It has been several decades since the introduction of claims-made liability insurance policies. Although claims-made forms were reluctantly accepted, problems and disputes continue over the reporting of claims under these policies. An example of claims-made policy pitfalls is this real-life case involving two major insurance companies, two major insurance brokerages, and one well-meaning but unsophisticated insured.
To illustrate how claims-made policies can result in a claims fiasco, consider the following example. The insured, a large, highly regarded not-for-profit organization, had been insured under an Association sponsored D&O liability policy for several years. The policy provided a broad range of coverages, including D&O and employment practices liability written on a claims-made basis.
During the policy period, the insured became aware of certain events that could potentially become claims for wrongful termination under the policy. However, the mere existence of these circumstances did not technically represent a claim under the policy. The policy's definition of claim required that there be a lawsuit or a demand for damages. Neither of these had yet occurred and it was uncertain if they ever would occur.
Nevertheless, there was some concern that a claim might be made against the insured in the future. The insurance broker was asked for guidance in deciding whether to report such information to the insurer. To complicate the situation, it was unclear whether sufficient information existed to allow the reporting of even a potential claim. The broker advised the insured that they had 60 days from the expiration of the policy to report a claim or potential claim. Because expiration was still some time off, the insured opted to monitor the situation and make any reports of a claim or potential claim at policy expiration, or sooner, if appropriate.
Later during the same policy year, the Association announced that the insurer of its sponsored D&O liability program would be replaced with another insurer. The broker managing the Association insurance program assured policyholders that the change in insurers would have no impact on the coverage provided and that the change would be "seamless".
Prior to renewing with the new Association insurer, the insured was required to complete an application and to report information regarding claims and potential claims to the new insurer. The application made specific inquiry as to whether the insured was aware of circumstances or events that might potentially result in a claim. Being aware of the circumstances mentioned above, the insured reported those instances to the new insurer.
Because the new program was described as providing so-called "seamless" continuation of coverage and did not contain a retroactive date limitation, the insured had no reason to suspect a disruption in coverage or to consider purchasing the extended reporting period.
Uh Oh
A few months after inception of the new policy, a lawsuit was brought against the insured based on events that had occurred under the expired policy. The prior insurer denied coverage because the claim had occurred and been brought against the insured after the policy expiration, and there had been no report of the underlying circumstances as a potential claim under the expired policy.
The new insurer also denied the claim, citing warranty provisions in the application that excluded any claim based on prior circumstances the insured was aware that might result in a claim.
The insured retained an attorney to assist in the dispute with its primary broker, the Association insurance program broker, both insurance companies and the Association. Although a lawsuit was avoided, it was only after much legal gyration that this dispute was resolved. The insured ended up paying 25% of the claim out of its own pocket with the rest being split between the two insurers and two brokers.
The Lessons
The above example is extreme yet illustrates how fragile the continuity of coverage under claims-made policies can be, especially when changing insurers. Keep the following tips in mind to avoid surprises under your own program or when contemplating a change of insurers.
Comply with the Reporting Provisions
When renewing coverage, the insured should take immediate steps to determine whether claims or potential claims – as those terms are defined by the policy – exist and report them in compliance with the provisions of the expiring policy, usually but not always within 60 days of the policy's expiration.
Seek Coverage for Prior Acts
As we have seen, it is crucial that any claims-made policy covers claims that result from acts taking place prior to the policy's inception date. Unfortunately, not all policies cover prior acts. Whether you are purchasing coverage for the first time, renewing an existing policy, or changing insurers, insist on "prior-acts" coverage. Be aware, however, that some insurers give coverage for prior acts but limit coverage to only those acts occurring after a certain specified date. Also be aware that policies that cover prior-acts almost always exclude any known instances or circumstances likely to give rise to a claim.
Understand Warranty Limitations in the Application
Most applications for new or replacement claims-made coverage ask the insured whether it is aware of any instances or circumstances that might give rise to a claim. These provisions also normally act as sweeping exclusions for any claims that arise out of such instances, whether reported or not.
One of the problems with such provisions is that they often are extremely broad in nature or loosely worded to the point of ambiguity. Because application warranty clauses have been the source of many claim disputes, take extra care to answer them honestly and accurately. It is important to understand the ramifications such clauses have and allow time to seek help from your broker, consultant, or legal counsel if you are not certain what information is required.
Carefully Consider Buying an ERP
When you change carriers the question of whether or when to purchase the expiring policy's extended reporting period (ERP) arises. ERPs are provisions that give coverage to claims reported within some specified period after the policy expiration but based on circumstances taking place within the policy or retroactive coverage period.
An ERP can be particularly desirable when a policy is cancelled and not renewed, or when a replacement policy excludes claims based on wrongful acts or occurrences taking place during a prior period. The effect of the ERP is to provide coverage for some known future period against the development of latent claims that otherwise would be excluded by either an expiring or replacement policy.
An ERP normally is written for unlimited time and usually does not increase the limit of liability of the policy. Although ERP's can be quite expensive, they can provide valuable protection any time a replacement policy excludes or does not offer key coverages provided by the expiring or replacement policy. Also, there may be instances when the insured is unable to trigger the expiring policy because known circumstances do not meet the definition or reporting requirements of a claim or potential claim. The new policy may also not be triggered when known circumstances are excluded by warranty provisions of the that policy. Where this occurs, the only source of coverage for resulting claims might be under the provisions of the ERP.
Conclusions
The very nature of claims-made coverage can represent danger for an insured not familiar with the special reporting provision and other mechanics of coverage. Even seasoned risk managers sometimes overlook the peril that can exist when changing insurers. To avoid the mistakes described in our example, make sure you have a thorough understanding of coverage issues and any reporting requirements or warranty provisions under both the expiring and new or renewing policies.
When getting advice from your insurance broker, make certain you understand what you are being told. Also, always get the explanation in writing – it is good insurance. But do not rely solely on your broker. Conduct your own due diligence in reading the policy, lest you end up with two insurers, two policies, and no coverage.
Gary W. Griffin ARM is President of Griffin Communications Inc., publisher of risk and insurance reference materials and G2 Risk Consulting, an independent risk and insurance consulting firm located in Southern California. Gary can be reached at 949.331.7522 or at [email protected]