By Lawrence Pavia
The accountancy profession has, for some years now, been legally obliged to insure itself against its own negligent acts, errors and omissions. This is more commonly known as professional indemnity insurance.
But what are the legal obligations? And how far are the implications appreciated by the accountancy profession? My impression is that in most cases this type of insurance is seen by the profession as an unnecessary burden and expense, until a claim hits you and then you start to realize that even the cover and limits of indemnity purchased might not be enough.
Another angle I discuss here is whether the professional indemnity insurance adequately covers the array of services offered by the accountant.
So let's start with the legal requirements. Under the Accountancy Profession Regulations as amended in 2016, an accountant is required to be adequately covered by an indemnity insurance policy without defining what the insurance policy should cover. The regulations simply state that consideration shall be taken of the type of the circumstances, size, type of practice and its clients.
Limit of Indemnity
The only other consideration the regulation refers to is the limit of indemnity that the practice should cover, and these range from €100,000 for a sole practitioner, to a multiplier thereof for the number of principals in the practice. In the event where the liability of the practice is somehow limited, the indemnity should be €500,000 multiplied by the number of principals.
Experience has shown that the limit of indemnity generally sought is the minimum required by law, but this might not be adequate to safeguard the accountant against claims that they may face. Certainly €100,000 do not take you far, nor any multiple thereof. This therefore may leave the accountants or the practice exposed to higher claims over and above the indemnity limit purchased.
The regulations do make reference to the type of practice and the size of its clients by relating the minimum limit of indemnity also to the fees generated by the practice. But neither the size of the practice, its fees, nor the number of principals are good measures for an adequate protection in terms of the limit of indemnity to be selected.
So how should one arrive at the correct limit to be insured? There is no clear formula, but the golden rule is to buy as high a limit of indemnity as you can afford, obviously also taking into consideration what the regulations refer to as the size and type of practice and its clients. But my advice is not to keep to the legal minimum. This may not be enough when things go wrong.
This may sound simple enough and today a number of local insurance companies already cater for indemnity insurance for accountants. However, while you may be experts within your profession and I suppose you expect your clients to rely on your advice, it would be wise to appoint an insurance expert to guide you through this. Appointing an insurance broker might be the easiest and most cost effective option for you, as they should have dealt with these types of policies for a number of clients and their experience may be used for your benefit. Brokers have access to a number of insurers both locally and internationally and therefore they can seek quotations on your behalf. The practice generally is that they are paid by insurers a brokerage for arranging the cover, while still maintaining their independence, and they have to act always in the clients' interests.
But if you decide to go your own way and arrange your insurance, what should you look out for? Invariably a proposal form needs to be completed and this should be completed diligently and in as much detail as possible.
A common pitfall is the description of the activity in which the accountant is involved. Are you giving a service of keeping the books for your clients? Or are you doing assurance work? What type of consultancy work is the practice involved in? Is it taxation planning, trustees, project estimates and planning? Is there any legal work involved? Is the firm involved in the provision of services for citizenship and passport applications?
The extent of the services provided does not only have a bearing on the limit of indemnity mentioned above, but also on the extent of cover that one seeks to be provided by insurers. In this respect it is essential that one discloses the full array and varied services that the firm is providing to insurers. It is better to be safe than sorry and disclose more to insurers, even if it seems obvious to you that this is part and parcel of the normal service offered by accountants.
Needless to say, apart from the general details always requested as to the annual fees generated by the practice and number of principals and employees, insurers would wish to know the loss history, if any, of the practice. Loss history does not mean claims history. You may have had a loss which was not insured and therefore a claim was never made. Nonetheless, you still need to disclose this loss. Failure to disclose what are known as material facts may lead to the insurance policy becoming invalid at a time when you need it most.
Directors' and Officers' Liability Insurance
Another area which has commonly become an additional service provided by accountants is that of allowing directors, generally their own employees, or the principals themselves, to act on the board of their clients' companies. This has become a bit of a headache as the distinction between the service being considered as a service covered by the professional indemnity insurance and it being excluded (which it generally is) is not always understood or clear.
Professional indemnity insurance policies generally exclude liability arising out of claims made against directors and officers of a company. But in the case where the director is being provided as part of a firm's suite of services, where does it leave the practice? Would a claim for negligence made against the individual director (acting on behalf of the accountancy firm) who has been appointed on the board of a company be covered by the professional indemnity insurance policy? The simple answer is no, unless special arrangements have been made to this effect.
Types of Losses and Claims made against accountants
Readers are probably already well versed with the type of claims that have arisen. Most of these cases are generally settled before they arrive in court to save embarrassment and also to protect the reputation of the people involved.
I shall refrain from quoting specific cases, as I would rather give a few examples of the pitfalls that the accountancy profession has found itself in. Like any other profession, accountants and auditors are expected to exercise a degree of care, skill, diligence and competence in the profession. Nowadays, with various industries under complex and strict regulator regimes, the level of professional competence expected, and therefore the responsibility, is not insignificant.
Auditors are expected to confirm that the systems of controls in place in a firm they are auditing are adequate and of good standard. Failure to detect any weaknesses, let alone any abuse of the system, including fraud, may lead to a claim being made against the practitioner. Although they may be tricked into accepting what is put in front of them, firms are expected to have the knowledge and competence to test through different sources the correctness of the information presented before accepting it as such. Some high profile international cases involved claims for failure to detect fraud, while other cases were related to circumstances which should have been pursued by auditors but either were completely ignored or not brought to the attention of the shareholders concerned.
The responsibility of the accountancy profession is not restricted to the clients only, but also to third parties, including regulators who might rely on their assurances.
A word of caution. If circumstances arise which may remotely give rise to a claim, insurers are to be notified immediately about such circumstances. Failure to do so goes against policy conditions and insurers may subsequently refuse to honour a claim which you had not immediately flagged. Once again, this is a very common problem.
Professional indemnity insurance is arranged on a claims made basis, that is, the policy will cover claims made against the insured firm or practitioner and notified to insurers during the policy period. But what about claims that relate to events prior to the inception of the policy, that is, in previous years? Insurers allow for cover to be purchased with a retroactive date so that the event resulting in the claim being made would had been committed after the retroactive date stated in the policy, but before the policy insurance period would also be covered. On the other hand, the insurance policy will not cover any events or circumstances leading to a claim prior to the retroactive date, even if the claim is actually made against the insured during the insurance policy period.
Although the aspect of legal prescription is critical here, the problem that usually arises is whether prescription time starts from the moment the error was made or when it was discovered. The general rule is that a claim can only be made once it is discovered and this can be many years after the actual error or omission had taken place.
In conclusion, while the regulations impose upon the accountancy profession, the requirement to have a professional indemnity policy in force, there is much more at stake which needs to be considered when putting the insurance in place. At the end of the day, one hopes never to need to make a claim, but if circumstances arise, there needs to be a good safety net.
About the author
Lawrence Pavia is Managing Director at Island Insurance Brokers Limited. Article first published in The Accountant Autumn 2016 Edition - http://theaccountant.org.mt/category/archive/autumn-2016/
Island Insurance Brokers Limited is enrolled to carry on business of insurance broking and regulated by the Malta Financial Services Authority.