Professional liability brokers repeatedly receive requests frominsureds to add the insureds' clients onto their errors andomissions policies as additional insureds. As outsourcing hasbecome more prevalent, so has this request.

At first glance, this request seems quite reasonable. A clientrequests to be added as an additional insured (AI) with the intentto have the insured's E&O policy provide defense andindemnification if an error or omission by the insured results inthe client being sued.

For example, a Web designer--the insured--uses an unauthorizedimage on a client's Web site. The holder of the copyright then suesthe client.

Although this might seem like a good reason to add the client asan AI, most of the time, a request to add a client as an additionalinsured on an E&O policy stems from a misunderstanding of thepolicy. There are three questions a broker should ask when such arequest comes in.

o Is it even possible? In other words, will the carrier take therisk?

o If it is possible, is it desirable?

o Finally, if the decision to add the client onto the policy asan additional insured is made, what changes to the program shouldthe insured make?

Adding clients as additional insureds on a general liabilitypolicy is commonplace, so why not on an E&O policy?

Quite simply, some carriers will not allow additional insuredson E&O policies for several reasons.

First, many reinsurance contracts will not allownon-professionals to be added to the policy, so the carrier's handsare tied.

Secondly, coverage under the policy is triggered by allegationof failure to render, or negligence in rendering a definedprofessional service. Typically, the AI is not rendering theprofessional service and therefore coverage will not betriggered.

Additionally, underwriters offer terms based on an analysis ofthe insured's exposure (services, revenue and other measures).Adding AIs broadens the scope of potential liability, and isdifficult to underwrite. When an AI submits a claim to the carrier,they expect defense to be tendered even when there are noallegations of professional misconduct or negligence. Furthermore,if the AI's operations involve broader services than the insured's,then it could potentially open the policy to claims from the AI'sother professional activities.

Professionals, by law, are liable for their own negligence andthe negligence of those for whom they have assumed vicariousliability (those who they have a right, ability and duty tocontrol). However, E&O policies, by and large, excludeliability assumed under contract except when liability would haveexisted regardless of the contract. Therefore, when an insuredaccepts additional liability via contract, the contractualliability exclusion would preclude coverage under the policy.

Additionally, E&O policies contain insured-versus-insuredexclusions that preclude coverage when one insured sues anotherinsured under the same policy. The thought behind this is not tocover internal disputes and to exclude such a moral hazard.

E&O policies are "pay on behalf of" policies, which meansthe insurer will pay damages in the insured's stead when a clientor third party is injured by the insured's negligence in providingprofessional services. The E&O policy is designed to compensateparties other than the insured. In situations where the client, anAI, is suing the insured, the exclusion in the policy will betriggered and, therefore, no coverage will be provided.

Furthermore, defense costs in most E&O policies are includedwithin the limit of liability. Therefore, covering the defense ofAIs can rapidly erode one's policy limit, thus potentially leavingthe insured exposed. Moreover, if the carrier is tendering adefense for both the insured and the AI, then a potential conflictof interest could arise.

If the carrier agrees to add a client onto the policy as an AI,and, in spite of all the above reasons not to, the insured electsto add their client as an AI, there are several items the insured,the broker and the AI need to address.

First, the AI endorsement needs to be carefully written toconsider the AI an insured only in certain limited and clearlydefined circumstances so as to limit the effect of theinsured-versus-insured exclusion. Even with such a well-writtenendorsement, however, once the client seeks coverage as an AI, thenany related claims made against the insured by the AI will not becovered.

Secondly, the AI must be made aware of the reportingrequirements under the policy. Some questions that must beaddressed are: When must notice be given to the carrier? What isthe definition of a claim? Is the policy a duty-to-defend policy?Does the policy contain a strict hammer clause? (See "Insureds NeedTo Sort Out Potential Hammer Effects," NU, Aug. 4, 2008,http://bit.ly/7x1ctI).

Alternatively, rather than adding a client onto their policy asan AI, consider coaching the insured to respond to the client'srequest by doing the following:

o Explain why such an action is not in the client's bestinterest. It provides no added protection and could actually reduceor eliminate coverage entirely.

o Work with the client and carrier to set a minimum policy limitand maximum deductible/retention that all parties feel comfortablewith--ones that will provide an adequate limit of liability and adeductible that the insured can meet even in a catastrophe, and ata premium that is affordable.

o Assure the client that all reasonable effort will be made tomaintain coverage for a specified period of time after the contracthas ended, and negotiate a preset bilateral tail option. Abilateral tail means the insured may elect to purchase tailcoverage (or an extended reporting period) if either the carriernon-renews or the insured elects not to renew the policy.

By working with their clients in good faith, and by expressing asolid understanding of the E&O policy, insureds can demonstratethat they are thorough, reliable and informed. Ultimately, such ademonstration can only help assure the clients that they haveselected the right professional with which to contract.

Damien Magnuson is an assistant vice presidentof Executive Perils, a Los Angeles-based national wholesaler solelydedicated to D&O, E&O, EPL, digital, intellectual property,media, legal malpractice, insurance agents E&O, crime andfiduciary liability insurance. He may be reached [email protected].