E&O claims are extremely rare. Their rarity is why so many agents do not think they will ever incur one. The infrequency of E&O claims is also why so many agencies can proclaim, “I’ve never had an E&O claim!”
Frequently their pride is based upon a fictional story, or more often, a series of vignettes they have told themselves. One vignette discounts luck. I have visited many agencies that should have had many E&O claims and yet they have incurred none. It is always better to be lucky.
The problem with luck in these cases is it creates a completely false sense of accomplishment. Agents are not alone in this misconception. In a fascinating psychological experiment replicated many times and in different forms, people were tested relative to whether they claimed credit for good outcomes of pure chance. For example, in coin tosses, people take credit when they call heads or tails correctly when there is absolutely no credit to be given. It is always pure, 100% chance when one correctly calls a coin toss. Yet over and over and over people will claim credit for correctly calling a coin toss. (Also, interestingly, when they don’t correctly call the coin toss, people assign the blame to bad luck rather than their lack of ability.)
The same goes for E&O. We tell ourselves we are good because we haven’t had any E&O claims when quite often luck is the key.
Another vignette goes, “I’ve never had an E&O claim because I’ve never turned a claim into my E&O carrier.” An E&O claim is an E&O claim. Whether or not you turn it into the carrier is a completely separate issue that is usually determined by the potential size of the claim. If you think about all the checks you’ve cut to clients as “accommodations”, how many E&O claims have you really had?
Even after considering all the small claims for which agencies self-insure their E&O exposure, E&O claims are rare because insurance claims in general are fairly rare. Consider this, there are approximately 330 million people in the U.S. There are around 30 million businesses and around 90,000 governmental entities. There are about 1.5 million nonprofits and about 14,000 school districts in the U.S. Put all of these together and you have at least 360 million insurable entities. Yet there are only around 52 million claims in any given year. That means only 14% of insurable entities, probably less, incur a claim in any given year. That is fairly rare in and of itself.
To incur an E&O claim (with only a few exceptions), an insured must have a gap between the coverage they needed and the coverage they had at the time of the claim. Most claims are pretty simple, so gaps are unlikely, at least those related to E&O issues. Certainly, many people involved in auto claims wish they had bought comprehensive and collision coverage after they get the body shop’s bill, but that is not often an E&O issue.
To the best of my knowledge, no national database exists that aggregates all E&O claims. I have, however, seen a ratio that one in seven independent agents are sued in any given year. Let’s use the IIABA’s number of 38,000 agents. That means 14% of agents will be sued. That percentage is an average though and the number will be higher in large cat years and lower in non-cat years. This means that only 14% of the 14% of insurable entities that have a claim involve an E&O situation if the same ratio applies to all distributors (and I do not know if it does or does not). That ratio shows that at most 2% of 52 million claims are reasonably potential E&O claims. In other words, the odds of an E&O claim are tiny. So, you should probably just ignore the entire issue, right?
Furthermore, the coverage gap needs to be fairly large with a fair chance of winning or plaintiff attorneys will not take the case. Additionally, the plaintiff has to have a reasonable belief that the agent’s standard of care was breached. A whole lot of uncovered claims have absolutely nothing to do with E&O because the insured acknowledges they chose to self-insure this or that (such as comprehensive and collision coverage).
If you put all this together, the odds of being sued relative to the number of clients you have or the number of claims incurred is miniscule. Of course, it is higher than the odds of being audited by the IRS or about the same odds of experiencing true food poisoning.
Conversely, if you’re a qualified applicant to begin with, your odds of getting into Harvard are about double. These odds are about the same odds as the U.S. Post Office finding a lost item. In other words, E&O claims are not and should not be written or considered on a frequency basis. One has frequency underwriting and severity underwriting. Professional liability tends to be a severity event and needs to be underwritten and managed from that perspective – with one exception: An agency that has multiple claims in a short period of time, excluding catastrophe scenarios, is so far outside the norm that either they are really unlucky (don’t stand next to them in a lightning storm) or the agency has truly serious problems.
An outlier involves catastrophe related E&O claims. Catastrophes by definition are rare events. Yet when catastrophes occur, E&O frequency spikes because while only 14% of U.S. entities have a claim in a given year, and if 75% of insureds have material coverage gaps, only 10.5% of those entities will have an E&O claim they can pursue against agents. However, 75% of insureds have material coverage gaps and a catastrophe affects 75% of the town, then the number of potential E&O claims increases to 56%, a 433% increase! This is why catastrophes have earned the E&O tagline that, “Catastrophes are the best E&O audit on earth!”
Excluding catastrophes, so many factors must align for an E&O claim to occur, a randomness often seems to exist. This seeming randomness and lack of frequency with emphasis on severity creates a truly dangerous risk environment because the normal human brain flat out cannot process these two variables well. The human brain is designed to look for patterns. Patterns are not found in random events that rarely occur. This is why I see so many agency owners and producers ignore E&O risk management. They attribute an E&O claim to bad luck, like a coin toss but the lack of an E&O claim to their skill. Both are attributable to a combination of luck and skill and risk management. You can control two out of three and two out of three is not bad.
The absolute best, inarguable method for creating better luck is by selling clients the coverages they truly need, or at least offering them the coverages they truly need. If they have the coverages they need, or it is documented they chose to self-insure, the basis for most E&O claims evaporates. Plus, if you sell the coverages, you make more money!
Furthermore, what is the purpose of agents? To sell inadequate coverages? No, the goal is to sell the right coverages!
It is really, really hard to overcome the limitations of the human brain which is built to find patterns and assess frequency risk and simultaneously built to not put much energy into dealing with high severity, low frequency issues. All kinds of examples exist. During the credit crisis a well-known and brilliant trader made a bet that a huge crash would occur at some unknown point in the future because he saw that humans and computers even were not assessing severity, only frequency. He made enough walk away money for a few lifetimes.
Few situations in life exist where one can truly have it all, but this is one of them. Good E&O risk management addresses severity first. To do so, one has to override the natural architecture of the human brain but it is easily doable with conscious and methodical effort. In the process, one usually solves the frequency issue while also making more money. You can have it all. If you want to have it all, call or email me for awesome coverage classes and E&O risk management.
NOTE: The information provided herein is intended for educational and informational purposes only and it represents only the views of the authors. It is not a recommendation that a particular course of action be followed. Burand Insurance Education, Burand & Associates, LLC and Chris Burand assume, and will have, no responsibility for liability or damage which may result from the use of any of this information.