Financial planners are not required to carry professional liability insurance, but most lawyers and consultants say it's unwise to operate without it. No one is ever immune from making mistakes -- and, of course, advisors can be sued or investigated even if they haven't been negligent.

The key is to understand the specifics of any professional liability or errors and omissions (E&O) policy, as well as the way it fits into your firm's specific risk protection needs.

"It's all about knowing who's covered, what to get coverage for, and when," says Andrew Fotopulos, a Boston-area insurance broker who specializes in working with investment industry clients. "You need to look at all the details."


Ask questions about exclusions, says Fotopulos, who adds that he's amazed how often he comes across planners with policies that "sneak in" an exclusion for discretionary advice.

"I've seen firms that are 90% discretionary buy policies with this exclusion because their brokers are not familiar with this line of business," he says. "If the advisor gets sued, and it was discretionary advice, the insurer won't cover it."

Professional liability coverage can also protect firms from the costs of regulatory compliance issues -- but, again, advisors must understand the specifics of their coverage. Some policies, says Fotopulos, only cover the expenses of a regulatory investigation when it is initiated by a client complaint. With that policy stipulation, if a regulator initiates a case on its own -- as the result of routine visit, say -- then firms are left holding the bag.


Most high-end E&O policies cover breach of fiduciary duty, but advisors should also understand the scope of professional services that are insured. In many cases, financial advisors serving as trustees to clients' accounts or performing bill-paying functions assume that they are covered because those functions are all part of their financial services responsibilities, but that's not necessarily the case, says Fotopulos.

Know which staff members are covered, too. For example, some liability policies will only cover employees who file W-2s and not independent contractors.


Once advisors understand how their professional liability policies work, they may need to change their methods of operation procedures to fit that coverage. Knowing when a policy gets triggered, for instance, can help a firm set up internal procedures to make sure no necessary actions or notifications are missed.
Finally, become familiar with the process the insurance company will follow should a claim be filed.

Does the policy have a "duty to defend" clause, which obligates an insurer to fight claims? Most often, that means that the insurer chooses the attorneys -- which means you may have less control, says New York securities and regulatory lawyer Mark Astarita.

"You may find yourself in a situation," he says, "where the carrier wants to settle the case, or the attorney -- an attorney you didn't pick -- is recommending you settle the case, and you don't want to."

If your policy has a "consent to settle" clause, the insured advisor will need to sign off on any settlement the carrier makes. But such clauses (also sometimes referred to as "hammer clauses") often make the insured responsible for paying any legal fees above the cost of the settlement.


If you're facing litigation, it can help to have a good relationship with your broker and a solid track record with your insurer, says Boston liability insurance lawyer John Hughes of Edwards Wildman.

"Stay with one carrier as long as you can, because that way you've got some bargaining power when you do have a claim," Hughes says. "If you're jumping to whoever's the cheapest, you don't build up that same kind of history and relationship."

And find a broker who will stay in the picture even after selling you a policy. "Use an insurance broker who will advocate for you if necessary with the insurance company when there's a claim," he says. "Some insurance brokers just see their job as selling the insurance and then leave you to your own devices when there's a claim – and that's really unfortunate. ... Insurance brokers have a lot of influence with insurance companies, and that influence can be very useful."

Paul Hechinger is a New York-based freelance writer.