When a client accuses a professional of an error, the cost of defending the claim can be significant, even if the accusation turns out to be baseless. How an errors and omissions policy treats those legal fees is one of the most important, and most overlooked, features of the contract.
Two Common Structures
E&O policies generally handle defense costs in one of two ways. In some policies, defense costs are “outside the limits,” meaning legal fees are paid in addition to the policy limit and do not reduce the amount available to pay a settlement or judgment. In others, defense costs are “inside the limits,” sometimes called eroding or burning limits. In that case, every dollar spent on defense reduces the money available for damages.
Why Inside-the-Limits Can Matter
Consider a policy with a stated limit that is eroded by legal fees. A long dispute could use up a large part of the limit before a settlement is reached. If the claim is then settled or lost, less coverage may remain than the policyholder expected. For professionals who sign contracts requiring a specific limit, this difference can matter, since the practical protection may be lower than the number on the declarations page.
The Duty to Defend
Many E&O policies include a duty to defend, which generally means the insurer takes responsibility for providing and paying for a defense against covered claims. Others are written on a reimbursement basis, where the policyholder hires counsel and the insurer reimburses covered costs. The structure affects who controls the defense, how counsel is selected, and what approvals are needed. Policies differ, so read the defense section carefully.
Panel Counsel and Consent
Some policies require the use of attorneys from the insurer’s approved panel, or require the insurer’s consent before fees are incurred. Hiring your own lawyer without permission may jeopardize reimbursement. Ask in advance how the carrier selects defense counsel and what rights you have to object.
Deductibles and Retentions
Defense costs may also be subject to a deductible or self-insured retention. Some policies apply the retention to both defense and damages, and others apply it differently. Understanding what you must pay first, and whether your own legal spending counts toward it, can help you plan for the financial impact of a claim.
Exclusions and Allocation
If a claim includes both covered and uncovered allegations, the policy may include allocation provisions that determine how defense costs are divided. Disputes about allocation can arise, so it is worth understanding how your policy approaches the issue.
Questions to Ask Your Agent
Ask whether defense costs are inside or outside the limit, whether the carrier has a duty to defend, how counsel is chosen, what retention applies, and whether any sublimits apply to particular types of claims. Comparing these features across carriers is often as important as comparing premium.
Terms vary by carrier and policy form. An independent agent can walk through the defense provisions of your current policy and compare alternatives.
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