I integrated an LLM (Large Language Model) chatbot for an e-commerce client. I prompted it to “be helpful.” It was too helpful. It started hallucinating a policy where it offered every customer a “full refund + $50 gift card” for any complaint. The client lost $50,000 in refunds before shutting it down. They are suing me for the coding error.
Key Takeaways
- Product Liability vs. Service Error: Did you build the AI (Product) or implement it (Service)? As an implementer, this is a Professional Liability claim (negligent configuration).
- “Software Failure” Clause: Hallucination is a form of software failure. Ensure your policy covers “failure of software to perform as intended.”
- Vendor Liability: You can’t sue OpenAI easily (their Terms of Service disclaim everything). The buck stops with you.
- Restitution: The client wants the $50k back. Insurance might pay this as “Damages.”
The “Why”: The AI Exclusion Trend
The Trap: In 2026, some carriers added “Generative AI Exclusions” to standard policies.
They say: “We do not cover errors arising from the unpredictable output of generative models.”
You need a policy with “AI Performance” affirmative coverage.
The Investigation: I Quoted 3 Major Carriers
1. Coalition
- My Analysis: Coalition is proactive. They understand AI. If you can show you followed “Prompt Engineering Best Practices” (e.g., system constraints), they likely cover the hallucination as a configuration error.
2. Munich Re (HSB)
- My Analysis: They offer specific “AI Performance” insurance. It covers financial loss if the AI underperforms or goes rogue. This is a specialty product, but worth it for AI agencies.
3. CFC Underwriting
- My Analysis: Their Tech policy is broad. They generally view AI integration as standard software development. Unless explicitly excluded, it’s covered.
[IMAGE: Screenshot of a chatbot log promising “Free Refunds”]
Comparison Table: AI Hallucination Coverage
| Carrier | AI Hallucination Covered? | Requires “Best Practices”? | Cost | Best For… |
| Munich Re | Yes (Specific) | Yes | | AI Agencies |
| Coalition | Yes (Tech E&O) | Yes | | Integrators |
| Standard | NO | N/A | $ | Risk! |
Step-by-Step Action Plan
- Kill the Bot: Immediate mitigation.
- Save the Prompts: Your defense depends on showing you tried to constrain the bot (e.g., “Do not offer refunds”).
- Check Policy for “AI Exclusion”: Do this now.
- Notify Carrier: “Software configuration error leading to financial loss.”
FAQ
Is OpenAI liable?
No. Read their Terms. You assume the risk of output.
Does General Liability cover this?
No. No physical damage occurred.
Can I cap my liability?
Yes, your contract should say “We are not responsible for AI outputs.”