E&O In the Know: A Financial Advisor’s Guide | ThinkAdvisor (2024)

Errors and omissions insurance, or E&O, is an important business expense for financial professionals such as financial advisors, CPAs, and life insurance agents. In our litigious society, where responsibility is consistently pushed onto another party, disputes are becoming increasingly common. In fact, according to the Financial Industry Regulatory Authority (FINRA), consumers have filed approximately 3,200 to 8,900 securities arbitration cases per year from 1999 to 2013, with the higher volumes occurring after down markets.[1]

Fortunately, most financial professionals are ethical and responsible and take great care managing the details of their work. With proper focus, advisors can avoid a potential lawsuit. However, even the most careful are not immune to a legal attack from a former or current client. Without the benefit of E&O insurance, a lawsuit can be financially devastating.

What You Need in an E&O Policy

Not all E&O policies are the same. And depending on your specialty, there are certain elements you may need that others do not. Here are some of the features you should look for in a high-quality E&O policy:

Adequate liability coverage

All E&O policies include liability coverage that protects you from financial loss due to a lawsuit arising from your error or omission. Liability coverage has two parts:

• Per Individual Claim – Usually, there is a limit per incident or claim. The typical individual limit is $1 million. This means that any single liability claim resulting from a lawsuit will pay no more than $1 million.

• Aggregate – Each E&O policy has an annual aggregate that limits how much an insurance company will pay each year. The usual annual aggregate is $2 million. That means the insurance company will pay on multiple claims up to, but no more than, $2 million. Some insurance companies state a lifetime policy aggregate limit rather than an annual aggregate. Be sure the lifetime limit is adequate if you go this route.

Remember, a general liability policy only covers incidents that affect bodily injury due to negligence from property or product safety. It does not cover financial loss to clients. Be sure to get adequate professional liability coverage from a high-quality E&O policy.

Legal and court costs

Whenever you are served legal papers that name you in a lawsuit, it will cost money just to defend yourself. Legal fees and potential court costs add up quickly and can turn even a small claim into a huge financial burden when you consider the total court and legal fees involved. Look for this important provision in your E&O policy to shield you from these damaging expenses.

Post-retirement claims coverage

E&O claims do not always arise while you are in business. They may surface years later after you’ve retired and a past client files suit against you. Your E&O insurance policy should have a provision to cover any claims that occur post retirement. This assures you will not be exposed to great financial risk after you stop working.

Employee or administrative coverage

Most financial professionals have employees or staff who serve clients directly. When they make a mistake or fail to carry out a required task, you will be held accountable. Employee or administrative coverage protects you from employee E&O risk.

Coverage extension to spouses, domestic partners, legal representatives, or beneficiaries

Nobody wants to have their family or other loved ones affected by a lawsuit. Some cases may name spouses as an actual defendant, even though they had nothing to do with the main financial professional’s business. Protect your loved ones with this important coverage feature.

Coverage flexibility

Make sure your E&O policy can be adjusted for whatever products and services you provide. Basic policies cover you for the sale and servicing of life, accident, and health products. But also look for optional coverage for fixed and indexed annuities, variable products and mutual funds, disability insurance, and RIA Series 65.

The Importance of Avoiding Coverage Lapses

Most E&O insurance policies are written on a “claims made and reported” basis. This means they cover claims that are “reported” during the current policy period even if acts or omissions giving rise to the claim happened in the past.

In other words, as long as you maintain continuous coverage (i.e., with no lapses), insurers cover claims that are made against you during the policy period, even if the original event happened when you were insured elsewhere. But watch out. If you lapse your coverage, and have not previously reported the circ*mstances, then no insurer is responsible for claims that arose before and during the coverage gap. Result: you will be completely uninsured for past acts, which can destroy your business should you get sued down the road.

Ethical Considerations for Agents

As a financial professional, whether you work in insurance, investments, or any other profession where you represent financial transactions for clients, you have the utmost fiduciary responsibility for your clients. Fortunately, most financial professionals behave and represent clients with consideration and the highest of ethical standards. To maintain these standards and prevent future E&O claims, here are some guidelines to follow.

Never misrepresent yourself

Honesty is one of the most important ethical standards for any professional in the insurance and financial services industry. But the temptation is always there to attract more clients and referrals by exaggerating your abilities, background, and experience.

Whether you’re a greenhorn recruit or a 20-year veteran, always be completely forthright with your experience and education. There is nothing wrong with highlighting your special abilities and skills as long as they pertain to your main job of serving clients and their best interests. For instance, before becoming a licensed agent who sells annuities, you may have worked for a time as a retirement plan specialist in a major insurance company. Don’t hesitate to share such information, as it is relevant and can help you convince others of your competency.

Update your knowledge

Rules and regulations regarding financial exchanges and investments can evolve on a continuous basis, especially whenever a new political administration enters office. You need to keep abreast of all changes that affect your industry so you can better represent your clients and offer the most current advice.

In addition, there is always more to learn about best practices in your industry. Join a trade association and become an active member. Attend seminars. Take additional college classes. The more you learn, the better you will serve your clients.

Educate clients

To help your clients make the best choices and avoid problems later, educate your clients the best you can about the products you provide. Always explain the benefits, as well as the potential risks, of an insurance product or investment. Go over regulations and policy provisions that affect how your client can invest money or make a withdrawal from investments such as IRAs or retirement annuities. Give your clients all the information they need to make informed decisions.

Write everything down

Any time you meet a client to discuss policies, investments, or other financial transactions, keep a written record of what was discussed and the outcome. When a client comes to you in the future claiming you sold him the wrong product, you will be able to defend your decision by referencing the extensive discussion you had about product features, investment risks, and suitability. If you ever face an E&O claim, having a paper trail can spell the difference between winning the case and paying a substantial judgment.

Don’t let clients push you into unethical behavior

Sometimes a client may ask for your help in bending the rules, perpetrating a fraud or engaging in other unethical behavior. Never agree to “look the other way” to benefit a client, even if the person proposes to share the profits with you.