More reasons why the coverage

you expect might not be there

 In this dispute, the insurer won but the insured did not lose.

That sorry fate fell to the claimant, who unwittingly surrendered its 

right to compensation by excusing the defendant from sharing in it.

By Joseph S. Harrington, CPCU

Professional liability insurance operates on the presumption that the people buying it are knowledgeable about the risks they face and can understand the coverage options needed to address them. For that and other reasons, professional liability policies are less regulated than general and auto liability policies sold to the general public.

That said, professional liability insureds can still find themselves stymied by surprising interpretations depriving them of coverage they had some reason to expect. Two such cases were adjudicated recently in Illinois and California.

Claimants beware

In the Illinois case, a state appeals court in June 2025 upheld a lower court ruling supporting an insurer’s denial of coverage in a case where a geneticist was sued over an erroneous test result for a genetic disorder.[1] The insurer defended the claim under a reservation of rights letter, denying that it had a duty to indemnify the defendant geneticist.

The defendant eventually settled the claim and assigned its rights under the professional liability to the claimant, with the settlement agreement explicitly stating that the defendant would not be required to pay any indemnity.

Seasoned observers of insurance claims will recognize one recurring dilemma in this: Insurance policies commonly disclaim any right to assign a policy to another party without permission of the insurer. It’s less clear whether a policyholder can be constrained from assigning the rights or benefits conveyed by a policy—rights and benefits that have been purchased and presumably belong to the policyholder.

In any event, that question did not affect the outcome of this case. The final ruling rested on two key facts:

• The insurer had defended the claim, even while reserving its rights, thus honoring its essential legal obligation in that regard.
• Under the settlement agreement, the insured was not legally obligated to pay anything. Thus, there was no award or settlement for the insurer to indemnify.

In this dispute, the insurer won but the insured did not lose. That sorry fate fell to the claimant, who unwittingly surrendered its right to compensation by excusing the defendant from sharing in it.

“Arising out of …”

In the California case, a U.S. district court ruled in September that an exclusion in an errors and omissions (E&O) policy for “[m]isappropriation or improper use of funds …” meant the insurer had no obligation to defend a claim or pay indemnity.[2]

There’s nothing new or surprising about that, except that the insured in this case was not the one accused of “[m]isappropriation or improper use of funds … .”

The case involved a human resource company that was charged by a client with conducting a faulty background investigation on an individual who, after being hired by the plaintiff company, allegedly embezzled more than $1 million. A subsequent background check found that the individual had a criminal record for fraudulent activities.

The insurer for the human resource company denied coverage for the claim, citing the provision that excluded coverage for claims “arising out of or resulting, directly or indirectly, from any actual or alleged commingling, misappropriation or improper use of funds … .” Since the alleged oversights in the initial background investigation involved misappropriation or improper use of funds, the insurer reasoned that the exclusion applied in this case, and the court agreed.

As one would expect, the insured argued that the claim was for a negligent background check, not for misappropriation of funds, and that California’s concurrent proximate cause doctrine required the insurer to provide defense coverage.

The court held, however, that the embezzlement was integral to the loss and too intertwined with the underlying claim to trigger the proximate cause doctrine, which refers to causes that apply completely independent of each other.

So, in the court’s view, the loss arose from misappropriation of funds. So did the denial of coverage.

[1] ISMIE Mut. Ins. Co. v. Pergament, 2025 WL 1679934 (Ill. App. Ct. June 16, 2025).

[2] Human Resource Advantage, LLC v. The Hanover Ins. Co., 2025 WL 2731859 (E.D. Cal. Sept. 25, 2025).

 The author

Joseph S. Harrington, CPCU, is an independent business writer specializing in property and casualty insurance coverages and operations. For 21 years, Joe was the communications director for the American Association of Insurance Services (AAIS), a P&C advisory organization. Prior to that, Joe worked in journalism and as a reporter and editor in financial services