If you’re starting out as a contractor, chances are you will be obliged to take out some kind of business insurance as a condition of your contract.
You don’t often hear of IT contractors getting sued for professional negligence. But, should it happen, the cost risks putting you out of business.
In the UK, claims for direct damages arising out of professional negligence can run in excess of £500,000. And that’s excluding indirect damages such as loss of future earnings, court costs and solicitors’ fees.
Unfortunately, there isn’t much you can do to prevent clients from suing you. Sometimes clients are unhappy even when you do your very best and sue even if their case is weak.
That said, you can take steps to protect yourself. Which is where professional indemnity insurance comes in.
What is Professional Indemnity Insurance?
Professional indemnity insurance covers you when an unhappy client claims your professional advice or services weren’t up to standard. It pays for:
- Your legal costs. This includes solicitors’ fees, court fees and other costs, such as the cost of hiring an expert witness
- Any compensation the court orders you to pay if the client sues successfully. At a minimum, you’ll have to pay back the money the client lost as a direct result of your mistake. But the courts often also award damages. For example, you may have to pay the client for future lost earnings
Umbrella companies usually provide you with this type of cover as part of their service. But if you work through your own limited company, you’d need to buy professional indemnity insurance yourself.
What does Professional Indemnity Insurance cover?
Professional indemnity insurance typically covers you when a client claims:
- Negligence. This would happen, for instance, if you gave the client the wrong advice or installed buggy software
- Breach of copyright or confidentiality. This is usually covered even if the breach is unintentional, for example, because you left a sensitive document on your desk and someone looked at it without permission
- Loss of data or documents
- Defamation. This is where a client claims you said or did something that has harmed their reputation
- Some other breach of your contract, such as a missed deadline
Many insurers also offer additional cover for an extra fee. The most common add-ons for IT contractors are employers and public liability insurance.
Why should contractors buy PI Insurance?
There are three main reasons why you’d buy professional indemnity insurance as a contractor:
- For your peace of mind
- To meet your contractual obligations
- To help you stay outside IR35’s scope
Professional Indemnity Insurance as peace of mind
This is the most compelling reason to buy professional indemnity insurance. Having professional indemnity cover in place means you don’t have to worry about the financial implications should a client sue you for professional negligence.
Unfortunately, many contractors underestimate this risk. As Zurich UK financial lines manager Jim Gaskin notes, many contractors “… either don’t recognise that they have an exposure, or perhaps they think it’s a one in a thousand-year event and it’s not worth the cost.”
But, Gaskin continues: “…it only takes one complex issue to take up all the management time for a small SME — which typically doesn’t have sophisticated resources, or a legal and compliance department like large companies have — and that can really threaten the business.”
Why risk it, when you can be covered for a small yearly fee?
Meeting your contractual obligations
Some professionals – such as solicitors and accountants must have PI cover.
This legal requirement rarely applies to contractors.
However, as a contractor, there’s a good chance that clients will make professional indemnity insurance a condition of your agreement.
Many clients won’t let you start your assignment until you’ve shown them proof you have insurance. And if they find out you never bought it, they may terminate your contract.
Professional Indemnity Insurance and IR35
IR35 is a tax law aimed specifically at individuals who provide services to clients via their own limited companies. We’ve covered it extensively on this site.
The legislation forces you to pay tax and National Insurance at employees’ rates if it can be shown that your working arrangements resemble those of an employee.
To stay outside IR35’s scope, you need to be able to prove that you’re legitimately self-employed.
And, well, having professional indemnity insurance helps your case by showing that you’re taking on some financial risk. It also is a pointer to you being ‘in business on your own account’.
Seb Maley, CEO of Qdos notes that, should HMRC investigate you, not having professional indemnity insurance in place may even work against you.
“…we have had cases before where, during an enquiry, the inspector identified that the contractor didn’t hold PI insurance, but it was stipulated in the contract. Because of that, the inspector suggested that the contract wasn’t a true representation of the reality of the arrangement, and so would need to delve deeper – i.e. speak with the end client, and ultimately prolong the investigation.”
When should you buy Professional Indemnity Insurance?
At the risk of stating the obvious, the sooner you buy professional indemnity insurance, the better.
That said, if you’ve been contracting without insurance, you can still protect yourself against claims arising from past work by buying retroactive cover.
What is PI retroactive cover?
Put simply, retroactive cover extends your professional indemnity policy. This way, you’re covered even if someone sues you for a job you did when you weren’t insured.
To buy retroactive cover, you just need to choose the date when you want it to start.
This could be the date when you registered your limited company, for instance. Or maybe some other date.
Clients have up to six years from the date they suffered the loss or damage to sue you for professional negligence. And they have up to one year to sue you for defamation.
This means they could sue you 12 years after you finish the work. Something to keep in mind when working out how much retroactive cover you need.
You’ll also need to make sure you don’t have any outstanding claims or knowledge of potential claims, such as a client who’s been very vocal about their dissatisfaction with your work.
Your insurer can cancel your policy and leave you to foot the bill if you’re not upfront about potential issues.
What happens if you stop working or retire?
Professional indemnity insurance only covers you if you have an active policy on the day of the claim and on the day you did the work giving rise to the claim. Let’s say you carried out some server maintenance in June 2017.
What is PI run off cover?
The client thinks you did a bad job and sues you in January 2019. To be covered:
- You must have had a professional indemnity policy in force in June 2017 (or retroactive cover that goes back to that date)
- You must also have had a professional indemnity policy in force on January 2019
So, seeing as clients could sue you several years after you’ve done a job, it’s worth investing in run-off cover if you’re thinking of stopping or retiring. Run-off cover protects you from claims against past jobs but not future jobs.
As we explained above, clients have up to six years from the date they suffered the loss or damage to sue you for professional negligence. Which means they could even sue you 12 years later. For this reason, you should speak to a solicitor before stopping your run-off cover.
How much cover do I need?
In most cases, your contract will specify how much you have to be insured for. This is called the sum insured, and it could be £250,000, £2 million, £5 million or anywhere in between.
But what if your contract doesn’t specify a particular sum?
Some of the factors you should consider include:
- How much is your entire contract worth – from start to end?
- How much would it cost to rectify any mistakes made?
- How much will you and your client’s legal fees be?
- How big is the project, how important is your role, and how many other individuals are working on it?
Of course, the higher the sum insured, the more expensive your insurance will be. Other factors that affect your policy premium include:
- The excess. This is the amount you have to pay out of your own pocket to file a claim
- Add-ons. You’ll pay more if you want public liability insurance, cyber liability insurance or some other type of additional cover. The flipside is that taking out an add-on is usually cheaper than buying a separate policy
- Your business. Do you do high risk or very technical work? Your insurance may cost more. Your turnover may also affect the premium
4 top tips for choosing the right PI policy
Need to buy a professional indemnity policy but aren’t sure where to start? Follow these tips and you can’t go too far wrong:
- Look for an insurer that specialises in insuring contractors. They’ll have a better understanding of the ins and outs of the contracting business and can give you tailored advice on the type of cover that would suit you best
- Understand what kind of cover you need. If you buy your policy from a specialist insurer, their standard wording will probably cover most of the technicalities. But if you do unusual or very specialised work, it’s best to flag this up. You may need a custom policy
- Read the policy wording carefully. What isn’t covered is just as important as what is covered. Knowing this before you sign on the dotted line ensures you avoid nasty surprises later on
- Shop around, but choose wisely. Don’t make it all about price. Cheap insurance usually means compromises. These compromises could be broad exclusions, a high excess to pay or, worst of all, a poor claims service
Specialist contractor insurance provider – get a quote
We work closely with a specialist insurer who provides tailored professional indemnity insurance for contractors.
For a real-time PI quote, visit our long-term insurance partner, Qdos.