What is Liability?
Liability refers to an obligation that legally binds an individual or a company to settle a debt or a wrongful act the entity might have committed. Liabilities are settled by transferring economic benefits such as money (in the form of cash or cheques), goods or services.
According to the Institute of Chartered Accountants of India, A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Insurance is a contract wherein an individual or a company is entitled to financial protection or compensation against losses from an insurance company. Insurance companies pool the combined risks of their clients in order to make the insured company or individual’s payments more affordable.
Table of Content
- 1 What is Liability?
- 2 What is Liability Insurance?
- 3 Features of Liability Insurance
- 4 Types of Liability Insurance
- 5 Professional Liability Insurance (Malpractice Insurance)
- 6 Need for Professional Liability Cover
- 7 Types of Exposure
- 8 Classification of Professional Risk
- 9 Exclusions Under Professional Liability Insurance Policy
What is Liability Insurance?
Liability insurance is a type of insurance policy that offers protection to businesses or individuals in case they are sued for reasons such as negligence, malpractice or injury. Liability insurance policies cover the legal costs for the insured if found liable. These policies, however, do not cover intentional damage and contractual liabilities. In India, liability insurance, like any other insurance contract, is subject to the provisions of Indian Contract Act, 1872. Thus, basic insurance principles, i.e., insurable interests, indemnity, subrogation, etc., are applicable to this class of insurance as well.
Liability insurance primarily covers the losses arising out of third-party damage. The purpose of liability insurance is to provide indemnity with respect to the financial consequences of the legal liabilities. Insurance brokers working in India have a mandate to insure their liability in terms of the Insurance Regulatory and Development Authority (IRDA) regulations for brokers.
Liability insurance provides cover for two main financial risks. These are:
- Legal cost of defending a claim
- Compensation that may be directed towards payment of legal costs to the injured or wronged party in case a claim is upheld
These financial risks include an additional amount that needs to be paid by the policyholder in the event of filing of a claim. A limit is set on the total amount that is payable under the policy along with a per-claim limit.
Features of Liability Insurance
There are certain key features of liability insurance that clearly distinguish it from other classes of insurance. These are described as follows:
- The claims are paid to the third party and not to the insured. Thus, it could be a member of the public or the employees of the insured, but on behalf of the insured.
- Indemnity is provided with respect to potential legal liability, i.e., liability arising out of common law or statutory law of the country.
- Legal cost incurred by the insured (with the written consent of the insurers) can be reimbursed under the policy.
In general, liability policies’ ‘limit of indemnity’ (the maximum amount of compensation that an insurer is liable to pay to cover the costs and expenses of a claim made by the insured during the period of the in- surance policy) is mentioned instead of ‘sum insured’ (the maximum amount that an insurance company pays in in case the house of the insured is completely destroyed or severely damaged).
As the policy is related to law, it is important to mention the jurisdiction clause in the policy. Cause of action may arise in any part of the world, but insurers restrict their liability to the courts within specific jurisdictions. For example, an insured living in Delhi would file a claim for car insurance in Delhi and not in Mumbai.
Types of Liability Insurance
Liability insurance provides protection against financial loss arising out of the insured entity’s actions or negligence or its property causes injury to another individual or the property suffers extensive damage or is destroyed. There are three types of liability insurance: public liability, professional indemnity and product liability. The following is a description of the three:
Public liability insurance
It protects a business against financial loss in case it is found liable by a third party for death or injury, or loss/damage to property resulting from negligence. The owner of the business would be liable to pay for damages or injuries that occur to another person or property. Even though liability insurance is optional, it is recommended that a business opts for it as there is likelihood of the business being sued for negligence or wrongdoing. More often than not, a business has the choice of taking out liability insurance but in some cases, it is compulsory.
For example, employers’ liability is compulsory if an individual is running a business, in order to cover for expenses if an employee suffers an accident, injury or death in the completion of his/her work duties. Public liability insurance generally does not provide insurance cover if an individual or a business is known to be involved in criminal actions or hazardous activities.
It is insurance provided to professionals to cover the cost of litigation. Professional indemnity insurance provides insurance cover to a professional against legal action that his/her customers might take against him/her if they have suffered a loss as a consequence of following his/her professional advice.
Professional indemnity also has specific types of insurance cover. For example, medical professionals generally have medical indemnity insurance as a part of their professional registration or license.
A company producing, selling, distributing or importing products from other countries should be covered with product liability insurance. Product liability insurance provides cover for any injury or loss that a person might suffer due to the company’s product or service.
Professional Liability Insurance (Malpractice Insurance)
Professional liability insurance covers professionals’ liability for dam- ages arising from errors, omissions or negligent acts while rendering or failure to render professional services. Professionals are individuals who have acquired special skills and are equipped to advise the general populace on the basis of these skills. Individuals like doctors, lawyers, chartered accountants, architects, etc., are referred to as professionals.
A professional liability insurance policy (also called Errors and Emissions or E&O insurance policy) provides cover for claims alleging an error or negligence in the performance of professional duties, and in exchange insurance premiums are paid to the insurance company. In India, the common understanding is that professionals who are governed by practices and services as laid down by a statutory organisation or body are answerable to their profession’s governing council. These councils provide professional liability policies to these professionals.
Medical professionals are governed by Medical Council of India, engineers by Engineering Council of India and chartered accountants by Institute of Chartered Accountants of India. Each of these bodies is responsible for issuing professional liability policies for the profession regulated by it.
Professional liability risk poses a threat to specialists in just about any industry or profession, but High Net Worth (HNW) individuals often face even greater exposure. HNW individuals can be directors of big firms or private business owners. The Directors and Officers Liability policy covers such individuals.
Need for Professional Liability Cover
The need for professional liability insurance is felt by professionals owing to an increase in claims filed by clients. Nowadays, clients commonly seek out the professional for recovery in case they feel that the professional’s performance was below their expectations. The key reasons for choosing a professional liability cover policy are as follows:
- High litigation fees and other legal costs which, if the offence or damage is serious, may lead to bankruptcy of a company. Also, during a lawsuit, the services of the professional would be disrupted, thereby hampering normal course of the business.
- There is loss of reputation of the professional due to his/her inability to render professional services.
- A prudent professional liability policy not only protects a company or its customers against losses but also provides for cover for the entities that are harmed.
- Mistakes are made even by the best of employees and with the best risk management practices in place. Therefore, it is beneficial to look to minimise risks as far as possible.
Types of Exposure
Advancements in technology help increase the expectations for professionals as they are able to offer better quality of services to the clients. These changes offer better opportunities, but they come at the cost of more complex solutions. Thus, these solutions provide increased options for success while raising the expectations of clients as well.
Professional exposure can take different forms. The following are some instances:
- Allegations of poor performance by a client
- Breach of contract between a client and a professional
- Conflict of interest
- Failure to provide quality consulting services
- Failure to protect proprietary and classified information
Professional liability insurance not only provides security against ex- posures but also provides the requisite funds needed to investigate, pay expert witnesses, hire a lawyer, and several other expenses that the professional would have to bear in case he/she is sued. In several situations, these fees can even exceed the amount of actual damages incurred. Professional liability insurance has gained more relevance and importance in the modern world because of the need to protect the reputation and the personal assets of the professional.
Classification of Professional Risk
Professional risk can be classified into the following three categories:
- Bodily injury/casualty: It occurs when professional negligence may result in bodily injuries (fatal or otherwise). Medical professionals such as doctors, dentists fall in this category.
- Financial loss: It occurs when professional negligence may result in financial loss. Chartered accountants, solicitors, etc., would come in this category.
- Combination of bodily and financial loss: It occurs when professional negligence may result in both financial loss and/or bodily injury. For example, architects, civil engineers would fall in this category.
Exclusions Under Professional Liability Insurance Policy
The exclusions in professional liability insurance are as follows:
- Professional services rendered while being under the influence of narcotics or alcohol
- Third-party public liability
- Claims related or owing to AIDS (Acquired Immune Deficiency Syndrome)
- Cosmetic plastic surgery, hair transplants, punch grafts and similar procedures
- Claims arising out of genetic injuries caused by X-ray or radioactive substances.