What Factors Determine My Professional Liability Insurance Premium

As a financial professional, you’ve probably heard about professional liability insurance. You may even own a policy. However, you might be uncertain about what it provides and what determines its cost. You might also be unaware of how the value of having this insurance exceeds its premium. This article will provide valuable answers to these and other questions to help you become a more informed buyer.

What is Accountant Professional Liability Insurance?

Accountants and bookkeepers do essential work. They collect client financial data, and then they analyze and report it to answer client questions and help them comply with legal requirements. It’s a detail-heavy job that can lead to errors. When clients suspect their accountant or bookkeeper of making a mistake that costs them money, they often will sue to recoup their losses. Enter professional liability insurance, otherwise known as malpractice insurance.

Professional liability insurance protects accountants, certified public accountants, bookkeepers and tax preparers against the costs of getting sued for making a professional error. If a client files a claim against you, your malpractice policy will pay for your legal expenses. This includes hiring an attorney, paying court-imposed judgments and reimbursing administrative fees.

Violating common or statutory law can lead to legal exposure. Liability grounded in common law traces back hundreds of years, assigning responsibility for client financial losses after a breach of contract, negligent act or fraud. Statutory liability flows from federal laws, such as the Securities Act of 1933, the Securities Exchange Act of 1934, the Racketeer Influenced and Corrupt Organizations Act (RICO) and state securities laws.

Furthermore, an accountant’s liability can arise from any number and type of mistakes, including fee disputes, failure to detect fraud, flawed consulting or financial-planning recommendations or errors made during audits. 

The bottom line is this: Since lawsuits against accountants and other financial professionals are common and can come from unexpected places, you should maintain strong professional liability coverage. This is even more important for fiduciaries. When you operate as a fiduciary, plaintiffs will have a low evidentiary hurdle to establish that you harmed them. This dramatically increases the need to transfer risk exposures to an insurance company.

Knowing what professional liability insurance is and why it’s necessary is just the beginning. You should also determine if it’s a good value. In most cases, it is because your annual cost will likely be lower than the cost of defending yourself against a single client lawsuit. Plus, if a court orders you to pay punitive damages, your claims cost might be far higher than what you would have paid for professional liability insurance.

How Insurers Determine Your Insurance Premium

Your insurance premium— the money you pay your insurance company to protect you— depends on the company’s analysis of your risk factors, including your:

  • Location– States often have different accounting requirements and legal climates. For example, it might be easier to sue an accountant in certain states than others or some states may be less inclined to impose large financial judgments than others. If you’re in a high-cost jurisdiction, you will probably pay more for malpractice insurance because the cost to resolve a dispute will be higher.
  • Annual revenue­– Larger firms tend to get sued more often. That’s because they have larger caseloads and handle more complex assignments. Also, big firms often attract litigation from people who assume they will have more money to spend on claim settlements. Due to these reasons, a larger accounting and bookkeeping firm represents a greater risk to insurers, which means they must increase what they charge to cover higher claim costs.
  • Years in business– A newer accounting or bookkeeping firm will usually produce more lawsuits because it has less experience and will tend to make more errors. The more mistakes you commit, the more often you’ll get sued. You’ll need to pay your insurer more to cover this additional risk.
  • Number of employees– Staff size affects risk potential, too. Why? Because it’s a proxy for annual revenue. Thus, the more employees you have, the more client engagements you’ll have. This translates into more risk and more lawsuits.
  • How long you’ve had malpractice insurance– Insurers provide coverage on a claims-made policy form. This means you’re only eligible to receive benefits when a loss occurs while your policy is active. You must also file your claim notice during this period. For these reasons, your insurance company will pay for a loss that occurs today and one that happened as far back as your retroactive date. That’s the first day from which you’ve maintained continuous coverage. 

    For example, if you paid your insurance premiums for a year, and a client files a claim regarding a loss that occurred in your first coverage month, your policy will protect you. Similarly, you’d still be covered if you had insurance for five years and a client sued you over something that happened in the initial month. What does this have to do with your premium amount? It means that the period your policy is protecting increases each year. When you first purchase the policy, the cost will be low because there’s no prior work to insure. In year two, the policy will have one more year of business to cover, so your second-year premium will be higher. You’ll pay even more in the third year because your premium now has to cover two years of prior activity. This gradual escalation, known as step-rate pricing, typically continues for five years. After that point, insurers will consider your policy to be “mature,” no longer requiring a premium adjustment.
  •  Claims history– One of the most accurate risk indicators is whether someone has sued you in the past. Prior litigation leaves breadcrumbs that indicate risk. This helps your insurer estimate how many claims you might produce. The more claims, the higher your premium. If your claims experience is quite excessive, your insurance company may refuse to provide coverage. However, it may discount your premium if you’ve never— or only rarely— been sued.
  • Practice areas– The type of work you do can pose a significant liability risk. If you do a large volume of audits, a mistake in a major engagement can result in costly litigation. Why? Because banks or investors will rely on flawed audits to make a business decision. If things turn sour, they may hold your audit— and you— accountable. Therefore, accounting firms that perform many audits will often pay more for malpractice insurance than those who have a more diverse engagement mix.

The above factors are intrinsic elements; they’re integral to your business. Other factors are extrinsic, meaning they’re external elements you can modify to reduce insurance costs. Examples of outside factors include:

  • Limits of liability– Limits of liability, or coverage limits, are how much insurance you’re buying. A policy with a $1 million limit means you’re protected against one or more claims equaling $1 million during the policy period. However, policies often have two types of limits: per occurrence and aggregate. The first is the maximum amount an insurer will pay for a single claim; the second is the maximum it will pay for all claims in a given year. The greater your per-occurrence and aggregate limits are, the greater your insurance premium will be. If you want to lower your insurance costs, talk to your broker about lowering your liability limits. Remember, though, that reducing coverage will increase your risks.
  • Deductible– This represents your share of claim expenses before your insurance benefits kick in. Increasing your deductible lowers the insurer’s risk exposure. This allows it to reduce your premium. However, selecting a small deductible will boost your insurance outlay.
  • Premium-payment mode– Insurers prefer customers to pay their insurance bill once to cover the entire policy period (commonly six months or a year). Since this lowers administrative expenses, they can offer you a modest premium discount. If you prefer to pay smaller amounts more frequently (example: quarterly), your insurer will add a fee to cover the higher expense of producing multiple bills.
  • Insurance bundles­ Some insurers may package professional liability insurance with another type of insurance. Because they’re bundling two coverages in one policy, which costs less from an administrative perspective, they may charge you less than if you bought the policies separately.
  • Loss prevention– Insurers may offer discounts if you’ve worked hard to reduce risk exposure. This is a common practice after an accounting firm sends staff to risk-management training, develops a loss-control program or begins using engagement letters.

Ultimately, it’s crucial to understand that your professional liability insurance premium is a reasonable number. It results from a careful actuarial analysis that fairly assigns cost based on observed risk data. If you take steps known to lower claims risk, your insurer will most likely lower your premium. Even if it doesn’t, you can take comfort in the knowledge that your insurance expense will likely be lower than what you’d pay to settle a client lawsuit out of pocket.