A claims made policy has a range of characteristics that make it stand apart from its somewhat better understood alternative, a loss occurring policy. At times it can be challenging to differentiate between them, however, failing to understand the differences can have a significant impact on the coverage available for an organisation and its management.
In this article, we will explore the concept of a claims made policy in the context of the following coverages:
- Directors and officers liability insurance
- Employment practices liability insurance
- Management liability insurance
- D&O insurance for nonprofits
You may also find that similar concepts apply to a broad range of financial lines insurances, such as professional indemnity insurance, cyber insurance, and even crime insurance to a certain extent. Keep in mind, however, that each policy is strictly interpreted according to its own terms and conditions.
Claims made policy: A definition
A claims made policy requires that a claim be made against an insured and be notified to an insurer during a policy period, for any subsequent loss to be covered. For this reason, it is best to refer to such coverage as claims made and notified, to adequately account for the second condition of notification.
A claim represents any grievance that an organisation’s stakeholders may have towards its management. A policy will define what exactly is meant by the term, however, it can be generally described as notice of an actual or intended legal proceeding against an insured, alleging a wrongful act. Any claim will often be received in formal correspondence, so it should be easily recognised.
Common examples of a claim include:
- A letter of demand
- The service of a writ
- An invitation to a proceeding
The key difference between a claims made policy and a policy written on any other basis, is that it relies less on when an actual or alleged act took place, and rather when an insured first becomes aware of any arising claim or intention to claim. Then, provided that a claim is made against an insured and notified to an insurer in a policy period, coverage should attach as intended.
What is a circumstance?
Importantly, it is not only claims that must to be notified to an insurer, but also any circumstance that may reasonably lead to a claim. In essence, this aims to capture any grievance which has not yet materialised into a claim but may do so in the future. This is an critical distinction, as it significantly broadens the scope of what should be notified to an insurer.
A circumstance is less obvious than a formal claim and requires a more nuanced understanding. A circumstance can be broadly defined as any knowledge of an incident that could reasonably lead to a claim. This could include information disclosed in a conversation, correspondence between parties, or even the knowledge of an act that could eventually result in a claim.
As an example, consider an organisation that releases a financial report to its stakeholders, who in turn will rely upon its accuracy for making important decisions. If a material error is discovered following its release, it would be prudent to notify an insurer of this instance as a circumstance that may reasonably lead to a claim, at least as a precautionary measure.
The nature of prior acts coverage
The natural language of a claims made policy allows it to provide prior acts coverage. By prior acts, we mean any act or decision that has taken place at some time in the past, even prior to the commencement of a policy period. Insuring behaviour that occurred prior to the inception of coverage is a unique aspect of a claims made policy.
In a liability context, prior acts coverage aims to capture what is commonly referred to as long-tail exposure. Long-tail exposure is the liability that remains long after the act that caused it. In a practical sense, this means that an act could have occurred long ago, but for whatever reason, any subsequent claim may not arise until a date sometime in the future.
Of course, there’s no such thing as a free lunch. The prior acts coverage of a policy only intends to insure to unknown claims and circumstances. Any claim or circumstance that is known prior to the inception of a policy will automatically be excluded. If an insured is already aware of a claim or circumstance and wishes to insure it after the fact, no coverage will be available.
Excluding prior acts with a retroactive date
A retroactive date, also known as a prior acts date, can be used to restrict a policy’s prior acts coverage. A retroactive date is typically listed on a policy schedule and is directly related to a retroactive exclusion. A retroactive exclusion will typically state that no claim will be covered if it arises as a result of an act that occurred prior to the retroactive date.
An insurer will impose a retroactive date if it wishes to exclude the acts of an organisation and its management occurring prior to a particular date. Alternatively, if an insurer has no concern about providing coverage for prior acts, a retroactive date may be set as unlimited; in other words, no retroactive limitation will apply to prior acts.
Sometimes a policy wording may not mention a retroactive date at all, essentially remaining silent on prior acts coverage. In such instances, the absence of a retroactive date may presume unlimited retroactive coverage for prior acts unless restricted by a prior acts exclusion; which attaches to a prior acts date and functions similar to that of a retroactive exclusion.
Continuity and a pending and prior litigation date
A policy may also include a pending and prior litigation date, which is related directly to a pending and prior litigation exclusion. A pending and prior litigation date aims to eliminate coverage for any claim that has, in any way, commenced prior to the date specified. It is an insurer’s way of excluding claims and circumstances that should have been most appropriately notified to a previous insurer.
A pending and prior litigation date is very closely tied to one of a policy’s extensions; continuity of coverage. Continuity of coverage allows a claim notification that should have been notified in a prior policy period, to be accepted late, as long as an organisation has held continuous, uninterrupted coverage with the same insurer over time. Alternatively, it may be attached to a continuity date, listed on a policy schedule
A pending and prior litigation date doesn’t always get as much attention as it should. If an organisation decides to change insurer at the expiry of a policy and during the replacement process, this date will typically be reset to the date in which a new insurer’s coverage commenced. It usually isn’t something that can be negotiated, however, it is an important concept to understand nonetheless.
The purpose of a claims made policy
A claims made policy offers a number of benefits to an organisation, such as the ability to insure prior acts, and automatically cover any new and acquired subsidiaries throughout a policy period. However, from an insurer’s perspective, the long-tail exposure attached to managerial-related claims can place pressure on its capital requirements, making it difficult to reserve for future liabilities.
An insurer’s underwriting appetite is guided by its claims experience of a given policy class, the risk profile of its policyholders, as well as insurance market conditions more broadly. The risks facing an organisation’s management can change quickly and requires constant monitoring. As a result, an insurer’s underwriting strategy can vary significantly from one year to the next.
A claims made policy, importantly, allows an insurer to come on and off risk for a particular policy period with relative ease, except when binding multi-year run off insurance. It allows an insurer to deploy capital into favourable conditions and adjust its strategy as required; protecting itself somewhat from the long-term uncertainty of a more traditional loss occurring policy.
Claims made vs occurring policy: What is the difference?
A claims made policy is often contrasted with its somewhat better understood alternative, a loss occurring policy. Below, we explore the difference between the two.
Loss occurring policy
A loss occurring policy covers an insured for any loss that arises from an incident occurring in a policy period, no matter when the subsequent claim is made. This basis of coverage does not rely on when an insured first becomes aware of an incident, but rather when an incident actually occurs. It is often observed in general insurance, which is predominately associated with short-tail liability exposure.
Claims made policy
A claims made policy, by comparison, requires that a claim be made against an insured and be notified to an insurer during a policy period, for any subsequent loss to be covered. This basis of coverage relies on when an insured first becomes aware of a claim, rather than when any incident may have occurred. It is often observed in financial lines insurance, which is predominately associated with long-tail liability exposure.
Claims made policy: An example
Now that we have explored the concept of a claims made policy and the various factors that influence coverage, we can tie it all together.
An organisation purchases an insurance policy to protect its management from board of directors liability. The policy period is twelve months, from 31 December last year to 31 December this year. The retroactive date is unlimited, and the pending and prior litigation date is set as 31 December five years ago.
The organisation has been operating for many years in the manufacturing industry. Last year, the managing director made a declaration to a national statutory tax authority on behalf of the organisation. This year, he receives notice that there will be an investigation into an alleged misrepresentation; constituting a breach in directors duties.
The director makes a notification to his insurer. Because the claim is made and notified in the current policy period, is it this year’s policy that will respond. The claim is not excluded by either the retroactive date or pending or prior litigation date. Legal counsel is appointed and defence costs are incurred in the amount of $25,000, however no claim settlement is made.
A claims made policy has a range of characteristics that make it stand apart from its somewhat better understood alternative, a loss occurring policy. Failing to understand their differences can have a significant impact on the coverage available for an organisation and its management, however, at times it can be challenging to differentiate between them.