Professional Liability Insurance In Associations


Another good one from the inbox:

I'm interested in starting a business in which I only use workers that I issue a 1099 to at year end. In other words, I'm not paying any of their taxes. So, I guess they would all be similar to subcontractors. Is there a business liability insurance policy that I can purchase that is a blanket policy which would cover them as well? Or can they purchase some sort of rider on to mine to cover themselves?

Let's start by pointing out that the questioner didn't mention specifically what line of work she's in. Problem? Not at all. In fact, it underscores the fact that Professional Liability Insurance (PLI)—whether the professionals involved are doctors, lawyers, or telephone psychics—is always more or less the same animal.

So what is PLI? Simply put, PLI is insurance coverage that pays a professional's legal fees and damages in the case that she gets sued over errors or omissions allegedly committed while engaged in the practice of her profession. PLI is often referred to as “Errors & Omissions Insurance,” for obvious reasons. Typically, the only errors and omissions covered are those made in good faith. In other words, fraud or deliberate negligence usually isn't covered. Also, there is a broad distinction between occurrence and claims-made coverage; see this article for a complete discussion of these terms. Otherwise, there is very little difference in form between, say, medical malpractice insurance and the kind of PLI that a computer IT consultant might carry.

A worker who gets a 1099 at the end of the year is effectively an independent contractor. Our questioner asked specifically about a scenario that involves the following three classes of actor:

  • Individual independent contractors (ICs).
  • An association of ICs—her company—which may also include various regular (i.e. non-1099) employees in administrative or support roles. Even if it doesn't, though, the association is a separate legal entity from its individual members.
  • A client, who employs the association, rather than the individual ICs, to complete some kind of job.

Let's consider this scenario from the client's perspective. Ideally, the transaction is a simple one from the client's point of view: the client hires the association to do a job, the association does the job, and the client pays the bill. End of story, and all parties go home happy.

But what if something goes wrong? Perhaps the association is unable to complete the job. Perhaps the association completes the job, but does it wrong, requiring the client to hire a new contractor to repair the damage. Maybe—think medical malpractice—the patient dies on the operating table in the midst of minor, routine surgery. In any of these cases, we can reasonably expect the client—or the client's heirs, or his own insurers—to go to court in an attempt to recover their losses.

But what if the neither the association, nor its members, has any money in the bank? In this case, both parties are effectively judgment-proof, which is a fancy legal way of pointing out that you can't squeeze blood from a turnip. The client—or the client's insurers—wind up eating the loss.

Because of this very real risk, a smart client—and a smart client's insurer—will generally insist that any sensitive work be performed only by contractors who carry sufficient PLI to cover any potential loss. This requirement is so common that contractors who don't carry PLI are rightly viewed with a jaundiced eye by prospective clients, and evidence of sufficient PLI is welcomed as “virtual due diligence” performed by the contractor's insurer on behalf of the client.

So we can easily see that there are plenty of reasons why PLI is a good idea, if not a downright necessity. The question posed above, though, is this: who should carry it? The ICs? The association? Both?

For the answer, let's consider the same scenario from the perspective of the association's PLI insurer. We'll assume that the patient died—so to speak—and that the client's insurers have hauled the association into court.

As we discussed above, the purpose of PLI is to cover legal costs and damages in just such a scenario. Since the association most likely couldn't have got the contract to begin with without providing evidence of PLI coverage, we can safely assume that the association's insurer is paying the bill. Does the chain of woe stop there?

Of course not. In an effort to recover its own loss, the association's insurer will instantly begin to cast about for a suitable scapegoat, and will very quickly decide that the real responsibility for the original loss lies with the association member—an independent contractor, remember—who performed the actual work. Before you know it, that IC will be defending himself in an adjacent room of the same courthouse.

So what if the IC is judgment-proof... or becomes judgment-proof by the simple expedient of declaring personal bankruptcy? In that case, the association's insurer has no option but to eat the loss (and jack up the association's premium by way of punishment).

It is precisely because of this risk that, when the association is shopping for PLI, the very first question any prospective insurer will ask is: “Do all of your independent contractors carry their own professional liability insurance?”

If the answer is no, most prospective insurers will simply walk away from the table.

Are there exceptions to this rule? Sure there are. For example, many hospitals try to attract the most talented physicians by offering to provide malpractice coverage—medical PLI, essentially—during their terms of employment with the hospital. The smart doctor, however, is wary of this deal: if the hospital offers only claims-made coverage, then a former employee who moves to another hospital or enters private practice can find himself paying through the nose for tail coverage for years to come. See this article for a more complete discussion of these issues, as well as for a clue to the awful pun cleverly hidden in the last sentence.

So, what's the bottom line? Two points:

  • Most insurers will refuse to issue professional liability coverage to an association whose members do not carry their own coverage. Any that actually issue such coverage are likely to charge an exorbitant premium. As a general rule, require your members to carry their own coverage as a condition of employment.
  • An insurer who covers an association is unlikely also to cover its members—even under separate policies—because the whole point of requiring separate coverage for members is to transfer as much risk as possible to some other insurance company.

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