Liability insurance provides financial protection for policyholders who are legally responsible for injuries to third parties or damage to their property. This type of insurance covers the costs of defending lawsuits, settlements, and judgments up to the policy limits.
Liability policies are important for both businesses and individuals to safeguard assets in case of a lawsuit. But what exactly does liability coverage include or exclude? This comprehensive guide examines what liability insurance covers, what it doesn’t, and what to look for in policies.
What is Liability Insurance?
Liability insurance policies protect the policyholder against the risk of being sued and held legally liable for damage caused to third parties. Instead of paying these costs out-of-pocket, the insurer covers defense and lawsuit expenses as well as any compensation owed to plaintiffs.
There are several common types of liability insurance:
- General liability – Covers claims of bodily injury, property damage, personal injury, and advertising injury connected to your business operations and premises.
- Professional liability – Protects against claims alleging your professional services caused financial harm to a client. Also called errors and omissions (E&O) or malpractice insurance.
- Product liability – Safeguards manufacturers and sellers against lawsuits claiming a defective product caused injury or property damage.
- Directors and officers (D&O) liability – Shields board members and executives from claims alleging wrongful acts and decisions.
- Cyber liability – Defends against lawsuits claiming your business’s negligence led to a data breach or privacy violation.
Liability policies pay legal fees and any compensation owed to third parties, up to the coverage limits. The insurer also provides legal counsel and negotiates settlements.
Having adequate liability limits prevents policyholders from paying huge lawsuit costs out-of-pocket, which could be financially devastating.
What Does Liability Insurance Cover?
Liability insurance provides protection against third-party claims that allege the policyholder is legally responsible for causing bodily injury, property damage, or financial harm. Here are some examples of what different liability policies cover:
General Liability Insurance
- Bodily injury from a customer slipping and falling on a wet floor at your business
- Property damage caused if your delivery truck accidentally hits a building
- Personal injury such as libel, slander, false arrest, or invasion of privacy
- Advertising injury like copyright infringement or misappropriation of a slogan
Professional Liability Insurance
- Financial loss due to an accountant’s negligence in preparing tax returns
- Patient injury from a doctor’s misdiagnosis or incorrect treatment
- Design flaws in architectural plans that result in added construction costs
Product Liability Insurance
- A physical injury or illness caused by a safety defect in a product you manufactured
- Property damage from a product that malfunctions and starts a fire
- Loss of wages from having to take off work to recover from a product-related injury
Directors and Officers (D&O) Liability Insurance
- Shareholder lawsuits alleging mismanagement or misrepresentation
- Claims of wrongful termination by former employees
- Allegations of discrimination or harassment
- Lawsuits from vendors or competitors over unfair business practices
Cyber Liability Insurance
- Notification costs, credit monitoring, and PR expenses after a data breach
- Legal claims of privacy violations if customer data is stolen
- Copyright infringement lawsuits over stolen intellectual property
- Defending lawsuits alleging your business’s negligence enabled a cyber attack
The examples above are situations typically covered under standard liability policies. Always carefully review the details of any liability insurance policy to confirm and understand coverage.
What is Excluded by Liability Insurance?
While liability insurance provides broad protection, every policy contains exclusions where the insurer will not pay claims. Standard exclusions under liability policies include:
- Intentional or criminal acts – Damages caused intentionally or by any criminal activity are not covered.
- Contractual liability – Lawsuits alleging breach of contract are often excluded.
- Prior acts – Occurrences prior to the policy period are typically excluded.
- Pollution – Gradual pollution and contamination are often excluded or limited.
- Property damage to your product – Damage to your own work or products is not covered in product liability policies.
- Employment practices – Discrimination, harassment, and wrongful termination may be excluded from D&O policies.
- Prior litigation – Lawsuits arising from circumstances known before getting coverage are generally excluded.
- Professional services – Professional liability policies rarely cover services outside of your core profession.
- Cyber extortion payments – Cyber policies may exclude extortion payments to hackers.
- War and nuclear risks – Damage from war or nuclear materials is typically excluded across liability policies.
It’s critical to read all exclusions and limitations in a liability policy. Request endorsements to add back coverage for key exclusions if needed. Being aware of the exclusions can prevent unexpected gaps in protection.
READ ALSO: What is Gap Insurance and When Should You Get It?
Key Factors in Liability Insurance Policies
Beyond understanding what is covered and excluded, evaluating liability insurance requires looking at other key factors in the policy:
Limits of Liability
The liability limits define the maximum amount the insurer will pay per claim and in total across all claims. Common liability limits are:
- $1 million per occurrence/$2 million aggregate per year
- $2 million per occurrence/$4 million aggregate per year
- $5 million per occurrence/$10 million aggregate per year
Higher risk industries like construction or healthcare often require $5 million or greater liability limits. Purchase enough coverage to fit your business’s claims exposure. Umbrella liability insurance can provide additional limits above your underlying liability policies.
Claims-Made vs Occurrence Basis
Liability policies are written on either a claims-made or occurrence basis. This impacts the covered claims:
- Claims-made – Covers claims first made against you and reported during the policy period. The injury could have happened years prior.
- Occurrence – Covers injury and damage that occurred during the policy period, no matter when the claim arises.
Occurrence form policies offer broader coverage. But claims-made policies are more common for professional liability coverage.
Deductibles
Most liability policies have a deductible, typically ranging from $500 to $50,000, that applies per claim. The policyholder must pay legal fees and settlements up to the deductible amount before coverage kicks in. Higher deductibles can reduce premiums.
Defense Costs
Many policies cover legal defense costs outside the liability limits. But some professional liability policies apply defense costs toward the liability limit, reducing available coverage. Paying for defense costs yourself changes your financial liability.
Retroactive Date
Professional liability policies often have a retroactive date, limiting coverage to acts after a specified date – usually when you first obtained coverage. Acts prior to the retroactive date are excluded.
Extended Reporting Period
Claims-made policies typically let you purchase an extended reporting period to report claims after the policy ends. This extends the covered incidents to those that occurred during the policy period.
Consider the factors above when evaluating different liability insurance policies to ensure you get sufficient and clear protection.
How Much Liability Coverage is Enough?
Choosing appropriate liability limits involves assessing your claim exposure and risk tolerance. Consider factors like:
- Your industry risk – Healthcare and construction carry greater risk than office-based businesses.
- Company size – Larger companies face more exposure from slip-and-falls and lawsuits.
- Revenue – Higher revenues enable larger claims and verdicts.
- Claims history – Check if past claims have nearly reached your liability limits.
- Contract requirements – Business partners may require minimum liability limits to work with you.
- Risk tolerance – Weigh your willingness to pay legal costs out-of-pocket if claims exceed your limits.
- Asset protection – Choose limits to protect business and personal assets from seizure.
- Umbrella insurance – Extra coverage above your primary liability policy limits.
While each business is different, these benchmarks provide a starting point to assess adequate liability policy limits based on revenue:
- Up to $1 million revenue – $1-$2 million liability limits
- $1 million – $5 million revenue – $2-$5 million liability limits
- $5 million – $25 million revenue – $5-$10 million liability limits
- Over $25 million revenue – $10-$25+ million liability limits
Conducting a risk assessment with an insurance agent or broker can provide greater insight into suitable liability limits for your unique operations.
Who Needs Liability Insurance?
Many types of individuals and businesses should consider carrying liability insurance:
Businesses
Nearly every business needs to insure against third-party claims of injury or property damage that could happen in its daily operations. General liability insurance is a basic policy that most businesses require.
Additional liability policies like professional, product, cyber, and D&O insurance may be recommended for specific exposures.
Professionals
Doctors, lawyers, accountants, and consultants should strongly consider professional liability coverage to protect their personal assets and businesses in the event of a client lawsuit.
Manufacturers
Any company that manufactures products, equipment, tools, or other goods will likely have some defect or safety liability. Product liability insurance is vital to managing this long-tail claim risk.
Real Estate Developers
Developers face many liability risks during the construction process, such as property damage or injury claims by contractors. General liability insurance is a necessity when undertaking new projects.
Property Owners
Homeowners or commercial property owners face premises liability claims if visitors are injured on their property. Homeowners insurance covers residences, while commercial general liability policies cover investment properties, retail stores, apartments, and office buildings.
Directors and Officers
The directors and officers of corporations have fiduciary duties to shareholders and employees. D&O insurance protects their personal assets from liability claims alleging wrongful acts.
Drivers
Anyone operating a vehicle should carry sufficient auto liability limits in case an at-fault accident leads to injury or property damage claims.
Event Organizers
Putting on events open to the public creates liability for injuries to attendees or vendors. Event liability insurance provides protection specific to organizing short-term functions.
Instructors
Fitness trainers, coaches, teachers, and other instructors interact closely with clients and students, risking injury claims. General liability or professional liability insurance can fill coverage gaps beyond any state certification requirements.
The list above covers those most likely to benefit from and need liability insurance. But many other individuals and businesses may also require protection based on their unique risks.
Purchasing the Right Liability Insurance
Follow these best practices when buying liability insurance to ensure you get the right coverage:
- Conduct a risk assessment – Thoroughly evaluate your claims exposure when determining appropriate liability limits and deductibles.
- Review exclusions carefully – Understand exactly what high-severity risks are excluded or limited under the policy.
- Compare multiple quotes – Shop policies from several reputable insurance carriers to find competitive pricing.
- Consider claims-made vs. occurrence forms – Occurrence basis policies offer the broadest coverage.
- Look for defense cost coverage outside limits – This provides more protection compared to eroding your liability limits.
- Ask about retroactive date for prior acts – Make sure any past professional services are covered or excluded as expected.
- See if the insurer offers extended reporting periods – This allows reporting claims after policies expire.
- Inquire about cyber and reputational risk coverage – Many businesses can benefit from cyber liability protections.
- Consider a commercial umbrella policy – This provides additional limits above underlying liability policies.
Working with an experienced agent or broker who understands your operations and exposures can provide guidance on structuring an optimal liability insurance program.
To Recap
Liability insurance provides vital financial protection for both businesses and individuals who cause unintentional injury or property damage to third-parties. Policies cover legal defense expenses and any compensation owed up to the coverage limits.
General liability, professional liability, product liability, D&O, and cyber liability are common forms of coverage against different claims scenarios. It’s critical to understand what losses are covered and excluded under any liability policy when evaluating options.
Buying adequate limits to cover your specific liability risks can help prevent severe financial consequences from costly claims and lawsuits. Discuss your exposures with insurance advisors to structure a tailored liability insurance program.
Frequently Asked Questions About Liability Insurance
Below are answers to some commonly asked questions about liability insurance policies:
What is the difference between general liability and professional liability insurance?
General liability insurance covers third-party bodily injury and property damage claims connected to your business operations and premises. Professional liability insurance covers financial harm to clients caused by errors in your professional services.
Does liability insurance cover intentional damage?
No, intentionally caused damages and criminal acts are explicitly excluded by liability insurance policies. Coverage is only for unintentional bodily injury or property damage.
What happens if a liability claim exceeds my policy limits?
You would be responsible for paying any amount in excess of your policy limits out-of-pocket. Having adequate liability limits prevents this major financial risk.
When should I increase my liability insurance coverage?
When your business grows substantially in size, enters new markets, or begins handling high-risk activities, it is a good idea to re-evaluate liability limits and purchase additional coverage if needed.
Does liability insurance cover employee injuries?
No, work-related employee injuries are covered by workers compensation insurance. General liability policies exclude bodily injury to employees.
Can I get liability insurance after an incident occurs?
No, liability insurance will only cover claims from incidents that happen after the coverage starts. It does not apply retroactively prior to the policy effective date.
Who pays for liability claims under a business insurance policy?
The insurance company pays legal costs and any compensation owed to third parties up to the policy limits. The business pays any deductible amount before coverage kicks in.
What happens after I report a liability claim?
The insurer will investigate the claim, assign legal counsel if needed, and negotiate a settlement if they believe you are liable. If unable to settle, they will defend you in court up to the policy limits.
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