking understanding, many advisors will rely upon the “school yard” as their primary source of information. In short, there is a crying need to shine light into the darkness.
The E&O professional liability polices available for financial advisors are not commodities, unlike other policies such as private passenger automobile, homeowners insurance and many commercial policies. The professional trying to evaluate various policies, therefore, needs a working understanding of their terms and conditions.
An insurance product is complex and technical – even the shortest policy will take 15 or more pages and thousands of words to define the conditions under which coverage may, or may not, apply. While it is unlikely that the layman will be able to understand all of the nuances of coverage, it is possible to evaluate the appropriateness of different policies and insurance programs. This article will attempt to do precisely that — wish us luck, as it is a tall order. Please note that this article addresses basic concepts of E&O policies, and the law in a particular state may be applied differently.
We all know one of life’s unwritten rules — for every benefit there is an offsetting price to be paid. In other words, there really and truly is “no free lunch”, also known as “The NFL Rule”.
As the NFL Rule applies in this case, all or nearly all E&O policies available for Financial Advisors are written in an unregulated market. This is the market of choice because the profession is highly fractured and complex. Accordingly, any insurance product must meet the needs of a variety of different types of practices. Only in the unregulated market can coverage terms be tailored as circumstances dictate.
Equally this also means that an E&O insurer can legitimately offer policy terms and conditions which simply would not pass muster in the regulated markets. For that matter, it can also change policy terms and conditions from one renewal to the next without having to disclose to policyholders what has changed.
Although it is not generally recognized outside of the insurance industry, it is typical for an insurer to pay, on average, at least as much for the defense of claims as is paid in damages to claimants. In other words, the defense provisions of the policy are a critical part of the overall insurance policy.
There are two clauses commonly used in E&O policies. Under the first, the insurer has ?the right and duty to defend?. Under the second, the insurer has only ?the right but not the duty to defend?. What is the difference between these innocent sounding words “right and duty” as compared with “right but not the duty”? (Right about now might be a good time to ?get smart? about ?duty to defend?. Type in the phrase ?duty to defend?, quotes included, into any of the general internet search engines and browse through what pops up ? it will be a real eye-opener when you see the body of case law defining the extent of the duty to defend.) Here’s where we go “techie” on you.
Under a right and duty to defend policy, the carrier is required to provide a defense if only a single allegation potentially brings the case within the scope of coverage. Alternatively, if a claim alleges only acts that are excluded, the carrier will deny coverage for the entire claim.
Nonetheless, in nearly all complaints, a count of some form of ordinary negligence will be included, if only to trigger coverage for the defendant. Failing to include at least one complaint of a covered act would result in a coverage denial of the claim by the defendant’s insurer. As a result, the defendant would have no available funds, other than his or her personal assets, with which to defend the claim and / or to pay damages. Surely the defendant’s lack of a “war chest” takes all the fun out of the game for the plaintiff and his or her attorney.
But if the insurer has no such duty to defend in the first place — that is, if its policy is a ?right, but not a duty to defend? contract — the carrier may simply elect not to provide a defense. Thus, if a plaintiff alleges wrongdoing that is covered, the insurer under a ?right but not the duty to defend? policy may elect not to provide a defense, leaving the policyholder to shoulder the considerable expense of a defense lawyer. While it may be appropriate in certain types of policies (e.g. excess or ?umbrella? policies, and commercial reinsurance contracts) for the carrier not to assume the duty to defend, the advisor?s primary E&O policy should always include the insurer?s duty to defend. Anything less is simply unacceptable.