Possible Dangers Lurking in Claims-Made Policy Forms
Frederick Fisher | March 1, 2019
The specialty lines insurance industry has come a long way since the early "Wild West" days of the 1970s. Since that time, claims-made policies have evolved significantly, but not necessarily in a positive way. In fact, claims-made policy forms have become the most dangerous insurance policies in the industry.
Given the passage of time, one would think that all of the foreseeable problems claims-made policies can create would have been resolved. Such is not the case. In fact, the situation has gotten worse, to the point where a host of potential coverage gaps can now be found in just about any claims-made policy, irrespective of whether one is insuring directors and officers (D&O) liability, fiduciary liability, employment practice liability insurance (EPLI), professional liability, or any other liability exposure currently being written on a claims-made basis.
This article is the first in a series to address the many pitfalls inherent in claims-made policy forms. We examine and explain the many hazards and consequent coverage gaps that may lurk in all claims-made policy forms. After all, if an insured cannot trigger the policy, what difference does it make what hazard the policy was intended to cover?
Problem #1: Insuring Agreements Do Not Stand Alone
I have often said that that there is only one "risk" in a claims-made policy. That "risk" is the probability of a claim being first made against the insured during the policy term. The specific hazard that gives rise to the claim (e.g., an attorney missing a statute of limitations for filing a claim on his client's behalf or a surgeon leaving a sponge in a patient's stomach) is yet another matter. Other so-called risk limiters, any of which could also preclude coverage for a given claim, include (but are not limited to) prior act dates or "retroactive dates," and prior and pending claim and litigation dates, also known as continuity or knowledge dates. Indeed, despite the evolution of claims-made policies since the early 1970s, the dangers of missing out on coverage for any given claim have not been mitigated.
Consider the paraphrasing of a standard claims-made-and-reported insuring agreement used by many insurance companies. Please see Figure 1.
"The claim must be first made against the insured and reported to the insurer during the policy term, and it must arise from wrongful acts subsequent to the retroactive date stated in the declarations, and further, no coverage will exist for claims first made and reported to the insurer after the end of the policy term unless, and to the extent, an extended reporting period applies."
This is fairly standard language. What could be wrong with that?
As indicated above, the insuring agreement clearly refers to an extended reporting period. This is quite common, and such frequently used language appears in Figure 2.
SECTION VIII – EXTENDED REPORTING PERIOD
In the event of cancellation or nonrenewal of this Policy, by either the "Named 'Insured'" or the Company, for reasons other than non-payment of premium or material misrepresentation in the Application, you shall have the right to an Extended Reporting Period as follows:
Automatic Extended Reporting Period
Coverage as provided under this Policy shall automatically continue for a period of sixty (60) days following the effective date of such cancellation or non-renewal, but only with respect to "Claims" made and ""Wrongful Acts" committed before the effective date of such cancellation or nonrenewal.
How the "Cancellation or Renewal" Requirement Can Eliminate Coverage
The problem with such wording is that the extended reporting period language requires that there be a "cancellation or nonrenewal." What happens if the policy, instead, simply renews? In addition, what if the policy includes no automatic extended reporting period, such as the one noted in Figure 2?
In fact, if a policy does not contain a postpolicy reporting window provision (separate from the extended reporting provision), there may be no coverage if, for example, a claim is made against the insured a day or two prior to policy expiration, yet is not reported to the insurer until several days (or even weeks) after the policy term expires.
Despite the value of a postpolicy reporting window, an automatic 60-day extended reporting provision may only be available in the event of a cancellation or nonrenewal. In other words, if the insured renews with the same insurer and is served with the lawsuit just prior to renewal but doesn't report the claim until after the renewal takes place, there could be no coverage. Such a situation has happened frequently, and claims have, in fact, been denied as a result. That is one hidden danger in claims-made and reported policies.
It would be better to have an extended reporting provision (or postpolicy reporting window) that always gives an extra 30 or, better yet, 60 days to report a claim that is not tied to a "cancellation or nonrenewal" of the policy as illustrated in Figure 3 below.
Policy Term: 1/1/20-21
60-Day Post-Policy Reporting Window: 1/1/21-3/1/21
Claim Made Against Insured: 12/25/20
Claim Reported to Insurer: 2/15/21
In this situation, the insured received the claim on Christmas Day and as a result of normal disruptions occurring during the holidays was unable to report the claim to the insurer until after the January 1, 2020–21, policy period expired. However, since the policy is written with a 60-day postpolicy reporting window, and one that applies regardless of whether the policy is canceled, nonrenewed, or renewed, coverage for the claim applies. This is because (1) the claim was made against the insured during the January 1, 2020–21, policy term and (2) the insured reported the claim to the insurer on February 15, 2021, which was well within the term of the 60-day postpolicy reporting window.
Problem #2: "as Soon as Practicable" Creates a Roadblock to Coverage
Depending on the jurisdiction, even 30- or 60-day extended reporting periods that apply irrespective of whether the policy is canceled, renewed, or nonrenewed, and also allow an insured to report a claim after expiration, still may not help prevent coverage gaps.
When a 6-Month Reporting Delay Is Not "as Soon as Practicable"
There have been several court decisions on the East Coast whereby a claim was first made against the insured during the policy term and also reported to the insurer during the policy term. Yet, in one case, a claim denial was still upheld by the appellate court. The court's rationale for the denial was that the insured did not report the claim to the insurer for 6 months after it was made against the insured, even though the claim was reported to the insurer during the policy term. In that instance, and as will be explored below, the applicable policy's claim reporting requirements demanded that the "claim be reported to the insurer as soon as 'practicable.'" The court found that a 6-month delay was not as soon as practicable because there was no compelling reason to justify a delay of this duration. The problem faced by the insured in this situation is illustrated in Figure 4.
Policy Term: 1/1/20-21
Claim Made Against Insured: 3/1/20
Claim Reported to Insurer: 9/1/20
Time Lag between Making of Claim and Report to Insurer: 6 months
Problem #3: What Is a "Claim"?
In the context of an insurance policy, especially a claims-made policy, the definition of "claim" becomes extraordinarily important. Figure 5 provides two definitions of "claim." Note that the second definition has three subdefinitions of the term.
"Claim" means a written demand for monetary damages arising out of or resulting from the performing or failure to perform "Professional Services."
Definition Two
C) "Claim" means:
- A written demand for Loss or nonmonetary relief against an Insured because of
- A Wrongful Act;
- Any Suit.
Based on these two definitions, a "claim" can be (1) a written demand, (2) knowledge of (a) a wrongful act, (3) any suit, or (4) a wrongful act. Still more variations (not depicted in Figure 5) include (a) a written demand for money or services, (b) a lawsuit, or (c) the commencement of an administrative proceeding. These are very common definitions that most insureds accept.
Why All These "Claim" Definitions Are Problematic
Recognizing that professional liability forms are virtually always written on a "claims-made-and-reported" basis, all of these definitions of "claim" create a serious coverage problem for insureds. The source of this problem arises from the fact that none of the aforementioned definitions require receipt of the claim by the insured. (Editor's note: in some lines of professional liability insurance, such as accountants, insurers in today's market require the insured to be personally notified within their policies' definitions of "claim." However, in a number of other lines, including D&O, EPLI, insurance brokers, and miscellaneous E&O, a significant number of insurers' forms still do not require that the insured be personally notified to trigger a "claim." Therefore, insureds should make sure that all definitions of "claim" require personal notification. Recognize that in Figure 5, in definition two, only the first definition satisfies this requirement, whereas the second and third definitions do not and are, therefore, unacceptable.)
For example, a "written demand" may have been made against an insured, yet not received by the insured. This sometimes occurs when attorneys file claims against insureds, but, for strategic purposes, may intentionally delay in actually serving insureds, and thereby do not actually notify the insured that a claim has been made against him or her. When this process occurs, an insured not only not know that he or she committed an alleged wrongful act for many months, but he or she may also not know that a lawsuit has been filed and not yet served. How does one report a claim/lawsuit that they do not know about?
A similar problem occurs with regard to administrative (versus legal) proceedings. For example, an employee may file a claim with the Equal Employment Opportunity Commission (EEOC). Yet, an insured may not know that the EEOC (or other regulatory agency) had begun an investigation months earlier but had not officially been informed of the claim or the investigation until a significant period of time had elapsed.
Thus, the most dangerous time for any policyholder is around a policy's renewal date because any of the aforementioned events constituting a "claim" may be something the policyholder does not know about and thus cannot report under the soon-to-be-expiring policy.
Claim Denial from "Claim" Definition Lacking an Insured's Receipt
One claim denial was recently upheld by an appellate court because a sealed indictment was not served on the policyholder until long after the policy expired. The indictment itself triggered the policy due to satisfying the "wrongful act" element in the policy's "claim" definition. This was despite the fact that the insured was unaware that the indictment had been handed down because it was sealed. The situation begs the question: how could an insured "report" something about which he or she had no knowledge? Despite the apparent impossibility of complying with the policy's language, the court nevertheless dispensed with common sense and decided to uphold the insurer's denial of coverage based on what it termed the policy's "clear and unambiguous" language!
What is the solution to the problem of claims being made against an insured—yet without the insured's knowledge of the claim? The obvious one is to include "receipt by the insured" wording within a policy's "claim" definition.
Figure 6 provides additional definitions of "claim," all taken from existing policies. Many of these definitions do not require receipt of the claim by the insured. More to the point, there have been definitions of claim that trigger a claim against the insured when (1) a lawsuit was served on the insured OR (2) a written demand is made OR (3) an administrative proceeding has been commenced against an insured. Nevertheless, only one of these three definitions (the first) requires actual receipt by the insured; the other two do not. Figure 6 provides additional definitions of the term "claim" as they appear in currently available claims-made policies. Importantly, some, but not all, of these definitions require that the insured be personally notified of the claim.
- "'Claim' means a demand received by any Insured for money or services including the service of suit or institution of arbitration proceedings. 'Claim' shall also mean a threat or initiation of a suit seeking injunctive relief…."
- "Claim means a demand received by you for money or services, including the service of suit or institution of arbitration proceedings involving you arising from any alleged wrongful act. Claim shall also include any request to toll the statute of limitations relating to a potential claim involving an alleged wrongful act."
- "'Claim' means a written demand for monetary damages arising out of or resulting from the performing or failure to perform 'Professional Services.'"
- "'Claim' means a demand for money or services naming the Insured and arising out of an act or omission in the performance of professional services. A claim also includes the service of suit or the institution of an arbitration proceeding against the Insured."
- "Claim means: (1) a demand for money or services; or (2) a suit...."
- "'Claim' means a demand or assertion of a legal right made against any Insured, even if any of the allegations of the Claim are groundless, false, or fraudulent. Claim also means a Regulatory Action or a suit seeking injunctive relief relating to the Wrongful Acts specified in Section I., INSURING AGREEMENT."
A definition of "claim" that doesn't require receipt by the insured or actual knowledge that a "claim" has or will be made can become a major problem since, by definition, a "claims-made-and-reported" policy requires that the insured report claims during the policy term. Indeed, it is impossible to report a claim one does not know about.
Major Takeaways
By now, it should be apparent that claims-made policies contain a number of structural "minefields," any one of which could produce an unexpected claim denial. This article addressed three of these problematic areas. Based on these, an insured should seek the following when purchasing claims-made policies.
- Contain at least a 30-day (and preferably a 60-day) postpolicy reporting window. In addition, the provision containing this window must specify that the reporting window will be available to the insured, regardless of whether the policy is being (a) canceled, (b) renewed, or (c) nonrenewed.
- Not use "as soon as practicable" claim reporting wording. Instead, the phrase "the claim should be reported to the insurer," and without any specific time requirement, is preferable.
- Define the term "claim" so that the definition includes a requirement that the insured be "personally notified" or "personally receive" the applicable lawsuit, administrative/legal proceeding, or demand that gives rise to the claim.
Upcoming articles will examine additional traps and how to avoid them.
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