What’s Your Magic Number? Determining How Much Professional Liability Insurance Your CPA Firm Needs

Imagine getting a text from your lawyer: The jury has reached a verdict. You barely had time to make it back to your office after the jury received instructions from the judge. You wonder what it could mean that they came back so quickly. Is it a good sign? Or bad?
 
You make your way back to the courtroom and take your seat. The verdict is read and it’s not good. The jury finds against your firm on a professional negligence claim, awarding damages of $7.5 million to your high-net-worth, former client. Your professional liability insurance policy has a limit of liability of $5 million, nearly $1 million of which has already been used for defense costs up to the time of trial. Your firm is faced with making up the difference, over $3 million. How will it pay? The firm’s assets could be seized to satisfy the judgment. How will the firm operate if assets are seized? How can it make payroll, pay vendors, and keep the lights on?
 
Getting sued for professional negligence and having a large verdict entered against your firm is never good, but the situation goes from bad to dire if you don’t have enough insurance proceeds to cover the amount of the verdict. Whether you are a solo practitioner who will have personal assets subject to seizure, or a firm with assets used to satisfy a judgment, an excess verdict adds an extra layer of pain. Maintaining an adequate level of professional liability insurance can help minimize that pain, but keeping that coverage at the proper level for your firm requires regular attention from the leadership team.
 

Determining Coverage Needs

The term adequate coverage can mean different things to different firms – but essentially it comes down to having enough insurance to cover a worst-case scenario verdict, like the hypothetical situation in the introduction. And just like with your personal insurance, what’s adequate for your firm may fluctuate over time. That means it’s important for leaders to re-evaluate coverage at least annually – if not more if the firm changes – and to take a long view of their needs.
 
Here are five questions to help you assess your coverage needs:
 

1. Is your firm growing?

The good news: Many CPA firms have maintained or increased their revenue over the last few years despite the effects of the pandemic. In fact, the 2021 AICPA National Management of an Accounting Practice (MAP) survey reported a median revenue growth rate of 4.2%. The bad news? Both organic and inorganic growth can present new and increased risks for a firm that leaders need to be aware of. Let’s look at how:
 
Organic growth can flow from both an improving economy and from new services or industry specializations. As revenues increase and operations become more complex, the firm faces increased professional liability risk. The economy can also impact professional liability claims, which tend to increase in frequency and severity during an economic slowdown. Professional liability claims may be asserted months or even years after the date of the service at issue, depending on applicable statutes of limitation and repose.
 
Inorganic growth – such as growth through a merger or acquisition – can add another layer of exposure to consider. For example, in the case of an acquisition, a firm’s professional liability exposure can increase as it inherits the acquired company’s portfolio of clients, professional services and staff. Lack of proper evaluation and integration of any of these items can increase a firm’s risk.
 

2. What does your client portfolio look like?

Clients in certain industries can create more risk, such as those that are quickly impacted by economic slowdowns or changes in interest rates or commodity prices like real estate, construction, farming, and mining. Industries that are highly regulated or are responsible for large sums of money such as banks, insurance companies, hedge funds and asset managers are considered high-risk. Industries that are undergoing rapid change due to government regulation, shrinking markets, consolidation and technology fall into this higher risk category as well. In general, these external factors are more likely to lead to business failures, which in turn can trigger professional liability claims from aggrieved investors and lenders. 
 
Celebrity or high-net-worth clients can also present a greater risk to a firm’s overall business and its reputation. Allegations made by these big name clients can be quite inflammatory (mismanagement of money, poor investment advice and more); the damages can be quite large; and the defense of a claim can be protracted and expensive.
 

3. What type of services does your firm offer?

In general, there are several services that present elevated professional liability exposures. These include audit and attest services, trustee services, client accounting services, investment advisory services, and specialized areas of tax practice. The latter includes tax planning for intergenerational wealth transfer, services to high-net-worth individuals, estate tax services, business tax planning involving multiple entities, state and local tax matters, business tax advice provided in connection with a planned or proposed transaction, and international tax matters. Damage claims from these complex practice areas range from six figures to millions of dollars. And the litigation costs are elevated because these claims can be intricate, which can require extensive legal discovery and expert witness testimony.
 
Firms should regularly review not just the services they’re offering, but also how much revenue each service area generates and any fluctuation in that revenue over time. For example, if your audit and attest work jumped from 40% to 75% of your revenue, your firm may need to increase its professional liability coverage.
 

4. How much coverage do your peers carry?

Understanding how similar CPA firms approach their coverage can help you make informed decisions about your own firm’s insurance. Ask your insurance broker to provide you with benchmarking data indicating the level of coverage your peer firms have. A competent broker should be able to supply you with anonymized data showing the coverage limits purchased by similarly sized firms in their client portfolio. Additionally, take advantage of networking opportunities at local industry events, tap into online communities, and have informal conversations with industry peers about what’s shaped their professional liability insurance strategy and what they’ve learned over time. You could walk away with some good advice as well as a few cautionary tales to help guide your decision.
 

5. What can you afford?

One of the biggest mistakes firms can make is looking at this question from a monthly payment perspective. What you can afford isn’t really about the premium – it’s about what you can afford to spend out of pocket if you get hit by a claim in excess of your current policy limit.
 

Conclusion

Protecting the reputation and financial interests of a CPA firm and its owners in both good times and bad is an ongoing process. And evaluating the adequacy of professional liability insurance coverage – at least annually, if not more, as your firm grows and evolves – is a fundamental element in the process. Taking the time to conduct a regular coverage evaluation can help protect your business and personal assets in the event of a claim and ultimately find that magic adequate coverage number for your firm.