This week on PLUS Blog we will be featuring a five-part review of claims made coverage authored by Frederick J. Fisher, J.D., President of Fisher Consulting Group, Inc. and Founder of E.L.M. Insurance Brokers, a Wholesale & MGA facility specializing in Professional Liability and Specialty Line risks.

In 1975, Mr. Fisher began his career on the service side, as an Independent E&O claims adjuster. In 1982, he bought the Company, continued with claims, while expanding the firm’s services to include  qualitative claim auditing, risk management & loss control services, and acting as a TPA. In 1995, he formed what is now known as ELM insurance Brokers, a firm that has acted as an MGA and Wholesale Broker of Professional Liability Insurance  and Specialty Lines. He has lectured extensively on professional liability issues since 1978, and authored over 64 articles in trade journals and periodicals.  In 1989, he became a Founding Member of the Professional Liability Underwriting Society (PLUS),  and was elected to the PLUS Board of Trustees in 1993. After serving in all Officer capacities, he was elected President in 1997.  He remains a Special Materials Expert for several RPLU courses and is the Senior Technical Advisor for The Professional Liability Manual, first published by the International Risk Management Institute in 1990. He has taught over 100  CE classes and lectures. He testifies regularly as an expert witness in cases dealing with the duties and obligations of professionals as well as on coverage and claims-made issues.

Part 1/5: A Review of the Modern General Liability Claims Made Form

Rarely are clients immediately aware of the wrongful or erroneous actions of the “professional” they trusted to perform specific duties or services; mainly because “professional” acts or errors do not or only seldom cause immediate injury. A “professional’s” wrongful acts or errors may not manifest in client injury until long after the act is perpetrated or the error is committed.

Because of the time lag between the wrongful act or error, the resulting injury and the ultimate claim or lawsuit, Joe D’Alessandro in 1964 deduced that there was a better way to insure a “professional.” Secondarily, D’Alessandro postulated that there had to be a way to provide greater actuarial certainty that there would be no further claim activity following the close of the policy period (eliminating the “incurred but not reported” (IBNR) problem). This creative thinking led to the development of the first “claims made” policy wording.

While D’Alessandro’s initial thinking was accurate, 45 years of history has shown the goal of achieving actuarial certainty to be elusive at best. The stability and evolution of the “claims made” policy has also been threatened during its history by poor form standardization, court decisions and shoddy policy form draftsmanship.

Profession/Professional Defined

“Claims made” coverage originated in the realm of professional liability. To understand the exposure and the reason for the desire to limit or eliminate the long-tail claim problems, “profession” and “professional” must first be defined.

A “profession” is a calling that requires specialized knowledge, has legal and/or educational barriers to entry, requires the practitioner to be dedicated to the vocation itself and necessitates a commitment to continual study and the increase in applied knowledge.  This intimates focused attention on the profession’s depth and details and surrendering to the fact that the well of the profession’s knowledge is infinitely deep and is not adequately explored shy of ongoing, personal study.

“Professionals” accept the challenges of the profession’s calling, dedicating themselves to studying and understanding the chosen industry, the industry’s clients and the mechanism. Receiving pay does not make one a professional, only the result of an individual’s membership in a profession.

Professions in antiquity included those that practiced medicine, law, the clergy and engineering. The modern definition of “profession” has been expanded to include architects, investment managers, insurance agents, accountants and others s meeting the above definition who “provide services to others for a fee”.

Since its creation, “claims made” wording’s use has expanded outside of the “profession” and professional liability realm, finding use in diverse liability coverages. But the roots of “claims made” wording, and its most common use still, is found in covering the exposures created by a “professional’s” activities. As seen by the list of true “professions,” professionals are individuals who provide a service to society which, if done poorly, could cause extreme or irreparable personal or financial harm.

Expanded Use of the Claims Made Concept – Two Branches

The expansion of claims made policy forms beyond “professions” caused the basic “claims made” concept to diverge and evolve into two distinct forms. One evolutionary branch commenced in professional liability coverages (known also as “errors and omissions” coverages in this series) and the second branch grew out of the financial services industry and the need for directors and officers liability protection, fiduciary liability and employment practices liability (referred throughout this series as “executive liability” coverages).

Although both branches attach to the tree at the same point; greatly different “claims made triggers” have resulted. Additionally, coverage terms, conditions and definitions differ between the two branches.

Developing “Claims Made” and the Problems Defining a “Claim”

“Claims made” policies were designed around a simple idea, “to indemnify for claims first made against the insured during the policy period.” This original language has since become known as a “pure claims made” form. There was only one event needed to trigger coverage: a “claim was first made during the policy term.” The current complexity evolved from this starting point!

The first problem to arise following the development of this form was the exact definition of a “claim.” “Claim” took on more meanings than ever imagined and its use became abused and confused depending on context. Was a claim “first made” when the insured received an angry phone call threatening to sue and/or hold him/her responsible? Was it not until the insured received a demand letter threatening suit; the filing of a complaint or the receipt of the suit papers? Each of these events likely takes place on different dates; this disparity of dates could have profound effect on coverage depending on when coverage incepted or renewed and how “claim” is defined.

Courts wrestled with the definition of a “claim” and rendered decisions making the definition and any attempt to narrow it down to one point even more complex. Many of these court-developed definitions actually made things worse. Most current forms specifically define “claim;” and the definitions can be as varied as the carriers that provide coverage (the differences are highlighted in the last post). Forms must be compared to know when a “claim” occurs; the “when” makes a difference since the carrier has to be informed during the policy period to ensure that coverage exists (this necessity and the danger of not meeting this requirement is highlighted in future paragraphs).

Correcting the Perception of Pricing Inequities – Creation of the Prior Acts Date

By 1976, “claims made” policies and the number of carriers offering them flourished. No longer would a professional have to keep boxes of “occurrence form” policies around should an error give rise to a claim, even years after the end of the policy period. But the new form led to pricing questions.

Consider two professionals with the same practice and similar revenues. The first insured has carried a “claims made” policy for several years and is preparing for renewal; the second is buying its  first “claims made” policy – and their premiums are – the same.

This didn’t seem fair; the insurance carrier was assuming the same risk for both, all prior acts or errors; yet the loyal customer has paid the carrier a large amount of premium for this exposure and the new insured pays only one-year’s premium for the same length and breadth of protection.

Beyond the fundamental financial inequity was the concept of potential knowledge. The insured MIGHT already know a claim is coming simply because they are aware of a previously-made  error; or perhaps the insured just believes that in years of practice, something might be lurking in the files. As a result of the pricing difference and the potential the carrier may become responsible for a previous act or error, the first risk/policy modifier appeared on the scene. The new add-on was called the prior acts date, retroactive date or retro date (used interchangeably); a now-common  feature of the “claims made” coverage.

Introduction of the retroactive date required the insured to meet two coverage trigger conditions:

1)  The claim must be first made against the Insured during the policy period (when the claimant supposedly notified the insured); and

2)  The insured’s error or wrongful act must be subsequent to a specified date- usually the inception date of their first “claims made” policy (provided there were no coverage gaps). No acts or errors before this prior acts date would be covered by the new policy.

With these two conditions becoming firmly entrenched, the insurance industry’s first inclination was that if an insured wanted to change companies, the new insurer could mitigate its exposure by not recognizing the insured’s current retroactive date, writing the renewal using the date of inception as the new retro date. While a good idea for insurer risk reduction, many quickly found that insured’s would not move their coverage, even for a better price unless the first coverage date was honored, giving prior acts coverage back to the original retroactive date. Thus began the tradition that, in the absence of a gap in coverage, poor claims history (or even multiple predecessor firm history), the new insurer would honor the insured’s expiring prior act date.

Executive liability insurers did not hold to this tradition. The few directors and officers policies that existed in the 70’s and early 80’s were still written on a pure basis allowing, in essence, any wrongful act dating back to the corporation’s formation to be covered – so long as no insured was aware of any fact or circumstance that a claim might be made (a question that became an actual warranty on the coverage application). Executive liability’s continued use of pure “claims made” wording marks the break in philosophies of errors and omissions underwriters and executive liability underwriters. The separate branches created by this conceptual difference reconnected years later with subtle yet potentially horrendous consequences.

Series to Follow

This is the first part of a five-part series exploring “claims made” policy wording. The remaining installments explore specific policy provisions such as reporting requirements, BERP’s, the prior and pending litigation exclusion, how E&O wording  combined  with executive liability wording and the seven potential problems with the incident reporting provision.

The series ends with a look at the varied definitions of a “claim” and the three keys to placing the best coverage for the insured.