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Liability insurance is a part of the general insurance system of risk financing to protect the purchaser (the "insured") from the risks of liabilities imposed by lawsuits and similar claims. It protects the insured in the event he or she is sued for claims that come within the coverage of the insurance policy. Originally, individual companies that faced a common peril, formed a group and created a self-help fund out of which to pay compensation should any member incur loss (in other words, a mutual insurance arrangement). The modern system relies on dedicated carriers, usually for-profit, to offer protection against specified perils in consideration of a premium.
Liability insurance is designed to offer specific protection against third party insurance claims, i.e., payment is not typically made to the insured, but rather to someone suffering loss who is not a party to the insurance contract. In general, damage caused intentionally as well as contractual liability are not covered under liability insurance policies. When a claim is made, the insurance carrier has the duty (and right) to defend the insured. The legal costs of a defence normally do not affect policy limits unless the policy expressly states otherwise; this default rule is useful because defence costs tend to soar when cases go to trial. In many cases, the defense portion of the policy is actually more valuable than the insurance, as in complicated cases, the cost of defending the case might be more than the amount being claimed, especially in so-called "nuisance" cases where there is no liability but the case has to be defended anyway.
- 1 Market
- 2 Insurer duties
- 3 Types
- 4 General liability
- 5 Insurable risks
- 6 Evidentiary rules
- 7 In the technology industry
- 8 See also
- 9 References
Commercial liability is an important segment for the insurance industry. With premium income of USD 160 billion in 2013, it accounted for 10% of global non-life premiums of USD 1 550 billion, or 23% of the global commercial lines premiums. Liability insurance is far more prevalent in the advanced than emerging markets. The advanced markets accounted for 93% of global liability premiums in 2013, while their share of global non-life premiums was 79%.
The US is by far the largest market, with 51% of the global liability premiums written in 2013. This is due to the size of the US economy and high penetration of liability insurance (0.5% of GDP). In 2013, US businesses spent USD 84 billion on commercial liability covers, of which USD 50 billion was on general liability, including USD 12 billion for Errors and Omissions (E&O) and USD 5.4 billion for Directors and Officers (D&O). US businesses spent another USD 13 billion on the liability portion of commercial multi-peril policies, USD 9.5 billion for medical malpractice and USD 3 billion for product liability covers.
The UK is the world’s second largest market for liability insurance, with USD 9.9 billion of liability premiums in 2013. The largest sub-line of business is public and product liability. This is followed by professional indemnity and employers’ liability (cover for employment-related accidents and illnesses). There has been a significant shift in the sub-segments of UK liability insurance. In the last decade, the share of professional indemnity has increased from about 14% to 32%, highlighting the shift towards a more services-driven economy. Manufacturing, meanwhile, comprises a lower share of liability claims as accidents related to injuries and property damages have declined.
In continental Europe, the largest liability insurance markets are Germany, France, Italy and Spain. Together they made up almost USD 22 billion of global liability premiums in 2013. Typically governed by civil law systems, these markets rely on local conditions and historical experience to determine which liability policies and covers are available. Penetration ranges from 0.16% to 0.25%, which is low compared to the common law countries such as the US, the UK and Australia.
Japan and Australia are the largest markets in the Asia Pacific region, with commercial liability premiums of USD 6.0 billion and USD 4.8 billion, respectively, in 2013. At 0.12% of GDP, the penetration of liability insurance in Japan is much lower than in other advanced economies. In Australia, penetration is much higher at 0.32% of GDP. This is due to the country’s English law derived legal framework, which has increased demand for employers’ liability insurance. Australia has mandatory covers for aviation, maritime oil pollution and residential construction and, in certain states, for medical practitioners, property brokers and stock brokers. Liability insurance premiums have grown at an average annual rate of 11% since 2000.
China is the ninth largest commercial liability market globally, with premiums of USD 3.5 billion in 2013 and strong annual average growth of 22% since 2000. However, penetration remains low at 0.04% of GDP. Growth has been driven by increasing risk awareness and regulatory changes.
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Liability insurers have one, two or three major duties, depending upon the jurisdiction:
- the duty to defend,
- the duty to indemnify, and
- the duty to settle a reasonably clear claim.
The duty to defend is prevalent in the United States and Canada, where most liability insurance policies provide that the insurer "has the right and duty" to defend the insured against all "suits" to which the policies apply. It is usually triggered when the insured is sued (or in some instances, given pre-suit notice that they are about to be sued) and subsequently "tenders" defense of the claim to its liability insurer. Usually this is done by sending a copy of the complaint along with a cover letter referencing the relevant insurance policy or policies and demanding an immediate defense.
In most U.S. states and Canada, the insurer generally has four main options at this point, to:
- defend the insured unconditionally;
- defend the insured under a reservation of rights;
- seek a declaratory judgment that it has no duty to defend the claim; or
- decline to defend or to seek a declaratory judgment.
The duty to defend is generally broader than the duty to indemnify, because most (but not all) policies that provide for such a duty also specifically promise to defend against claims that are groundless, false, or fraudulent. Therefore, the duty to defend is normally triggered by a potential for coverage. The test for a potential for coverage is whether the complaint adequately pleads at least one claim or cause of action which would be covered under the terms of the policy if the plaintiff were to prevail on that claim at trial, and also does not plead any allegations which would entirely vitiate an essential element of coverage or trigger a complete exclusion to coverage. It is irrelevant whether the plaintiff will prevail or actually prevails on the claim; rather, the test is whether the claim if proven would be covered. Vague or ambiguous allegations broad enough to encompass a range of possibilities both within and without coverage are usually construed in favor of a potential for coverage, but speculation about unpled allegations (that is, matters on which the complaint is totally silent) is insufficient to create a potential for coverage. Some jurisdictions allow extrinsic evidence to be considered, either because it is expressly described in the complaint or it is relevant to the facts expressly alleged in the complaint.
If there is a duty to defend, it means the insurer must defend the insured against the entire lawsuit even if most of the claims or causes of action in the complaint are clearly not covered. An insurer can choose to defend unconditionally without reserving any rights, but by doing so, it waives (or is later estopped from asserting) the absence of coverage as a defense to the duty to defend and impliedly commits to defending the insured to a final judgment or a settlement regardless of how long it takes (unless the policy expressly provides that defense costs reduce policy limits). In the alternative, the insurer may defend under a reservation of rights: it sends a letter to the insured reserving its rights to immediately withdraw from the insured's defense if it becomes clear there is no coverage or no potential for coverage for the entire complaint, and to recover from the insured any funds expended to that point on defending against any particular claims or causes of action which were never covered or even potentially covered to begin with.
If the insurer chooses to defend, it may either defend the claim with its own in-house lawyers (where allowed), or give the claim to an outside law firm on a "panel" of preferred firms which have negotiated a standard fee schedule with the insurer in exchange for a regular flow of work. The decision to defend under a reservation of rights must be undertaken with extreme caution in jurisdictions where the insured has a right to independent counsel, also known as Cumis counsel.
The insurer can also seek a declaratory judgment against the insured that there is no coverage for the claim, or at least no potential for coverage. This option generally allows the insurer to insulate itself from a bad faith claim, in the sense that an insurer acts in good faith when it promptly brings coverage disputes to the attention of a court, even though it also places the insured in the awkward position of defending itself against two lawsuits: the plaintiff's original complaint and the insurer's complaint for declaratory judgment. Indeed, in some jurisdictions an insurer acting in good faith must seek declaratory relief from a court before declining to defend its insured (e.g., Illinois) or withdrawing from its defense pursuant to an earlier reservation of rights (e.g., Georgia).
Finally, the insurer can decline to defend and also refrain from seeking declaratory judgment. If the insurer is absolutely certain that there is no coverage or no potential for coverage, then in most jurisdictions the insurer adequately preserves its defenses to coverage by sending a letter to the insured explaining its position and declining to provide a defense. But this option can be very risky, because if a court later determines that there was a duty to defend all along, then it will hold that the insurer necessarily breached that duty, and may also hold that the insurer is subject to tort liability for bad faith. So insurers will often defend under a reservation of rights rather than decline coverage altogether.
Outside of the United States and Canada, liability insurers generally do not assume a duty to defend, in the sense of assuming a direct responsibility for hiring and paying a lawyer to defend the insured. Many write policies which promise to reimburse the insured for reasonable defense costs incurred with the insurer's consent, but this is essentially a form of indemnification (covered in the next section below), under which the insured remains primarily responsible for hiring a lawyer to defend themselves. Such insurers often expressly reserve a right to defend the insured, presumably so they can intervene to protect their own interests if the insured's counsel of choice is not providing an adequate defense against the underlying claim.
The duty to indemnify is the insurer's duty to pay all covered sums for which the insured is held liable, up to the limits of coverage and subject to any deductibles, retained limits, self-insured retentions, excess payments, or any other amounts of money which the insured is required to pay out-of-pocket as a precondition to the insurer's duty.
It is generally triggered when a final judgment is entered against the insured, and it is satisfied when the insurer pays such covered amounts to the plaintiff who obtained the judgment. Most policies provide for payment of monetary damages as well as any costs, expenses, and attorney's fees which the plaintiff may also be entitled to as the prevailing party.
Unlike the duty to defend, the duty to indemnify extends only to those claims or causes of action in the plaintiff's complaint which are actually covered under the policy, since a final judgment against the insured would normally be supported by a factual record in the trial court showing exactly why the plaintiff prevailed (or failed to prevail) on each claim or cause of action. Thus, an insurer could have a duty to defend based on mere allegations that show a potential for coverage, but may not have a duty to indemnify if the evidence supporting a final judgment against the insured also takes those claims or causes of action completely outside of the policy's scope of coverage.
While the duty to defend and the duty to settle are rare outside of English-speaking North America, the duty to indemnify is universally found in liability insurance policies.
To settle reasonable claims
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In some jurisdictions, there is a third duty, the duty to settle a reasonably clear claim against the insured. This duty is generally triggered only if a reasonable opportunity to settle actually arises, either because the plaintiff makes a settlement offer, or the insurer is aware of information to the effect that the plaintiff would accept a settlement offer. The insurer is neither required to initiate an offer to a plaintiff likely to refuse it, nor required to accept an outrageous offer from a plaintiff who filed a frivolous lawsuit and cannot prevail against the insured under any theory.
The duty to settle is of greatest import in the scenario where the insured may have some liability exposure (i.e., there is some evidence apparently linking the insured to the plaintiff's alleged injuries), the plaintiff has evidence of substantial damages which may exceed policy limits, and the plaintiff makes a settlement demand (either to the insured or directly to a defending insurer) which equals or exceeds policy limits. In that situation, the insurer's interests conflict with the insured's interests, because the insurer has an incentive to not immediately settle. That is, if the insurer refuses to settle and the case then goes to trial, there are only two possible outcomes: (1) the insured loses and the insurer must pay the ensuing judgment against the insured up to the policy limits, or (2) the insured wins, meaning both the insured and the insurer bear no liability. If the first outcome occurs, then it is essentially "nothing gained nothing lost" from the insurer's point of view, because either way it will pay out its policy limits. (For simplicity, this analysis disregards sunk costs in the form of defense costs incurred to that point, as well as additional costs sustained by the insurer in defending the insured to a verdict at trial, and opportunity costs sustained by the insured while participating in trial.)
While the insurer may be indifferent in this scenario as to whether it pays out its policy limits before or after trial, the insured is most certainly not. If the first outcome above were to occur, the insured may be held liable to the plaintiff for a sum far in excess of both the pretrial settlement offer and the policy limits. Then after the insurer pays out its policy limits, the plaintiff may attempt to recover the remaining balance of the judgment by enforcing writs of attachment or execution against the insured's valuable assets.
This is where the duty to settle comes in. To discourage the insurer from gambling with the insured's assets in pursuit of the remote possibility of a defense verdict (under which it can avoid having to pay the plaintiff anything at all), the insurer is subject to a duty to settle reasonably clear claims. The standard judicial test is that an insurer must settle a claim if a reasonable insurer, notwithstanding any policy limits, would have settled the claim. This does not require an insurer to accept or pay settlement offers that actually exceed policy limits, but in that instance, the insurer must discharge its duty to settle by at least making an attempt to bring about a settlement in which it would have to pay only its policy limits (either because the plaintiff agrees to lower their demand or the insured or another primary or excess insurer agrees to contribute the difference).
Effects of breach
Generally, an insurer who breaches any of the foregoing duties will be held liable for breach of contract. In most jurisdictions, the result is a judgment requiring payment of the insured's expectation damages—the sums that the insurer should have paid under its duty to indemnify. But this will be circumscribed by the policy limits, and will generally not compensate the insured for losses incurred as a consequence of the insurer's breach, such as lost business opportunities when money intended to be invested in those opportunities was diverted (or seized) to pay judgments.
In the United States (and to a lesser extent, Canada), an insurer who breaches any of these three duties in a particularly egregious fashion may also be held liable for the tort of insurance bad faith, under which the insured may be able to recover compensatory damages in excess of the policy limits, as well as punitive damages.
Occurrence v. claims-made policies
Traditionally, liability insurance was written on an occurrence basis, meaning that the insurer agreed to defend and indemnify against any loss which allegedly "occurred" as a result of an act or omission of the insured during the policy period. This was originally not a problem because it was thought that insureds' tort liability was predictably limited by doctrines like proximate cause and statutes of limitations. In other words, it was thought that no sane plaintiffs' lawyer would sue in 1978 for a tortious act that allegedly occurred in 1953, because the risk of dismissal was so obvious.
In the 1970s and 1980s, a large number of major toxic tort (primarily involving asbestos and diethylstilbestrol) and environmental liabilities resulted in numerous judicial decisions and statutes that radically extended the so-called "long tail" of potential liability chasing occurrence policies. The result was that insurers who had long ago closed their books on policies written 20, 30, or 40 years earlier now found that their insureds were being hit with hundreds of thousands of lawsuits that potentially implicated those old policies. A body of law has developed concerning which policies must respond to these continuous injury or "long tail" claims, with many courts holding multiple policies may be implicated by the application of an exposure, continuous injury, or injury-in-fact trigger and others holding the policy in effect at the time the injuries or damages are discovered are implicated.
The insurance industry reacted in two ways to these developments. First, premiums on new occurrence policies skyrocketed, since the industry had learned the hard way to assume the worst as to those policies. Second, the industry began issuing claims-made policies, where the policy covers only those claims that are first "made" against the insured during the policy period. A related variation is the claims-made-and-reported policy, under which the policy covers only those claims that are first made against the insured and reported by the insured to the insurer during the policy period. (There is usually a grace period for reporting after the end of the policy period to protect insureds who are sued at the very end of the policy period.)
Claims-made policies enable insurers to again sharply limit their own long-term liability on each policy and in turn, to close their books on policies and record a profit. Hence, they are much more affordable than occurrence policies and are very popular for that reason. Of course, claims-made policies shift the burden to insureds to immediately report new claims to insurers. They also force insureds to become more proactive about risk management and finding ways to control their own long-tail liability.
Claims-made policies often include strict clauses that require insureds to report even potential claims and that combine an entire series of related acts into a single claim. This puts insureds to a Sophie's choice. They can timely report every "potential" claim (i.e., every slip-and-fall on their premises), even if those never ripen into actual lawsuits, and thereby protect their right to coverage, but at the expense of making themselves look more risky and driving up their own insurance premiums. Or they can wait until they actually get sued, but then they run the risk that the claim will be denied because it should have been reported back when the underlying accident first occurred.
Claims-made coverage also makes it harder for insureds to switch insurers, as well as to wind up and shut down their operations. It is possible to purchase "tail coverage" for such situations, but only at premiums much higher than for conventional claims-made policies, since the insurer is being asked to re-assume the kind of liabilities which claims-made policies were supposed to push to insureds to begin with.
Not surprisingly, insureds recognised what the insurance industry was up to in trying to use claims-made policies to push a substantial amount of risk back to insureds, and claims-made coverage was the subject of extensive litigation in several countries throughout the 1970s, 1980s, and 1990s. This led to important decisions of the U.S. Supreme Court in 1978 and 1993 and of the Supreme Court of Canada in 1993.
Retained limits and SIRs
One way for businesses to cut down their liability insurance premiums is to negotiate a policy with a retained limit or self-insured retention (SIR), which is somewhat like a deductible. With such policies, the insured is essentially agreeing to self-insure and self-defend for smaller claims, and to tender only for liability claims that exceed a certain value. However, writing such insurance is itself risky for insurers. The California Courts of Appeal have held that primary insurers on policies with a SIR must still provide an "immediate, 'first dollar' defence" (subject, of course, to their right to later recover the SIR amount from the insured) unless the policy expressly imposes exhaustion of the SIR as a precondition to the duty to defend.
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In many countries, liability insurance is a compulsory form of insurance for those at risk of being sued by third parties for negligence. The most usual classes of mandatory policy cover the drivers of vehicles, those who offer professional services to the public, those who manufacture products that may be harmful, constructors and those who offer employment. The reason for such laws is that the classes of insured are deliberately engaging in activities that put others at risk of injury or loss. Public policy therefore requires that such individuals should carry insurance so that, if their activities do cause loss or damage to another, money will be available to pay compensation. In addition, there are a further range of perils that people insure against and, consequently, the number and range of liability policies has increased in line with the rise of contingency fee litigation offered by lawyers (sometimes on a class action basis). Such policies fall into three main classes:
Industry and commerce are based on a range of processes and activities that have the potential to affect third parties (members of the public, visitors, trespassers, sub-contractors, etc. who may be physically injured or whose property may be damaged or both). It varies from state to state as to whether either or both employer's liability insurance and public liability insurance have been made compulsory by law. Regardless of compulsion, however, most organizations include public liability insurance in their insurance portfolio even though the conditions, exclusions, and warranties included within the standard policies can be a burden. A company owning an industrial facility, for instance, may buy pollution insurance to cover lawsuits resulting from environmental accidents.
Many small businesses do not secure general or professional liability insurance due to the high cost of premiums. However, in the event of a claim, out-of-pocket costs for a legal defence or settlement can far exceed premium costs. In some cases, the costs of a claim could be enough to shut down a small business.
Businesses must consider all potential risk exposures when deciding whether liability insurance is needed, and, if so, how much coverage is appropriate and cost-effective. Those with the greatest public liability risk exposure are occupiers of premises where large numbers of third parties frequent at leisure including shopping centres, pubs, clubs, theatres, cinemas, sporting venues, markets, hotels and resorts. The risk increases dramatically when consumption of alcohol and sporting events are included. Certain industries such as security and cleaning are considered high risk by underwriters. In some cases underwriters even refuse to insure the liability of these industries or choose to apply a large deductible in order to minimise the potential compensations. Private individuals also occupy land and engage in potentially dangerous activities. For example, a rotten branch may fall from an old tree and injure a pedestrian, and many people ride bicycles and skateboards in public places. The majority of states require motorists to carry insurance and criminalise those who drive without a valid policy. Many also require insurance companies to provide a default fund to offer compensation to those physically injured in accidents where the driver did not have a valid policy.
Product liability insurance is not a compulsory class of insurance in all countries, but legislation such as the UK Consumer Protection Act 1987 and the EC Directive on Product Liability (25/7/85) require those manufacturing or supplying goods to carry some form of product liability insurance, usually as part of a combined liability policy. The scale of potential liability is illustrated by cases such as those involving Mercedes-Benz for unstable vehicles and Perrier for benzene contamination, but the full list covers pharmaceuticals and medical devices, asbestos, tobacco, recreational equipment, mechanical and electrical products, chemicals and pesticides, agricultural products and equipment, food contamination, and all other major product classes.
New policies have been developed to cover any liability that might be imposed on an employer if an employee is injured in the course of his or her employment. In those countries where such insurance is not compulsory, smaller organizations risk insolvency when faced by employee claims not covered by insurance.
In the United Kingdom, Employers Liability Insurance is compulsory, unless the only employee is the owner of the company (who holds at least 50% of the shares) or the business is a family business which is not incorporated as a limited company.
Similarly, workers' compensation insurance is usually compulsory in the United States unless the employer can demonstrate the capability to self-insure by demonstrating sufficient financial capacity and risk management capabilities. Employers that self-insure may carry excess insurance for occurrences that generate unacceptably large losses for the employer.
Original jurisdiction over workers' compensation claims has been diverted in much of the United States to administrative proceedings outside of the federal and state courts. They operate as no-fault schemes in which the employee need not prove the employer's fault; it is sufficient for the employee to prove that the injury occurred in the course of employment. If a third party other than the employer actually caused the injury, then the workers' compensation insurer (or self-insured employer) who is ordered to pay an employee's claim is usually entitled to initiate a subrogation action in the regular court system against the third party. In turn, workers' compensation insurance is regulated and underwritten separately from liability insurance. Just as the Insurance Services Office develops standard liability insurance forms and obtains approval for them from state insurance commissioners, the National Council on Compensation Insurance (NCCI) and various state rating bureaus provide similar services in the workers' compensation context.
U.S. workers' compensation insurance generally covers only bodily injury to and death of employees, but it does not always cover other persons who may suffer injury as a direct result of such bodily injury or death. U.S. employers often carry Employers' Liability coverage (which is not necessarily compulsory) to protect themselves from lawsuits from such persons who would still have the right to sue them in the courts, such as an employee's spouse who claims loss of consortium as a result of the employee's bodily injury on the job which was allegedly caused by the employer's negligence.
Workers' compensation also does not cover intangible torts that merely cause emotional distress. During the 1980s, as U.S. employees began to obtain jury verdicts against their employers more frequently on the basis of such torts, ISO revised the Commercial General Liability insurance policy form to exclude coverage for torts related to the employer-employee relationship like racial or gender discrimination in the workplace, as well as liability for negligent supervision of midlevel managers who committed such torts. It soon became evident that U.S. employers were strongly interested in obtaining some kind of insurance coverage for such torts, which resulted in the development of Employment Practices Liability (EPL) insurance in the U.S. market.
Many of the public and product liability risks are often covered together under a general liability policy. These risks may include bodily injury or property damage caused by direct or indirect actions of the insured.
In the United States, general liability insurance coverage most often appears in the Commercial General Liability policies obtained by businesses, and in homeowners' insurance policies obtained by individual homeowners.
Generally, liability insurance covers only the risk of being sued for negligence or strict liability torts, but not any tort or crime with a higher level of mens rea. This is usually mandated by the policy language itself or case law or statutes in the jurisdiction where the insured resides or does business.
In other words, liability insurance does not protect against liability resulting from crimes or intentional torts committed by the insured. This is intended to prevent criminals, particularly organised crime, from obtaining liability insurance to cover the costs of defending themselves in criminal actions brought by the state or civil actions brought by their victims. A contrary rule would encourage the commission of crime, and allow insurance companies to indirectly profit from it, by allowing criminals to insure themselves from adverse consequences of their own actions.
It should be noted that crime is not uninsurable per se. In contrast to liability insurance, it is possible to obtain loss insurance to compensate one's losses as the victim of a crime.
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In the United States, most states make only the carrying of motor vehicle insurance mandatory. Where the carrying of a policy is not mandatory and a third party makes a claim for injuries suffered, evidence that a party has liability insurance is generally inadmissible in a lawsuit on public policy grounds, because the courts do not want to discourage parties from carrying such insurance. There are two exceptions to this rule:
- If the owner of the insurance policy disputes ownership or control of the property, evidence of liability insurance can be introduced to show that it is likely that the owner of the policy probably does own or control the property.
- If a witness has an interest in the policy that gives the witness a motive or bias with respect to specific testimony, the existence of the policy can be introduced to show this motive or bias. Federal rules of civil procedure rule 26 was amended in 1993 to require that any insurance policy that may pay or may reimburse be made available for photocopying by the opposing litigants, although the policies are not normally information given to the jury. Federal Rules of Appellate Procedure rule 46 says that an appeal can be dismissed or affirmed if counsel does not update their notice of appearance to acknowledge insurance. The Cornell University Legal Institute web site includes congressional notes.
In the technology industry
Because technology companies represent a relatively new industry that deals largely with intangible yet highly valuable data, some definitions of legal liability may still be evolving in this field. Technology firms must carefully read and fully understand their policy limits to ensure coverage of all potential risks inherent in their work.
Typically, professional liability insurance protects technology firms from litigation resulting from charges of professional negligence or failure to perform professional duties. Covered incidents may include errors and omissions that result in the loss of client data, software or system failure, claims of non-performance, negligent overselling of services, contents of a forum post or email of an employee that are incorrect or cause harm to a reputation, getting rid of office equipment such as fax machines without properly clearing their internal memory, or failing to notify customers that their private data has been breached. For example, some client companies have won large settlements after technology subcontractors’ actions resulted in the loss of irreplaceable data. Professional liability insurance would generally cover such settlements and legal defense, within policy limits.
Additionally, client contracts often require technology subcontractors working on-site to provide proof of general liability and professional liability insurance.
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