on Business Insurance Uncategorized

Defense Costs and Professional Liability Insurance (Errors & Omissions): Who Pays What?

Professional Liability Insurance (Errors & Omissions, or E&O) protects professionals from claims alleging negligent acts, errors, omissions, or poor advice. One of the most confusing and commercially critical questions for businesses in the USA — from solo consultants in Los Angeles to small accounting firms in New York City — is who pays defense costs, how defense interacts with policy limits, and what out-of-pocket exposures the insured can expect.

This article breaks down who pays what, how different policy structures work, sample price signals from major carriers, and practical guidance for buyers in the United States.

Key concepts: duty to defend vs. duty to indemnify

  • Duty to defend: The insurer pays for the insured’s legal defense (attorneys, expert witnesses, court costs) when a claim is filed alleging a covered act. This can hinge on the policy wording and whether the allegation falls within coverage.
  • Duty to indemnify: The insurer pays settlements or judgments that the insured is obligated to pay as a result of a covered claim.

Why it matters: whether defense costs are paid inside or outside policy limits changes how quickly your limits are eroded. (Sources: Investopedia, Insurance Information Institute)
(https://www.investopedia.com/terms/e/errors-and-omissions-insurance.asp) (https://www.iii.org/article/how-much-does-professional-liability-insurance-cost)

Defense costs: who pays what (common structures)

  1. Defense costs paid outside the limits (Defense Outside Limits, DOL)

    • Insurer pays defense expenses in addition to the policy's liability limits.
    • Best for insureds: settlements/judgments do not get reduced by defense spend.
    • Common with higher-end carriers or as a preferred endorsement.

  2. Defense costs paid within the limits (Defense Inside Limits)

    • Defense expenses reduce the available limit for settlement or judgment.
    • If a policy is $1,000,000 per claim and defense costs consume $200,000, only $800,000 remains for settlement.
    • More likely in lower-premium or admitted-state forms.

  3. Retentions / deductibles

    • The insured typically pays a retention (often called deductible in E&O) per claim before the insurer pays indemnity or elements of defense costs.
    • Retentions vary widely — from $0 to $25,000+ depending on profession and revenue.

Always read the Declarations and Definitions pages of your policy to confirm which structure you have.

Example scenarios — who pays what (numbers)

Scenario assumptions: $1,000,000 / $1,000,000 policy (per-claim/aggregate), $50,000 retention.

  • Claim A: Alleged negligent advice. Legal defense = $60,000. Settlement = $250,000.

    • If DOL: Insurer pays $60,000 defense; insured pays $50,000 retention; insurer pays $250,000 settlement (subject to defense allocation rules).
    • If Defense Inside Limits: Legal defense ($60k) reduces limit. Insurer pays $60k defense and $190k settlement; insured pays $50k retention and remaining $60k shortfall if settlement exceeds limit.

  • Claim B: Frivolous suit that costs $120,000 to defend and is dismissed.

    • DOL: insurer covers full $120k, insured pays retention only.
    • Inside limits: $120k consumes limits; if later claim arises, less coverage remains.

These scenarios demonstrate why DOL is especially valuable in professional services with high litigation costs (e.g., architects, IT consultants, financial advisors).

How premiums and pricing reflect defense arrangements

Premiums reflect industry risk, policy limits, location, revenue, and whether defense is inside or outside limits.

Note: Quotes vary dramatically by state. For example, in New York City or San Francisco, carriers often charge 10–40% higher premiums than in lower-cost markets due to higher defense costs and jury awards.

State focus: Los Angeles, New York City, Houston

  • Los Angeles, CA: High frequency of disputes in entertainment, tech, and consulting. Expect premiums ~10–25% above national base for comparable exposures.
  • New York City, NY: Elevated legal costs and plaintiff-awarded damages often push premiums higher; high-exposure professional services like financial advisors pay more.
  • Houston, TX: Professional services tied to energy and construction can face specialized exposures — premiums vary, often tied to contract language and performance guarantees.

Ask carriers for multi-state pricing if you operate in multiple jurisdictions.

Practical buying checklist (what to negotiate & verify)

  • Confirm whether defense costs are inside or outside policy limits.
  • Check for consent-to-settle clauses (some insurers require you to accept settlements even if you prefer to litigate).
  • Verify retroactive date (claims-made policies cover claims from after the retro date).
  • Confirm whether regulatory defense or fines/penalties are excluded.
  • Ask if cyber/privacy claims are included or need a separate policy or endorsement.
  • Compare retentions versus premium savings: higher retention often lowers premium but increases out-of-pocket risk.

For a detailed breakdown of specific coverages to expect in a professional liability policy, read: Breakdown of Coverages Inside Professional Liability Insurance (Errors & Omissions): What to Expect.

For guidance on third-party exposures and how E&O responds, see: Does Professional Liability Insurance (Errors & Omissions) Cover Third-Party Claims? A Deep Dive.

Carrier selection & sample carriers

  • Lower-cost, digital-first options (good for low-exposure sole practitioners):

  • Admitted-market & specialty carriers (best for higher limits, complex exposures):

    • Chubb — strong for high-limit professional liability and D&O bundle options.
    • The Hartford — broad small-business product suite and national agent network.
    • CNA, Travelers — long-standing capacity for professional lines.

Get 3–5 competitive quotes. Ask insurers to show you the policy language for defense allocation and settlement authority — not just a summary.

Final takeaways

  • The insurer generally pays defense costs per the policy terms, but whether those defense costs erode your limits depends on whether the policy provides defense inside or outside the limits.
  • For professionals in high-litigation markets (New York, Los Angeles), prioritizing defense outside limits, a reasonable retention, and strong consent-to-settle language can materially protect your balance sheet.
  • Premiums vary widely by carrier, profession, revenue, and state. Expect solo practitioners in the USA to pay roughly $300–$1,500/year for standard E&O limits, while small firms with greater exposure commonly pay $1,500–$6,000+/year.
  • Always compare policy forms, not just price. Read defense clauses and get confirmatory quotes for your state and revenue profile.

External references:

Recommended Articles