III. Probing the Mysteries of “Claims – Made” Policies

Insurance companies use claims-made concepts to be more effective in pricing their products, control their exposures and account for their losses in a timely manner. It is not my intent to explain why they are using this language in liability insurance contracts, but rather to clear up some of the mystique surrounding these concepts.

Claims-made coverage is nothing new. In fact, physicians and hospitals have been familiar with this concept for more than 20 years. In general, long-term care operators have been able to purchase occurrence policies for years but have encountered claims-made language only recently.

So, what’s the issue? At its core, the difference between claims-made and occurrence coverage has to do with isolating one key variable in the policy: Which insurance policy pays for the expenses associated with a claim that is made today but stems from an event that took place in years past?

As an example, look at the timeline in Figure 1. An adverse event (E) occurs in 1998. Time goes by and (forgetting statute of limitations issues) a claim (C) is filed in 2002. If you have an occurrence policy in place, then the policy that was in force when the adverse event occurred is the policy that should respond. Thus, in this example, the 1998 policy form, limits, deductible, broker and insurance company should apply.

If a claims-made policy had been in force when the claim was made, then that policy, i.e., the 2002 policy form, limits, deductible, broker and insurance company, should apply.

When a change is made from an occurrence to a claims-made policy, the retroactive date should be set as the inception date of the new insurance contract. In future years, as the claims-made policy is renewed, the retroactive date should remain the same as it was in the first year. If the retroactive date is inadvertently advanced, then a gap in coverage will be created.

Look at Figure 2 again. Assume that the first claims-made policy was purchased on July 1, 1997; that it was renewed each year on July 1; and that we find out that we are being sued on April 1, 2002. If the policy was renewed correctly each year, then our current policy (for July 1, 2001, to 2002) would have a retroactive date of July 1, 1997. Our claim would be covered (assuming all other policy provisions allow for this). The scenario we are concerned about shows up, however, if we find out that somehow, at the renewal on July 1, 2000, for example, the retroactive date was inadvertently advanced to July 1, 2000 (R2). Since the event (E) occurred before the retroactive date (R2), we have no coverage.

It is critical that you do not let a gap in coverage result from accidentally letting your retroactive date change. Remember, you never want to change your retroactive date once you have one. The principal ex-ception to this is discussed later in this article.

An interesting feature of claims-made policies is that the premium for these products will frequently increase each year for a certain number of years until the policy ‘matures.” You should understand this when you enter into the contract. Claims-made policies are frequently discounted in early years for very good statistical reasons. Consider that, during the first year your policy is in force, the probability of an adverse event occurring and a claim being filed during the same policy year is relatively slim. The second year, the probability of a claim being filed for an adverse event that occurred during that year or the original year is greater. The third year, the probability is even greater, and so on.

Most claims get filed within 3 to 5 years (depending on several variables). This explains why claims-made policies will often increase in price for several years-for long-term care facilities, typically, 3 years, though some underwriters will make an exception. In any case, you should understand what the ‘mature” premium might be for your policy when you buy it so that you know where you are heading, pricewise, at future renewals. This won’t be exact-no insurance underwriter will give you a quote today (especially in the current liability crisis) that is good for three years from now; we’re doing well enough to get one that is good 30 days from now. You can, however, get a quote for a policy that has a retroactive date that is several years prior to the current date. Theoretically, this would be more expensive than a current retroactive date, but remember that exposure changes, other rate changes and the market in general will affect the ultimate premium, as well.

This endorsement is purchased one time at the end of the last policy period during which you owned a claims-made policy. By purchasing this coverage, you can cover claims that occur in the future that result from the adverse events that occurred between the retroactive date and the end of your expiring policy. You can elect to purchase tails of various lengths of time-commonly, 1, 2, 3 and 5 years. Some companies offer ‘unlimited tails,” but this is not very common in today’s liability environment.

Be sure that you have a quote in writing for this tail coverage when you purchase and renew your claims-made policy. The cost of this endorsement is significant, often ranging from 100 to 200% of your annual mature premium. The tail endorsement usually must be purchased and paid for within 15 to 30 days of your policy’s expiration date. And, remember, the insurance company has no obligation to sell you this coverage.

In addition to the three cases described above when you could consider purchasing tail coverage, a fourth scenario can arise. You might find that when you leave an insurance company with which you had a claims-made policy and move to another company and purchase a new claims-made policy, the new company will not honor your retroactive date and will insist that you advance the retroactive date to the date of inception of the new policy. If this occurs, then you must purchase the tail coverage from the company that you are leaving to appropriately close out the old policy and maintain coverage.

A final point to consider has to do with the definition of a claim. A good policy will allow you to report ‘incidents that occur during the policy period that you believe may eventually turn into a claim.” Your insurer would then consider that claim to be ‘reported” and would cover it if such an event does arise, even if you are no longer insured with that insurance company. This is important because when you change insurance companies, the new insurer will ask if you ‘know of any known incidents that could give rise to a claim.” If you know of such an incident, you would obviously have to report it, and this event would be excluded from the new policy. You can afford this as long as the prior company is obligated to cover the incident.

A problem could arise, however, if your original policy defined a claim as ‘a written demand for damages.” Avoid this unsatisfactorily narrow language in your policy because, with it, if you know of an event that ‘could” lead to a claim but has not materialized to date, then you cannot change insurance companies without losing coverage for that incident. In fact, if you change insurance companies, neither insurance company is going to pay for that claim. You are at the mercy of the insurance company that you are stuck with to charge you whatever it wants for a renewal policy, and you must pay it if you want coverage for those ‘known incidents.”

In sum, be sure to take time to understand these concepts at least during the week that you renew your policy. Your insurance broker should be a great source of help as you work through your next liability insurance renewal. Be sure to seek his or her advice prior to making any decisions. NH

Richard Todd, BB&T Insurance Services, Inc., Statesville, North Carolina, works with long-term care facilities around the country to develop insurance programs and solve insurance renewal challenges. He is a member of the National Council of HealthCare Agents. For more information, phone (800) 522-8094, ext. 3923, fax (704) 878-3927 or e-mail rtodd@bbandt.com.