By Harry J. Lew
The COVID-19 pandemic has frozen economic activity. Have you reacted by cutting expenses? If so, be careful about cutting essential insurance.
Has government-imposed social distancing reduced your access to prospects, freezing your ability to bring in new business? Has your income fallen so much you can’t pay your bills? Are you burning through your savings so fast you’re worried about having nothing left in several weeks or months? Don’t worry; you’re not alone. You can take proactive measures to help your firm weather the storm.. To this end, many small business owners are looking hard at their expense budgets to see what they can cut. Perhaps you subscribed to a business computer application, but no longer use it. Or maybe you can save money on office supplies or professional memberships. Even small expense reductions can add up, extending how long you can stay in business with lower or no revenue. As you go through the exercise of reducing nonessential expenses, perhaps you’ve considered cancelling your E&O (or professional liability) insurance. This might save you hundreds of dollars a year you could put toward office rent or payroll (if you have employees). But before you do that, weigh the potential cost savings against the disadvantage of being defenseless against client lawsuits. Here are some points to consider:
Is E&O (or professional liability) insurance an essential expense?
Many small-business advisors believe it is. That’s because it provides cash to cover legal judgments and settlements arising from customer disputes. Without this money, you’d have to cover your legal expenses yourself, potentially bankrupting your business and putting your personal assets at risk. Rather than viewing business insurance as a non-essential expense, experts suggest putting it in the same category as your health insurance—i.e., as something to keep in force at all costs. Just as health insurance helps you stay personally healthy, E&O or professional liability insurance helps your business remain financially strong for years to come.
Is now a good time to be uninsured against legal claims?
There’s never a good time to be uninsured. But now is an especially bad time. With the U.S. economy likely to enter a major recession or worse, your customers will soon begin experiencing greater financial stress. Just as you may be financially challenged, they may be out of work, burning through savings at an alarming rate. When this happens, clients may target alternative sources of income such as your professional liability insurance policy. Most clients won’t do this, of course. But someone who is desperate might grasp at any straw to generate cash.
In fact, the more serious the financial crisis, the more liability claims small businesses will face. “A rise in disputes typically accompanies an economic downturn,” warns Gerry Pecht, head of dispute resolution and litigation at Norton Rose Fulbright, a global law firm. “If the economy goes sour, more deals may fail, more contracts will fall through, and employees will be laid off.” In this environment, the last thing you should do is jettison your insurance.
Will you get your premium back?
If you pay annually for your E&O or professional liability insurance policy, you may be eyeing a premium refund. Problem is, some insurers charge for early cancellations. This is done using one of two methods:
- With “short-rate cancellations,” insurers levy a penalty for canceling before the annual coverage period is up. Normally, they reduce the penalty gradually throughout the year, reaching zero by your annual renewal date. Upshot: if you’re contemplating canceling early in your coverage period, your refund may fall well short of what you’re expecting.
- With “prorata cancellations,” the insurer doesn’t levy a penalty but instead returns part of your premium based on how much of the coverage you didn’t “use.” Example: if you’re six months into your annual policy period, you’d get a refund representing six months of unearned premium.
In either case, cancelling your annual-payment policy may result in freeing up less cash than you imagined. It may not be enough to outweigh the added liability exposure.
Will cancelling your policy trigger past liabilities?
Your E&O or professional liability insurance policy most likely was issued on a “claims made and reported” basis. This means your policy will protect you when a dispute and resulting insurance claim happen while your policy is active. This also applies to past incidents under prior policies, as long as you have maintained continuous coverage. The minute you cancel your policy, you’ll lose protection against lawsuits from past clients. In effect, you’ll open yourself to lawsuits from potentially any client you’ve ever worked with. However, you can fix your mistake by reinstating your policy (or buying a new one). Except now you’ll need to pay extra for prior-acts coverage. Bottom line: cancelling your E&O or professional liability insurance may actually increase your insurance costs over the long run.
Does replacing your policy with cheaper insurance make sense
Perhaps you’re considering cancelling your current policy and replacing it with something less expensive. This may involve switching to a lower-rated insurer (with less ability to withstand financial shocks) or to a non-admitted insurer (which are unregulated by state insurance departments). In the second case, you’ll be dealing with an entity whose benefits, rates and policy forms aren’t subject to insurance commissioner approval. In fact, non-admitted coverage is not actually insurance from a legal standpoint, and you won’t find that word anywhere in your sales materials or policy documents. Consequently, buying your E&O or professional liability insurance from a non-admitted insurer might save you money initially, but cost you more over the long haul if the firm fails to keep its promises.
Should you reduce your coverage to save money?
Another option is to lower your policy limit. By reducing the maximum amount your policy will pay for a covered loss, you might be able to reduce your premium a nominal amount. But it’s important to weigh the benefits of a modestly lower cost against the additional risk you’ll face by weakening your safety net.
As you can see, cancelling your E&O or professional liability insurance has many downsides. It might not save you as much money as you thought, and it will likely create additional legal risks in uncertain times. Being short of cash due to the coronavirus crisis is a serious concern. But weakening your legal protection to save money might actually be a penny-wise, but pound-foolish solution. Perhaps revisiting other expenses in your budget will generate comparable savings without exposing you to so much extra risk.