The insurance industry as a whole is experiencing pressures that affect its ability and level of willingness to insure certain activities. This, in turn, has major implications for accountants' professional liability, or E&O (errors and omissions) insurance.
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"There have been a series of natural disasters over the past few years, with billions of dollars taken out of the industry through claims," noted James Frazier, the chief executive and principal at Primus Assurance Group. "An insurance company has only two ways to make money: by underwriting where premiums exceed losses, and through investment income on reserves. Since reserves are down and investment income is down, the only way for them to make money is through underwriting profitability, and a lot of carriers are taking a look at the pricing on all their lines of insurance."
Over the past five to seven years, accounting E&O policies have shown significantly higher losses than prior to that period, according to Frazier. "Losses are greater, both in terms of frequency and severity, over that period than during the time before it," he said.
"For a multi-billion-dollar insurance company, a $5,000 premium is small," he said. "It's hard for such a company to figure how to re-underwrite and turn a non-profitable book into a profitable book, because they're not really set up to underwrite individual policies of that size premium any longer. What you're going to see over the next several years is that more carriers will be getting out of the market for small policies, including accounting, and the ones that stay will take significant price increases. They will ask more questions, and there are certain things they either won't insure or will give coverage for at a higher rate."
"Economically, we're in a time period where everyone wants to save money on their premium," explained Tom Henell, chief operating officer of NAPLIA (North American Professional Liability Insurance Agency). "Carriers are in a position where they really need to increase their rates, but the economy won't let them. The carriers are putting pressure on the underwriting side to be more profitable without increasing premiums, so they're being selective on firms they write, as well as the coverage they provide."
"We're seeing accounting firms getting away from basic priorities. They're trying to get the lowest premium and losing coverage," he said. "In the long run it will cost more money if they're not covered when a claim arises."
A key coverage issue currently is information security, or cyber-liability, according to Henell. "Accountants assume they have coverage under their professional liability policy without understanding the ramifications of their first-party exposure. Policies cover against claims made for professional services, so the question can arise whether the breach was tied to professional services, or was more of a business exposure. If they have a data breach but the client doesn't sue, they still have exposure because every state has data breach laws requiring notification and credit report monitoring. These can add up quickly, and very few have this coverage built in to their policy."
Several new carriers have entered the market in an opportunistic play that assumes a short-term increase in premium pricing, according to Rickard Jorgensen, chief executive of CPAGold. Moreover, he said, "Certain large, longstanding participants in the accounting professional liability marketplace have dropped underwriting standards and are now chasing accounts that in the past were outside the insurer's area of appetite."
There have been no new significant claims trends, although in the past year there were more bankruptcies and consequent lawsuits, he indicated. "Defalcation remains the largest type of claim, while tax errors are the most frequent."
Mike Chovancak, senior underwriter at Insight Insurance, predicts "rate increases by some of the larger carriers in the market, and an intensified interest in identity theft and related IT property exposures."
Other trends on the horizon are "a larger volume of temporary [chief financial officer] and CEO engagements by accounting firms, and a pronounced interest in risk management and loss prevention measures by accounting firms, including the increased usage of engagement letters," he said.
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With many firms branching out in new niche areas, it is important that they make sure they have the requisite expertise and resources to be able to support the service of new or prospective clients, cautioned Suzanne Holl, CPA, vice president of loss prevention services for Camico.
"Some firms have high-risk niches, but what they do, they do well," she said. "It's a question of balancing risk versus reward and making sure it's the right client for the firm. Now is not the time, given troubled economic times, to dabble in things you are not really equipped to do. In trying to expand and grow, you want to grow wisely. Make sure you have a business plan in place, and address growth with an eye on minimizing risk."
"Make sure you don't short-change defensive documentation when you get into new niches," she cautioned. "Address client expectation issues so there's no gap in what the client expects, and don't take on what you would deem to be out of your risk tolerance."
Defensive documentation needs to be ongoing at accounting firms, Holl emphasized. "You don't want the only piece of defensive documentation to be the engagement letter. You have to communicate any significant points that you are relying on as the engagement progresses, and if there are representations made by your client, make sure there is documentation. How fees will be paid, the timing of fees and who owns the records, retention of work papers and how to resolve later disputes should all be addressed along the way."