If you have been in real estate investing, you may hear people ask: do I need errors and omissions insurance in real estate? While many haven’t even heard of this sort of insurance, it’s a great question.
Errors and omissions insurance is a type of professional liability insurance that protects firms providing transaction-related real estate services (not investors). If these service providers make a mistake or forget an item during a transaction, this insurance will cover the associated costs.
Are errors and omissions insurance necessary? In this article, I will talk in detail to guide you through each step of errors and omissions insurance in real estate.
What is Errors and Omissions Insurance?
In simple terms, errors and omissions insurance protects service providers in case they accidentally make a mistake during a real estate transaction. For example, someone forgets to sign somewhere on a contract or mistakenly omits a key part of a contract.
Technically speaking, errors and omissions insurance falls under the umbrella of professional liability insurance. As such, it protects companies and other service providers against legal claims of inadequate performance or negligence. And, in doing so, errors and omissions insurance generally covers mistake-related court costs and settlements up to the amount specified in the insurance policy.
Why Brokers and Title Companies Need Errors and Omissions Insurance
In the real estate world, brokerages and title companies need to have errors and omissions insurance. And, after providing a broad overview of errors and omissions insurance above, I’ll use this section to expand upon why real estate brokers and title companies require it.
As a real estate broker or title company, you represent clients (buyers and sellers) with a fiduciary duty, that is, you agree to have the client’s best interests in mind during your service. Furthermore, in this capacity, you need to provide services related to real estate transactions in the hundreds of thousands to millions of dollars range, a significant amount of money. If you make a mistake in facilitating these transactions that financially harms your clients or one of the other parties, your errors and omissions policy will cover that mistake (up to your policy amount).
On the other hand, if you fail to have an errors and omissions policy and make a mistake causing financial damage, any successful lawsuits against you will need to be paid with your own money, a potentially catastrophic event.
NOTE: When I act as a lender in a real estate transaction, I place significant funds at risk. Consequently, I insist on getting a copy of the title company’s errors and omissions policy to review. That way, I know A) that I’m protected in case of a title company mistake, and B) who to call directly at the insurance company in case of a mistake (rather than needing to go through the title company).
To provide some more clarity, the following list includes the broad categories of real estate-related issues errors and omissions insurance covers:
- Professional mistakes: If a client argues that a title company or broker made a mistake that resulted in a financial loss, that client could sue the party that made the mistake. For example, a real estate agent that mistakenly records an incorrect square footage for a property could materially affect the substance of a transaction, leading to a major lawsuit. In this scenario, errors and omissions insurance would help cover 1) attorney fees, 2) court costs, and 3) settlements/judgments/fines.
- Failure to deliver agreed-upon services: Whereas the above includes active mistakes, this category refers to oversights and missed details that had previously been promised. For example, if a client and real estate agent agreed that the agent would include a specific clause in a sales contract, and the agent forgot to include that clause, it would qualify as a failure to deliver promised services and could result in a lawsuit. An errors and omissions policy would help with hiring an attorney and paying the other lawsuit-related expenses.
- Accusations of negligence: As either a title company or real estate agent, you can be exposed to liability arising from alleged negligence. For example, a client may claim that an agent failed to inform him or her about mold in a property. If the client then claims that including this information about mold would have actually prevented the home purchase, the agent could face a lawsuit for professional negligence. Once again, in a negligence-related lawsuit, errors and omissions insurance would help cover 1) attorney fees, 2) court costs, and 3) settlements/judgments/fines.
Considering the above risks, I personally insist on having errors and omissions insurance any time I represent someone else – either in a title capacity or as a real estate agent – and have a fiduciary duty to that client. I’d just rather have a policy than face a lawsuit related to any of the above scenarios without insurance protection.
Do Investors Need Errors and Omissions Insurance?
Now, the question most new investors ask is whether they, as investors, also need errors and omissions insurance?
No, investors do not need to carry errors and omissions insurance (and I don’t think insurance providers even offer these policies to investors).
However, while you don’t need your own policy as an investor, I highly recommend that you request a copy of the title company’s policy and your real estate agent’s policy. As discussed above, by reviewing those policies you confirm A) that these service providers actually have insurance, and B) how to get a hold of the insurance company in case of a professional mistake.
Does Errors and Omissions Insurance Cover Property?
The other question I hear from new investors involves property. More precisely, people ask if errors and omissions insurance covers property damage. People first entering the real estate investing world hear the word insurance and assume that means some sort of protection in case of damage.
No, errors and omissions insurance does not cover property damage or investor liability; it solely provides protection to service providers related to a real estate transaction.
As such, investors still need to purchase property casualty and liability insurance for their rental properties, as these policies protect you as a landlord (and are the landlord’s equivalent to a homeowner’s policy on a primary residence).
Final Thoughts on Errors and Omissions Insurance
In my capacity as a real estate service provider (not an investor), I have had an errors and omissions policy for over 20 years, and I’ve never needed to make a claim. Basically, brokerages and title companies keep these policies for exceedingly rare – but potentially costly – situations. In that respect, errors and omissions insurance somewhat resembles catastrophic insurance; it’s rarely used, but due to the potentially massive financial consequences, it’s better to have and not need than need and not have.
Furthermore, errors and omissions insurance does not cost a ton for real estate agents. While every provider and situation will differ, a typical policy for an agent comes out to around $100/month. If you average 15 or so closings per year, you can – and should – more than justify these small costs for the protection the policy provides.