Read this article before buying Technology Errors & Omissions Insurance.
Taking time to understand Tech E&O insurance before buying can make a big difference to the bottom-line of a Technology Start-up should the company get sued. Read this article to understand:
- the legal liabilities addressed by Tech E&O insurance
- examples of claims covered by a Tech E&O policy
- reasons for buying a Tech E&O policy
- how a Tech E&O policy fills coverage gaps in CGL and Cyber policies
- considerations when purchasing a Tech E&O policy
Understanding Tech E&O for Start-ups
Technology Errors and Omissions Insurance (Tech E&O) is one of the very first insurance products recommended for new technology companies. As a buyer you may ask, “Is this product truly necessary for my company?” To help you answer that question, this article takes a close look at the legal liability tech start-ups typically face that a Tech E&O insurance policy is designed to address.
Legal liabilities and Technology Errors & Omissions Insurance
Tech E&O Insurance is a specialty insurance for technology product and service providers. It covers the legal defence and damages that result from claims brought by a third-party claimant alleging harm directly stemming from mistakes made in services or mistakes in the products that cause them to fail to perform as intended.
For your start-up, each sale you make to a customer is a contract that the customer will pay you to deliver the product or service as agreed. If your company fails to deliver and the customer suffers financially as a result, they may choose to sue for damages.
“But wait”, you say, “we don’t have customers yet so that’s not a risk for us.” Perhaps you’re an early-stage start-up, pre-revenue, your products/services are in the design stage with your company focus is on research and development. Let’s look closely to see if there may still be a legal liability that you’re not yet aware of:
- Are you currently or do you plan to beta test a product in the coming year?
- End users involved in beta testing may or may not be paying customers in terms of cash but you will nevertheless have a contractual relationship with them and with that comes legal obligations.
- Insurance is not just for today, the insurance policy period is typically 12 months, so you should look carefully at your product development and go-to-market plans and plot your insurance purchase accordingly.
Here are some examples of insurance claims that may be covered under Tech E&O insurance:
Tech company – sued for product failure
A company designs computer systems for food manufacturing assembly lines. A week after installation at the client site, the system malfunctions as a result of a coding error and the manufacturing process comes to a halt. It remains shut down for 5 days while the company works to locate and remedy the coding error. All the ingredients on the production line spoil and must be disposed of. The manufacturing company sues to recoup its loss.
Website development agency – sued for failure to deliver
A website development agency is hired by a municipality to develop their new website including online payment collection for taxes and fees and a new online booking system for municipal recreation facilities. As per their contract, the project was to be delivered in 6 months. After numerous adjustments in scope as well as staffing challenges, the site finally goes live at the 6-month mark but is without a functioning online booking system. The municipality sues for breach of contract.
Cybersecurity company – sued for failure to stop a security breach
A cybersecurity company is hired to investigate and secure a suspected payment system hack at a large casino operator. Two months later the security company declares the breach contained. The client suspects otherwise and hires a security consultant to investigate. The consultant determines that part of the system was compromised while the cybersecurity company was on contract. The client sues the company.
Why buy Tech E&O Insurance?
As with many start-ups, you may be bootstrapping the initial years so money is tight, spending decisions are tough and the question remains, “Why buy Tech E&O insurance?”
To transfer financial risk:
The most obvious reason for considering Tech E&O insurance is that there is the chance that your company may get sued for product or service failure. While some large, established companies may self-insure by holding a reserve that they can tap into in case of a claim, start-ups can rarely afford to do so. The cost of a claim, especially when you consider legal defense, even if the claim is proven to have no merit, could place a significant burden on a start-up’s finances. Insurance is a valuable tool for minimizing the negative financial impact of a lawsuit.
To meet contractual requirements:
Another common motivation for purchasing Tech E&O insurance is to close a sale – most customers require that the company they buy from carry Tech E&O insurance. It is assuring for the customer to know that there is a financial backstop for its vendor should something go wrong requiring you to compensate them.
Tech E&O insurance vs other insurance
If you’ve already purchased some insurance for your start-up, you may be wondering, “Are Tech E&O risks not already covered by one of my existing insurance policies?” Unless you’ve purchased an insurance package that specifically lists Errors and Omissions coverage as an insurance component, the answer will be, “no.”
You may have already considered or purchased Commercial General Liability (CGL) Insurance or Cyber Insurance. Tech E&O can compliment and fill gaps of legal liability exposure between CGL and Cyber.
If you’re still not sure what you need, take a look at the following claims scenarios. Could any of these situations happen to your company? Note, this list is not conclusive nor exhaustive.
Will the claim be covered?
|Claims scenario||Technology Errors & Omissions||Cyber Insurance||Commercial General Liability|
Are you covered?*
|Sued by client who tripped and broke an arm exiting your office||Bodily injury||X||X||✔|
|Sued by landlord for fire in rented office||Property damage||X||X||✔|
|Power surge causes major server crash and data loss||Property damage||X||X||✔|
|Sales rep loses company laptop||Property loss||X||X||✔|
|Lost company laptop contains client data||Data breach||X||✔||X|
|Computer virus transferred to your client causing a system shutdown||Network security breach||X||✔||X|
|Hacker threatens to expose client files||Cyber extortion||X||✔||X|
|Hacker exposes client files||Privacy data breach||X||✔||X|
|Fraudster persuades staff to change vendor bank account and as a result a large payment gets diverted||Social engineering fraud||X||✔||X|
|Sued by client when your tech product fails to work as promised||Impaired property / breach of warranty||✔||X||X|
|Sued by client when software project delivery misses deadline||Breach of contract||✔||X||X|
|Sued by client when your chip defect damages their equipment||Impaired property||✔||X||X|
|Sued by client when their equipment is damaged by your installation team||Negligence||✔||X||X|
|Sued by client when your subcontractor installs your product incorrectly||Vicarious liability||✔||X||X|
|KEY:||✔= Yes||X = No|
|*No two insurance policies are the same and coverage will vary to some degree among policies of the same insurance type.|
In reality, given the above, many insurance companies today offer a Tech E&O Insurance policy that includes Cyber Insurance and often also CGL, catering specifically to the needs of technology companies. A combined solution presents a good way for start-ups to buy the necessary insurance and avoid coverage gaps.
Buying Tech E&O insurance – what the insurance company will want to know
In order to assess your company’s Tech E&O risk, an insurance company will need to understand the nature of your business operations, your financial situation, your approach to risk management, and your plans for the coming year.
Expect to answer questions on your:
- Products or services: the percentage of total revenue from each product or service and plans for new products or new markets within the coming year.
- Client contracts: largest and average customer contract size, use of formal legal contracts, and agreements with liability limitations.
- Management and operations: do you have formalized project management and operations procedures in place, do you use contractors or subcontractors, and what liability requirements you place on them?
You may find that the process of buying a Tech E&O insurance policy in itself can provide significant value to your start-up as it forces your leadership team to take a serious look at your company’s approach to risk management and risk mitigation. Having a realistic understanding of your situation and what you can do to limit your start-up’s exposure will help you to run your company better. It will also serve you well later on should you need to pitch for investment or funding.
Finances are tight when tech companies are starting out and prioritizing purchases and business strategies can be tough. Nonetheless, having adequate insurance in place is crucial, especially when wading into unchartered territory. No matter how prepared your company is, or how insulated from claims you feel you are, it can be difficult to anticipate risk. Known risks should always be managed by robust business policies and procedures, and the many unknown risks mitigated through the appropriate insurance policies. Tech E&O insurance can be a valuable tool for a technology start-up.