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Experiencing technical difficulties: demand for information technology malpractice insurance is increasing as risks become more varied and pervasive. (Errors and Omissions).

A small Internet technology firm advises a manufacturer to use a particular software package, but the manufacturer finds that the software doesn't work as promised. The technology firm ends up owing more than $50,000 in defense costs. A company hires a software developer to build an application, but later accuses the developer of negligently staffing the project and sues it for breach of contract. A system integration company leaves a customer's system unusable for days, leading to the temporary halt of operations. The company holds the system integrator liable for the losses.

These are claims scenarios that real companies have encountered in today's marketplace, say officials of TechShield, an Aon-affiliated affinity marketer and program administrator for technology--and cyber-liability digital risk insurance products. And although insurers such as Chubb Corp. and St. Paul Cos. have been writing these information technology errors and omissions policies--also known as information technology malpractice professional liability policies--for decades, the clamor is increasing for this insurance because it fills gaps in liability coverage.

"Demand is very strong," said Tim Ehrhart, a vice president at Chubb & Son Inc. and manager for global errors and omissions, technology information specialty, at Chubb Commercial Insurance. "In the early to mid '90s, if you took 10 tech companies, the number that would want to buy E&O was probably five or six. Today, I'd say eight or nine out of 10 would buy it."

In fact, TechShield, which first marketed its technology-risk products in May 2002, has been seeing 15 to 20 submissions a day, an excellent volume for an insurance broker in the technology sector, said Michael Kihm, manager of the technology specialty program at Affinity Insurance Services, a part of Aon.

Even this hard market, with rising costs in various lines of insurance, isn't dulling the demand. Aaron Latto, underwriting director in the technology business division of St. Paul, noted that although many companies have been scrutinizing their insurance programs, including their E&O needs, to see what they can cut from their insurance budgets, "we've been successful in retaining companies because we can show why they need the technology E&O coverage--this is the kind of catastrophic event that makes a lot of sense to insure."

For smaller companies offering products or services that tend to be fairly standard across their customer base, the cost of this coverage can be fairly affordable, Latto said. "But when you get into larger companies that have different types of IT operations--for example, an IBM that does so many things--coverage would tend to he more expensive," he said.

Taming the Technology Explosion

In those cases, the price of technology E&O coverage--like the price of other professional-liability lines--definitely has risen in the past few years, agreed Ehrhart. "The losses have become pretty severe," he said. "If you think about what has happened over the last five years with the transformation of the Internet, everyone trying to fix their Year 2000 problem, the technology acceleration, and then the bubble burst--there were a lot of tech companies out there promising to deliver on their product or service and they failed to do that. There were a lot of lawsuits." And Chubb, as a leading writer of tech E&O, has felt pain from the loss side, Ehrhart said.

Companies have been relying more and more on information-technology solutions, increasing the likelihood that these solutions will be core business solutions. As a result, much more is at stake if the solution fails, Chubb says.

Chubb has been writing E&O for technology companies for more than 25 years, Ehrhart said." I would view us as a pioneer in developing an E&O form for tech companies," he said. Chubb's product, INTegrity, was developed to help information and network technology companies survive the legal expenses and monetary damages that can flow from an E&O lawsuit.

St. Paul has been marketing its Technology Errors and Omissions Liability Protection product since the early 1980s, Latto said. It offers two main coverages: for damages that flow from contract disputes, which form the bulk of technology malpractice claims, and for compensatory damages. "Typically, you do not see compensatory damages in a breach-of-contract claim, but because there are negligence claims that pop up from time to time, we also make sure we cover that," Latto said.

In St. Paul's case, the evolution of this product has kept pace with changes in the marketplace, he added. Until 2000, the insurer's coverage was very similar to the industry's standard coverage for electronic products and services. "In 2000, we expanded the platform to be what we call enterprisewide, so it's not specifically limited to computer-related products or services--it's the company's products or services portfolio," he said. The reason: St. Paul was finding an increasing number of its technology clients were offering more than narrowly defined computer-related products and services. Also, the pace of change in business definitely was accelerating, Latto said.

"As an underwriter, you get to touch a company usually once a year--you underwrite it right before renewal and then you probably don't have too much hard-core underwriting interaction until the next year," he said. "Over the course of that year, the company may well have changed its direction and might have a whole different slate of products and services out there."

Latto said that insurers offering tech E&O coverage fall into two groups: companies that have been active in this arena for some time and have filed forms and rates, and those that are participating in a "fairly robust" surplus-lines market.

"Over the last 10, 15 years, we have seen companies that will go into this market, stay for a couple of years, have a couple of bad losses and then pull out," Latto said. Ehrhart said some carriers simply didn't understand the risk. "They started, they dabbled and then they found it's a pretty risky business," he said. "So some of these companies have exited the tech space."

According to Kihm, the five major players in technology E&O now arc St. Paul, Chubb, American International Group Inc., Lloyds and MediaPro. And in terms of newcomers, one of TechShield's partners, Hartford Financial Services Group Inc., is making a major attempt to enter this market, Kihm said.

TechShield's three products include businessowners (general liability and property) policies for technology firms; technology errors and ommisions; and digital risks insurance for network security such as hacking or viruses and Internet media types of exposures. "Going through the traditional brokerage model, a lot of the small or second tier brokers were having a difficult time with the risks and getting their hands around the coverages as well as working with insurance markets to provide these coverages, so TechShield was started to fill the gap" Kihm said.

New and Different Risks

One way competitors can set themselves apart is by offering broad coverages and displaying a willingness to underwrite dynamic types of firms, Kihm said. Some companies don't entertain the more difficult technology types of risks represented by Internet service providers or dot-coms that are doing unique things on the Internet, he said."A lot of the insurance companies are going to back away because they have filed insurance forms and have only certain appetites--it has to fit into their underwriting boxes--whereas some of the other insurance markets are going to underwrite those," he said.

In some cases, contractual obligations arc prompting technology firms to seek E&O and copyright/trademark coverage. Kihm said that TechShield recently wrote a Miami-based firm that was contracting with Microsoft to do search-engine work in Latin America and needed to obtain tech E&O to take on the job.

Even so, some types of technology businesses still lack insurance, Kihm said. "We're trying very hard to target those and provide them with adequate coverage," he said." We'll partner with some groups that have specific needs." One partner is the American Alliance of Service Providers, a group of 1,000 Internet service providers that have found it difficult to obtain both general liability, property and technology errors and omissions coverage, Kihm said. "We're able to find markets that will write ISPs," he said.

Having this coverage also can be a selling point for technology firms, Kihm said. "They're going out to their clients and they can represent they have insurance in place for general liability, property and technology errors and omissions to make their clients more comfortable," he said. "From the technology standpoint, it's really completing the network security equation where if their products, services, anti-virus software and fire-walls fail, they still can offer true security ill this marketplace."

Cases in Point

Following are claims stories from four technology policyholders of St. Paul Cos. The amounts shown are the defense and indemnity amounts that the insurer Paid on behalf of its policyholders in connection with the claims.


Web site and e-business platform developer

Claim Description

Policyholder was hired to develop a client's Web site; the client alleged that policyholder failed to meet the required project milestones, misrepresented its capabilities, and supplied personnel not capable of carrying out the project. In its defense, policyholder contended that the client failed to identify what specific work it wanted done and repeatedly altered the project specifications.

Defense Coots: $915,887 to date

Indemnity Costs: Uncertain; case still in litigation. Jury trial resulted in a verdict of $604,000 against policyholder; post-trial motions are pending.

Total Costs: At least $915,887


Web design and integration services

Claim Description

Policyholder was hired to create e-commerce Web site for trading and selling valuable colletible. Client later alleged that policyholder failed to deliver a working Web site and negligently recommended that the client purchase Web-enabling software from a company that abandoned the project and the software.

Defense Costs: $555,928

Indemnity Costs: $180,000

Total Costs : $735,928


Software designer

Claim Description

Policyholder developed software to conduct risk modeling. Client purchased the software and relied on it in making financial decisions. Following the client's financial collapse and bankruptcy, it sued the policyholder for providing inadequate software on which it relied in making decisions that led to its collapse.

Defense Costs: $1,084,390

Indemnity Costs: $3,810,000

Total Costs $4,894,930


Software application developer and systems implementer

Claim Description

Policyholder developed IT technologies to manage an enterprise labor force and integrate with client's Human Resources and payroll systems. Policyholder fell behind in delivering the work, resulting in missed milestones and nonfunctioning project modules. Policyholder contended that the client repeatedly changed the size and scope of the project. Ultimately, the client fired policyholder and filed a lawsuit, seeking to recover the costs of hiring a new consultant and lost profits due to the disruption.

Defense Costs: $554,872

Indemnity Costs: $2,200,000

Total CoOts: $2,754,872

Source: St. Paul Cos.
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Comment:Experiencing technical difficulties: demand for information technology malpractice insurance is increasing as risks become more varied and pervasive. (Errors and Omissions).
Author:Bowers, Barbara
Publication:Best's Review
Geographic Code:1USA
Date:Aug 1, 2003
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