This is despite the very common scenario where insured clients make a notification to their policies (and proactively pursue indemnity), when they have made negligent errors but have not yet received a third-party claim which would trigger their PI policy.
In this context, it is an oddity of the Middle East market that Mitigation of Loss extensions don’t appear more often in PI policies.
What is the gap in cover?
In typical professional indemnity wordings, written on a claims-made basis, the policy insuring clause is only triggered if and when an insured receives a third party demand for compensatory damages arising out of a negligent error by the insured in the performance of its professional business. It is only when a claim is made that the PI policy triggers, and insurers pay defence costs and ultimately indemnify against a settlement or judgment.
Insureds are generally obliged, by express wording and at all times, to incur costs at their own expense to mitigate the chance and size of any potential claims
This leaves a gap: what happens in situations where the insured makes a negligent error, but realises before it receives a claim? In this circumstance, it may have a chance to swiftly rectify that error, preventing any claim from arising, avoiding all defence costs and limiting the costs incurred to a level below what would have been claimed otherwise. The problem is that traditional PI cover won’t kick in at this point, because there has been no claim.
Put in this position, is the insured expected to simply absorb all of the costs arising to rectify its negligence (against which it has paid premium to insure itself)? Or to simply wait until a claim arises, in an adversarial process and probably for a higher sum, to let the policy trigger? Or even to contrive with the third party to provoke a claim, to which PI cover would respond?
None of these options are attractive to insureds, or the insurers with whom they have partnered in a joint endeavour to protect against liability arising from negligence. The latter options would breach policy obligations and create new coverage issues of their own.
A true partnership between insured and insurer should be able to avoid and overcome this gap, and it is generally better to do so in advance, rather than reactively when live issues arise and may at times be business critical. Nevertheless, this is generally the state of PI insurance in the Middle East.
What can Mitigation of Loss extensions do?
It is precisely this gap which Mitigation of Loss extensions are designed to fill, and have done successfully in jurisdictions worldwide for a number of years.
As well as providing valuable cover (in exchange for valuable additional premium), they can encourage healthy and transparent claims behaviour when negligence issues arise, keeping the overall temperate (and value) down.
Examples of these covers have appeared in architects and engineers’ policies, and those of financial professionals engaged in selling investment schemes.
How are they written?
Whilst wordings vary, the essential cover offered is to:
"..indemnify the insured for reasonable and necessary costs and expenses incurred to mitigate or prevent a potential claim that may result from the insured's negligence in the performance of its professional services."
This extension, which usually covers the insured’s own first-party costs rather than third party liabilities, will be tightly defined. Extensions may appear as standalone (with sub-limits), or in some policies including D&O, may be added to defence costs, and even include payments to potential third party claimants.
It generally requires that any costs and expenses are incurred with insurers’ prior written consent, and that the insured can demonstrate precisely why the costs are required and how they would prevent or reduce the likelihood of an indemnifiable claim. The costs must be reasonable and proportionate, and insurers will reserve a right to exclude disproportionate amounts.
Additionally, the cover will exclude costs of remedying errors if a claim wouldn’t have arisen, or costs the insured would incur in any event to perform its scope of services.
This is to be expected – indemnity insurers cannot underwrite what would otherwise be pure performance guarantees, and the circumstances in which payments allow a claim to be avoided must be narrow and clear for such extensions to be commercially viable.
Why aren’t they more common in the Middle East?
This article can only speculate, but reasons may include:
- Limited understanding of these covers and how they operate, as they are rare in the market. In fact, we have seen instances where insureds are prevented by contract from buying mitigation of loss cover, demonstrating a likely misunderstanding by their appointing employer as to the benefit to all parties for issues to be mitigated;
- The liberal approach to coverage under PI policies in the region in the pre-claim scenario described above. Very regularly in practice, we see insureds and insurers discussing informal mitigation of loss cover under PI policies which don’t have a Mitigation of Loss extension and where negligence has occurred but a claim hasn’t been made. Whilst admirable and co-operative, it creates tricky issues, particularly where reinsurance sits above local market covers, and markets of reinsurers may approach policy interpretation differently; and
- The method of contracting. Quite often (at least in the engineering context), with professional and contracting teams appointed separately by the employer, any issues arising before handover are robustly pushed towards the contractor, and in circumstances where the lines between workmanship and design are difficult to spot, this keeps the professionals out of the firing line. Professionals may not therefore see the need for such cover.
What comes next?
In a maturing market, we would expect to see a gradual uptick in these types of extensions. They represent a real opportunity for insurers and brokers to support their insured clients and to clarify the coverage position in the early stages of notifications. They also present a real opportunity to prevent actual claims from arising; to limit the costs incurred to a level below what would have been claimed otherwise; and to limit or even completely avoid defence costs.
Mitigation of Loss extensions have obvious promise for Financial, Engineering (including SPPI), and IT/Cyber professionals’ PI in particular.
As and when the Mitigation of Loss cover market develops, we look forward to working with our insureds, brokers and underwriting colleagues to support the kind of insurance cover which reflects a true partnership when facing professional liability risks.
Contact Adam Pryor for more information.
