Who's Afraid of Claims Made?
The insurance industry experienced a liability crisis during the mid-1980s that changed the industry forever. Insurance companies received decades-old claims for asbestosis and pollution damages, while the courts introduced new legal theories to ensure that policyholders had coverage and victims were compensated. Concurrently, insurance companies had record general- and specialty-liability losses causing the revision of underwriting guidelines and premium charges. The industry cancelled or nonrenewed thousands of policyholders, rewrote all of the commercial insurance policies using simplified language, and introduced a claims-made liability policy.
Prior to the 1980's crisis, the vast majority of liability policies (including professional liability) were written on an occurrence form. Coverage under an occurrence policy is triggered based upon when the accident or injury happened; thus, the policy in force on the date of the accident responded to the claim regardless of when the claim was presented to the insurance company. For example, if a child were harmed in 1985 but the injury didn't manifest itself until 2003, the 1985 policy would cover the loss. Most claims are reported promptly and don't involve a long time between the occurrence and the resolution of the claim. However, the advent of asbestos, pollution and other latent-injury claims created a crisis in determining when the injury occurred and which policy was to respond. The courts resolved the issue by expanding the definition of occurrence to include all policies in force from the first exposure to the harmful situation to the manifestation of the injury. The new interpretation of "occurrence" created a pricing problem for the insurance industry, since the companies had to calculate current premiums for losses that might not be submitted for 10 to 20 years. The effects of economic inflation combined with social inflation (the amounts rendered by juries that affect the amount offered by the insurance companies and the amount the plaintiffs expect to receive) were impossible to predict and, without change, would lead to substantial premium increases. The claims-made policy offered a solution to these problems. In a claims-made policy, coverage is triggered if the claim is made during the policy period for an injury or damage that occurred after the policy's retroactive date. The new insurance company is no longer responsible for any losses occurring prior to the retroactive date.
Claims Made Concerns
A claims-made policy has certain provisions that if not understood can get a nonprofit into trouble. The potential problems involve the retroactive date and the extended reporting period.
Claims-made policies didn't become common until the 1980s and were written for entities that previously had occurrence coverage. Any losses that occurred prior to the first claims-made policy were insured under the previous occurrence policies. The insurer, to avoid redundant coverage and prior exposures, added a retroactive date to the policy. The claims-made policy doesn't insure any incidents that occur before the retroactive date, which is usually the inception or start date of the first claims-made policy. For example, if the nonprofit purchased its first claims-made policy on January 1, 2000, with that as its retroactive date, the policy wouldn't cover any claims arising from an accident occurring prior to January 1, 2000, even if the claim is presented during the current policy term. The nonprofit's prior occurrence policies would cover that loss.
The rule is: Never change the retroactive date. Often when a nonprofit changes insurance companies, the new carrier wants to advance the retroactive date to the inception date of its policy. If the carrier does this, the nonprofit has no coverage for any losses that occur between the date of its first claims-made policy and the inception date of the new policy. This creates a huge gap in coverage that is expensive to address. The only exception to this rule is if the new policy is written with "full prior acts" coverage and a retroactive date doesn't apply.
Extended Reporting Period
A claims-made policy requires that the claim be presented to the insurance company during the policy period. If a nonprofit learns of a situation that could lead to a claim or receives a notice of a claim, it must notify the insurance company immediately and before the policy expires. This reporting provision is difficult to comply with if the nonprofit receives notice of the claim near the policy's expiration date. Be sure to have procedures in place to report a claim policy immediately — a delay in reporting can negate coverage. Some insurance companies provide a 30-day extension beyond the policy expiration to report claims for that policy period.
Several situations necessitate the purchase of an Extended Reporting Period (ERP). An ERP extends the claims-reporting provisions for a specific time period beyond the policy expiration date. A nonprofit should purchase the extended reporting period when:
- The nonprofit ceases all operations and cancels or nonrenews its claims-made policy.
- The insurance company cancels or nonrenews a claims-made policy and the nonprofit is unable to obtain new insurance coverage.
- The nonprofit replaces a claims-made policy with an occurrence policy.
Under all three of these situations, the nonprofit wouldn't have insurance coverage for any losses that occurred after the retroactive date and weren't reported to the insurance company prior to the last policy's expiration date. The ERP extends the reporting provisions so that the nonprofit can report any claims received during the extended reporting period to the insurance company. The purchased extended reporting period can be for several months or up to three years. The cost depends upon the nature of the risk with the premium charge ranging from 50 percent to 200 percent or more of the expiring annual premium.
Each policy has very specific requirements for activating and purchasing the extended reporting period. The insured usually needs to notify the insurance company in writing of the desire to purchase the ERP, request the coverage within 30 days of the expiration date and pay the premium in full before the coverage is in force. Talk to an insurance advisor before ending any claims-made coverage.
Occurrence policies tend to give policyholders a somewhat false sense of security with the assumption that any injury occurring during the policy period is covered. However, injuries that may occur but not be reported for a long time can cause problems, such as inadequate limits from an older policy, an impaired aggregate and an accident arising from ceased operations.
Low Limits on Previous Policies
The limits of liability from previous policies may not be adequate for paying today's claims. If an incident occurred 20 years ago, the nonprofit may have had $50,000 or $100,000 per occurrence — very low limits by today's standards. These older limits don't meet today's insurance needs and place the nonprofit's assets at risk.
Another issue involves the 1986 introduction of the "general aggregate" for the commercial general liability and many umbrella policies. When a policy has a general aggregate, any paid or reserved claims are charged against the general aggregate, reducing the funds available to pay future losses. When the remaining general aggregate limit falls below the occurrence limit, the nonprofit no longer has full policy limits available for future claims or loss payments. When this occurs, the aggregate becomes "impaired," leaving the nonprofit with a greatly reduced policy limit that may be inadequate to meet its needs.
If a nonprofit goes out of business or ceases certain operations, it may still have products or work in existence that can cause an injury but have no insurance coverage. Any injuries occurring after the last policy expires aren't insured since the injury occurred after the end of the policy term. The board members responsible for the dissolution of the nonprofit could be personally liable for any insured losses. To be protected, the nonprofit would have to purchase insurance coverage for "discontinued operations" and continue to pay for the coverage long after the nonprofit has closed its doors.
Insurance is a complex issue requiring every nonprofit to have a trusted insurance professional to help it through this maze. The use of claims-made policies can complicate the handling of an insurance program but shouldn't be feared. The main factors to remember are to never advance the retroactive date, and once the coverage is written on a claims-made policy never convert to an occurrence policy without exploring the cost and need for an extended reporting period.