Claims Made Coverage vs. Occurrence Policies
Claims Made Coverage vs. Occurrence Policies
By Paul F. Mahaffey, CPCU of TIG Specialty Insurance Solutions
Lawyers professional liability insurance written on an occurrence basis followed the pattern of automobile liability and general liability coverage. However, there are obvious differences between professional liability claims and those under automobile policies. With an automobile claim, the driving error (occurrence) and resultant crash (discovery of error) occur simultaneously, and a claim is usually made against the driver soon thereafter. Thus, the insurer has adequate knowledge, facts and time immediately after the accident to assess its probable future liability in terms of both defense and loss. With professional liability claims, however, the occurrence of the error, its discovery and the resulting claims made against the insured may take place over a considerable amount of time.
Occurrence policies also contemplate that damage or injury can be precisely fixed at a particular time. Unfortunately, with respect to the activities of professionals, fixing the date of an act, error or omission is not so easily accomplished. For example, if a claim is made against an attorney based upon alleged improper advice rendered over a period of five years, what then is the date of the error (occurrence)? Resolving such a question can become exceedingly complex and can consume considerable time and money -- especially if the attorney had more than one insurance carrier during the five years in question. Imagine the conflicts raised by the various insurers, each of whose policies might have different limits of liability and different coverage provisions.
It also must be noted that there can be a considerable timelag between the date on which a professional's act, error or omission takes place and the date of its discovery. For example, an attorney might make an error drawing up a will. It is not unlikely that such an error might not be discovered until many years later at the settlement of the decedent's estate.
These factors give professional liability insurance its reputation for "long tail", an expression which means that many years often elapse between the issuance of a policy and reporting a claim. As a result, professional liability insurers had to deal with three problems: 1) the problem of future inflation as it affected knownclaims, 2) the problem of unknownclaims that might be made in future years and 3) the effect of future inflation on presently unknown claims when they became known. The adverse development of claim costs resulting from these three problems often continued long after the applicable professional liability policy had expired. In addition, the number of claims escalated each year because of some of the social and legal changes described earlier, such as increased consumer awareness and a more aggressive legal profession. These factors caused the insurance industry to reevaluate the means by which they had been writing professional liability insurance.
It became obvious that there are at least three essential deficiencies in writing professional liability on an "occurrence" basis: 1) the difficulty of determining the date of the "occurrence", 2) the application of unrealistic limits of liability of previously purchased policies by reason of current inflation and inflated verdicts and 3) the inherent injustice of determining a premium based upon incalculable considerations. Each of these factors is overcome by the use of the "claims-made" policy.
By offering insurance coverage based on the date that a claim is first made, the question of when an occurrence takes place is insignificant. The single criterion at issue is the date at which the claim is made. The difficulties posed with respect to fixing the date of the act, error or omission (occurrence) are eliminated.
A "claims-made" form eliminates the long tail of the occurrence policy because the insurer knows at the expiration of a given policy all the claims that will be reported against that policy. The insurer need not be concerned with unknown claims that may be made in future years at inflated costs.
"Claims-made" coverage eliminates the statistical "guesswork" required of insurers in establishing reserves under "occurrence" policies for claims that are "incurred but not reported" (IBNR). Hence, IBNR reserves can be eliminated. (Due to uncertainties, these IBNR reserves have often represented a substantial part of the total premium charges.) Of course, the insurer must provide adequate reserves for claims that are reported during the policy period and finally settled years later, but that is a requirement of all liability lines.
The ability to review claims experience each year gives the insurer the opportunity to preserve its financial integrity by adjusting rates on a timely basis, reflecting actual experience. This benefits not only the insurer but also the insureds who expect and deserve financial responsibility from the insurer in return for the premiums paid.
Claims-made policies also offer other advantages to insureds. Premiums for today's coverage need not be loaded to provide for future unknown claims (IBNR) or for the inflated costs of handling such claims. Tomorrow's claims are paid with tomorrow's premiums. As a result, premiums charged for claims-made coverage are lower than properly-rated occurrence coverage, since there is no IBNR.
Another benefit to insureds is that the amount of coverage carried can keep pace with the effects of inflation of court awards and claim costs. The insured can increase the limits of liability each year, thereby maintaining adequate protection in the year of any claim made against him or her. How many insureds have discovered that the occurrence policy with a limit of $50,000 purchased in the 1960s is wholly inadequate to cover claims made against them in the 1970s or 1980s?
When the claims-made form was first introduced, some in the industry objected to its use, fearing that insureds would not accept the new type of coverage. Experience has shown, however, that the claims-made form has been accepted. Today, thousands of attorneys, insurance agents and brokers, architects and engineers, real estate agents, accountants and other professionals are covered under claims-made professional liability policies.
Critics of the claims-made form have been concerned that, once a claims-made policy expires and is not renewed, the insured is left exposed to claims resulting from acts, errors or omissions of the past. Although this is a proper concern, most insurers do provide subsequent "discovery" coverage or optional extension periods that allow additional time for claims to be reported under the expired policy. More significantly, though, since more and more insurers now offer the claims-made form, the insured may readily change from one carrier to another without a gap in protection.
With respect to the professional who retires or otherwise leaves active practice, responsibleinsurers do provide subsequent coverage for claims arising from prior acts, errors or omissions. This is accomplished either through specially priced annual claims-made policies covering only "prior acts" or through a single policy to cover all future claims after retirement. Even the latter "occurrence-type" policy can be rated more intelligently than the usual "occurrence" form because it is issued at the time needed and closer to the claims that may arise. Further, since there are relatively few attorneys who leave practice in any given year, their future claims represent only a small proportion of the claims made against all the professionals of their class. Hence, an inadequate IBNR for the retired group can be more easily absorbed into an adequately rated "claims-made" book of business among active professionals.
This article is reprinted with permission of the author through Aon Attorneys' Advantage and Aon Direct Insurance Administrators.
This article is intended to inform the reader of potential liability exposures for attorneys. These exposures and their management vary among attorneys and over time. This article reflects general principles only and does not render legal advice. This article does not establish or recommend specific guidelines or standards for legal practice or its management, or for attorney liability exposures or their management. Readers should consult legal, financial, insurance and other advisors if they have specific concerns. Neither the Los Angeles County Bar Association nor Aon and its affiliates assumes any responsibility for how the information in this article is applied in practice or for the accuracy and completeness of this information.
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