Staff are more likely than ever to take their employer to court and compensation payouts can be huge. So the onus is on employers to know their liability products.

Did you know that a small or medium-sized business is significantly more likely to face an employment tribunal than a fire? Or that claims for unfair dismissal are rising exponentially as recession-hit employers lay off more workers? Yet only 15% of these firms have insurance cover.

According to the most recent government statistics, the frequency of employment tribunals is spiralling at a dizzying rate. Over the past nine months there has been a 25% rise in the number of unfair dismissal cases reaching tribunal. There have been 38,000 cases recorded across the country compared with fewer than 41,000 for the 12 months to March 2008.

With many cases settled before they even reach tribunal, that could be just the tip of the iceberg. So why are so few employers buying protection against such a pricey risk? And why aren't brokers pushing the products?

"It's a scandal," says Callum Taylor, Hiscox's management liability underwriting manager. "Most brokers and clients assume that standard directors" and officers' (D&O) policies cover employment practices liability (EPL), but in fact 80% of them don't."

This seems to be the nub of the problem. Businesses in the UK have started to cotton on to the fact that in today’s litigious society they would be well advised to have some form of employer's liability insurance, but they don't realise the limitations of the standard products.

And while an EPL add-on costs just a fraction of the price of a standard D&O or professional indemnity policy, getting hauled up before a tribunal can be very costly indeed. Actual damages, punitive damages and even legal costs can often be awarded to claimants by sympathetic courts.

The average tribunal costs a small business up to £20,000, says Taylor, while larger companies can face bills running into tens of millions.

Frustrated by the lack of awareness among the business and insurance industries, Hiscox has been visiting regional business groups to give presentations on the risks.

"It's very much the insurers driving this," says Taylor. Hiscox itself employs two in-house employment lawyers to help its clients fight tribunals. It's a specialist area and Taylor says new insurers should be wary of entering it without experienced staff on hand.

So why are claims rising so quickly? The answer is two-fold. First, there's the long-term trend towards a "compensation culture" in which employees are increasingly aware of their rights and less stigma is attached to bringing cases against employers.

This has been exacerbated by the recession. If an employee is facing redundancy, they may be more likely to bring a claim they would not otherwise have considered.

"We're seeing an increase in the number of spurious claims by ex-employees," says Taylor.

Second, employers having to cut large chunks of their workforce – particularly small businesses – may be less likely to adhere strictly to the intricate rules governing dismissals and redundancies, leaving them open to claims made on technicalities.

Until this month, employers could have lost tribunals simply for not having followed the letter of the law. The law has now changed, so they cannot be hung simply on a technicality, although failing to follow procedures still leaves employers dangerously exposed.

Professions such as law, medicine, accountancy and architecture are particularly exposed to these kind of claims in a downturn and because their employees tend to be high earners, damages awards can be massive.

Consequently, insurers' risk appetite for EPL policies for the professions can be limited, according to Aon, which has a division specialising in this field.

"Insurers are very worried about professional services firms because one or two or three people in any given year could be looking for a pay-off," says Andrew Swan, an associate director in Aon's professions team.

This is particularly true of US companies or even UK companies with a degree of US exposure. "Insurer appetite is varied," he continues. "Premiums are much higher in the US, but it's fair to say there have been more high-profile cases there. In the UK, we are starting to see insurers turn away from too much US exposure."

However, there are ways that a good broker can help clients drive down their premiums. According to Swan, insurers in this field will look at the policies and procedures an employer has in place, as well as more detailed data such as the balance of male and female staff, the number of women at board level and so on.

A company with a strong track record on diversity will be able to secure a better premium, as will one with a robust risk management framework.

"One of the first questions will be: 'Have you got a human resources manual and a human resources director?'," says Swan. "Any firm ought to have these as standard. Insurers will look for diversity rules and procedures and if they see gaps the firm needs to have some work done."

As companies tighten their belts to survive the recession, insurance add-ons will be one of the first things to go. But as claims against employers continue to rise, this is the very time that EPL policies are most needed.

Insurers and brokers should be quick to point this out to their clients. IT