What is a claims-made policy and do I have to buy a tail?
There are two basic liability coverage forms: Occurrence and Claims-made. Occurrence is the type that we are all familiar with, as almost all homeowners and auto liability coverages are occurrence, as are standard market general liability policies. The terms Occurrence and Claims-made are essentially guides to when the insurance policy’s coverage is triggered.
Occurrence policies are triggered by the date on which the occurrence takes place, regardless of when the claim is made. The insurance policy that is in force at the time of the occurrence is the one that pays.
Prior to the 1970’s, almost all policies were occurrence. It does seem pretty logical that the coverage should work in this manner.
So why was a new coverage form necessary – what had changed?
Let’s use this example, as it had a lot to do with it. A manufacturing company, ABC Co., made a wonder compound, and we’ll call it asbestos, that was safe enough to use as a component to a wide array of products, from brake linings to blankets to hair spray. ABC’s insurer charged a small amount for products liability coverage, as the stuff was looked at as pretty safe. Rock Solid Insurance Company provided the products liability coverage to ABC from 1968 to 1979. It was provided on an occurrence form.
In 2002, ABC receives notification of two separate lawsuits naming ABC and other parties as defendant, for harm due to use of the product starting in 1971.
This means that we have to understand the occurrence to have taken place as far back as 1971, and that means that it is the old insurance company from back then, Rock Solid, who is presented with the claim for coverage. Rock Solid is not happy. Rock Solid did not charge rates that considered the newly emerged understanding of the problems with asbestos. Rock Solid is now concerned about other claims, as they had a small niche insuring companies in this industry. This could cripple Rock Solid.
Rock Solid wrote an account that has what’s called a long tail exposure; the problem is that they didn’t know it.
In addition, ABC is not too happy. ABC was a smaller enterprise back then, and their policy included what seemed like an appropriate limit in an early 1970’s economy, and it was $500k.
A homeowner’s policy doesn’t have a long tail exposure; if something happens, you know about it pretty quickly, and occurrence coverages works fine for you and the insurance company – same thing with auto coverage, and general liability for most businesses. Is asbestos aberrant in having exposures unknown at the time coverage is written – do other activities have long tail exposure?
The insurance industries’ answer to this has been we’re not sure and we don’t want to find out the hard way. Due to that, the industry puts many activities that may have a long tail exposure on claims-made coverage forms. One activity in which we can understand the preference to use a claims-made form is physician malpractice, initially due to injuries realized by a child with the claim brought long after. Those situations put malpractice carriers in the same position as Rock Solid. Today, almost all professional liability, executive liability, and much products liability, are claims-made.
A claims-made policy allows the claim to be presented to the carrier who is providing the coverage during the period when the claim is made. This means that in the asbestos example, under a claims-made form, the claim is presented to the insurance company providing the coverage in 2002. It also means that in this scenario, and as a practical matter, coverage had to have been in place retroactive to 1971. Doing that is called having a 1971 retroactive date, and there is a place in claims made policies where the retro-date is stated. Claims made allows you to submit the claim to todays policy, which likely has much higher limits than the 1971 policy, and has the added benefit of you being able to locate the policy, and the carrier.
Ok, so what is an Extended Reporting Period, or Tail, endorsement? This is what we buy when the claims-made underwriter ceases to offer a renewal, or cancels the policy mid term, and we can’t find a competing carrier. The incumbent carrier is required to offer an extended reporting period that may charge somewhere around 200% of expiring premium for a Tail or Extended Reporting Period. Actually dealing with this situation is rare, and is the possible outcome if you have multiple substantial claims, and the industry begins to look at you as uninsurable. Generally, we are able to find a replacement carrier who would maintain the retro date, should the incumbent carrier bail on us. The replacement terms are not always pretty.
It’s very worthwhile to keep in mind that should a claims-made policy cancel or lapse for non pay, there is generally no obligation on the underwriter to offer a tail. This can be critical to know, as particularly with certain executive liability policies, a firm’s financial duress and the receipt of lawsuits are often during the same period of time. A claims-made policy cancelling or lapsing for non-pay may not be solvable, as underwriters run from this type of situation.
Don’t fear claims made coverage; in a lot of industries and for many exposures, the coverage form is the only option. Claims-made is a mechanism to allow insurers to underwrite properly, as you can’t do that for certain activities with occurrence policies. Having the claims-made option makes the market for coverage larger, and more stable.
Also important to know is that any acquisition or sale requires a review of buyers and sellers insurance program, with particular attention to claims-made policies. Transactions may trigger automatic changes to the coverage which need to be addressed. Business cessation, and new big investment, may do the same thing. These happenings may force the purchase of a non-cancellable, and non-financeable, tail. Those considerations are not the subject of this memo, but please be sure to call us early in these processes.