Guide to the Limit of Indemnity

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Guide to the Limit of Indemnity

a pile of pound coins to illustrate the limit of indemnity in a professional indemnity insurance policy

The limit of indemnity (LOI) is the monetary amount of cover provided under a professional indemnity insurance policy. It's the policyholders responsibility to decide the amount which is adequate to fully protect their business.

When assessing the risks, consideration of worst-case scenarios or catastrophes as well as the more mundane things that can commonly go wrong is necessary. Basing the decision on the cost of the insurance rather than the worst case risk exposures, could be a false economy.

Regulatory requirements aside, calculating the right limit of indemnity for a business isn’t an exact science. Whatever the figure, getting the limit right is critical to avoid the disastrous consequences of being under-insured.

So, how much is enough? Here are some points which should help guide you to an adequate level of cover for your business.

What's your risk?

calculator with the word risk to illustrate calculating the cover required.

You know your clients and workloads far better than your PI insurer or broker. Therefore you are in the best position to assess the risks to which you are exposed when considering your limit of indemnity.

When assessing these risks, consider them in the context of your worst-case scenarios or catastrophes as well as the more mundane things that can commonly go wrong. Basing the decision on the cost of the insurance rather than your worst case risk exposures, could be a false economy.

Major claims are almost always unexpected and the circumstances usually unforeseen - their size will often catch people unawares. Clauses that limit liability in the terms and conditions can be useful to a point but they should certainly not be relied upon, especially for larger claims.

Bear in mind that as a professional services firm grows, it can become a bigger monetary target for litigation. Lawyers may factor in the size of a firm when assessing the compensation they are going to attempt to claim on behalf of their client/s.

Being under-insured can destroy a firm, so it's very important to spend some time discussing possible major claim scenarios at Board or Partner meeting level.

The claimant's legal costs

The third-party (the claimants') legal costs can double the amount of the PI claim against you. These legal costs will be a major part of the claim and you need to ensure that your level of cover not only factors in the client loss but also factors in a significant amount for their legal costs.

What are your regulatory or customer requirements?

If you are a regulated business, check the mandatory insurance requirements of your regulator to ensure you fully comply with the minimum level of cover they require you to carry. But do bear in mind that this minimum requirement will be a simple arbitrary figure, without any consideration of the specific risks to your business. Also, your customers could specify a minimum level of cover they require you to carry in order to be able to undertake work for them.

Consider historic work

This is ‘claims made’ insurance cover. It’s the level of cover purchased today which will apply to all of your historic work. So, if you reduce your cover because a project or piece of work has been completed and you feel you no longer need that higher level of cover, bear in mind that it will be the lower level that now applies if a claim comes in, NOT the level you were purchasing when you carried out the work.

Inflation

Professional indemnity claims can take years to reach settlement. In some cases, for larger claims it can take five years or more! But the level of the insurance cover is fixed at the limit purchased when the claim is first notified. Would that limit still be enough to cover the claim and costs at the time of settlement in five years? You should factor in inflation.

Statutory interest

PI claims usually include an amount for statutory interest on the loss, incurred over several years. This can significantly increase the amount of the claim eventually paid. Factor in an amount for this part of a potential claim against you.

Expecting the unexpected

There’s no exact formula for calculating an accurate level of PI cover and many professionals do not always appreciate or even imagine the scale of the worst-case scenario risks to their business. In the event that this does happen, they find themselves under-insured and the main reasons for this are:

  • They wanted to spend the minimum amount on the cost of the insurance.
  • They only bought the minimum amount of cover required by their regulator.
  • They didn't believe a catastrophe scenario could happen to them.
  • They didn't fully appreciate the full extent of the risks they face.

Minimum limit of indemnity

Although most Institutes and Associations provide their member firms with specific minimum requirements for the level of PI insurance cover they must carry, this is only a minimum requirement and cannot possibly take account of each firm's individual risk. Based only on our experience, we recommend the following as a minimum guide:

  • Sole Trader - Insure for at least four times fee income (£ 250,000 minimum)
  • Limited Company - Insure for at least three times fee income (£ 500,000 minimum)
  • Partnership - Insure for at least four times fee income (£ 1 million minimum)

How much does it cost?

The cost of increasing the level of cover reduces as the LOI increases, making it extremely good value. If you would like to discuss your level of insurance cover or require indications of the cost of increasing your cover please contact us.

Claims made cover

It's important to know that professional indemnity falls into the 'claims made' type of insurance. This means that the policy LOI in force when the claim is first notified will apply to the claim, not the LOI in force when the work causing the claim was carried out. This is particularly relevant if the limit of indemnity is ever reduced as the lower limit would apply to all future claims.

We recommend this guide is circulated to Partners, Directors and Senior Managers for general awareness and risk management purposes.

 

DISCLAIMER This guidance note is intended for information purposes only. It is not and does not purport to be legal advice or specific insurance advice. Whilst all care has been taken to ensure its accuracy at the time of writing it is not to be regarded as a substitute for specific advice. If you require specific advice, please contact your brokers or call us on 0345 251 4000. This guidance note shall not be reproduced in any form without our prior permission. © All copyright is owned by Professional Indemnity Insurance Brokers Ltd.