Errors and omissions coverage for franchisors can be a challenging line of business for insurers to underwrite, but it is and increasingly growing area of the economy.

Observers say franchisor insurance generally covers issues reflected in the Franchise Disclosure Document required by the Federal Trade Commission. The issues include marketing or solicitation activities, services provided to franchises, approval or rejection of proposed sites, supplies franchisees can buy on their own and those they must purchase from designated providers, and the distance they must be from each other.

There will be an estimated 757,350 franchise establishments in the U.S. this year, according to a forecast by IHS Global Insight, a unit of El Segundo, Calif.-based IHS Inc. Quick-service restaurants will account for 20.3% of the total, followed by personal services, at 14.3% (see chart, page 26).

Peter Taffae, managing director at wholesale brokerage Executive Perils Inc. in Los Angeles, which recently established a franchise unit, said the franchise business is growing, spurred by returning military veterans who are finding few available jobs and by experienced middle-age workers who “can't get back into the corporate world and don't want to, because they feel like they've been burned.”

Jim Donovan, New York-based senior vice president of the professional liability unit at Liberty International Underwriters, a unit of Liberty Mutual Holding Co. Inc., said most insurers provide the coverage in their miscellaneous professional liability policies.

“A good chunk” of the estimated 50 underwriters cover franchisors, and rates in the sector are “pretty stable,” Mr. Donovan said.

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But rates are “pretty much going up. It's not a cheap line of business,” said Jeanmarie Giordano, New York-based chief underwriting officer of professional liability of the U.S. and Canada at American International Group Inc.

Much of the coverage is purchased by large fast-food and hospitality franchisors.

“The main exposure on franchises is the class action,” where multiple franchisees join in litigation if they feel the franchisor is not meeting their needs, Ms. Giordano said. An example would be where the franchisor requires supplies to be purchased from a particular source, when they are available more cheaply elsewhere. As a result, “you are typically seeing higher retentions and the rates staying pretty strong,” said Ms. Giordano.

Stacie A. Waller, president of national accounts at Althans Insurance Agency Inc. in Chagrin Falls, Ohio, who said she is seeing slight rate increases, said another focus of litigation is franchisor “overpromising,” often concerning territorial issues.

“It's a difficult class of business,” said Florence Levy, senior vice president of Aon Risk Solution's financial services group in Denver. “It's very litigious,” where investors, or individuals who make a big life change and invest their life savings, sue if the franchise's business does not go well, she said.

Mr. Donovan said the quality of franchisors varies. “We are definitely selective” as to which franchisor Liberty Mutual insures, he said.

“The beautiful thing about franchising from an insurance underwriter's perspective” is that it's a “proven business plan,” said Mr. Taffae. “When you go into a McDonald's, you know those french fries are going to be the same. You design a business model for the business and you multiply it, you rubber stamp it and you charge people for it.”

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The challenge for the insurer is to underwrite professional services but not areas considered to be a business decision, such as distance requirements in the franchise agreement, said Ms. Levy.

“My advice would be to try to structure a program where there's a lot of communication and sharing of information” between franchisors and franchisees to nip any problems in the bud, she said.

When it comes to using specified providers, if franchisors communicate openly with their franchisees about the cost of those products and their potential profit, or on how the profit is shared, they may be able to avoid legal disputes, Ms. Levy said.

Meanwhile, some observers see room for growth in the coverage.

Franchising is a “huge business and it's a nice, potential revenue for insurers,” said Harold L. Kestenbaum, a partner with law firm Gordon & Rees L.L.P. in East Meadow, N.Y., who specializes in this area.

However, Kenneth Rand, New York-based managing director for Marsh Inc.'s E&O practice, said policyholders' appetite for this coverage “is generally most focused on food or casual dining” and the hospitality industries, with less interest in other areas.

Janice M. Dwyer, president of the franchise business division at Cleveland-based Luce, Smith & Scott Inc., works with about 50 franchisors, most of which have fewer than 500 units and only about 15% buy E&O insurance.

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“If you look at the community for franchisors, oftentimes they feel they have control over their system. It's a friendly situation and it doesn't warrant the cost of buying the E&O policy,” she said. The specialized franchisor coverage is limited, so buyers may conclude that the coverage is not broad enough, Ms. Dwyer said.

However, “it tends to be your more seasoned and experienced franchisors” that are purchasing such insurance, said Ms. Waller, who also sees growing interest in E&O coverage in the service industry.