Claims made policy

What Is a Claims-Made Policy?

A claims-made policy is a type of insurance policy that provides coverage for claims that are first made against the insured during the active policy period, regardless of when the incident that caused the claim occurred. This contrasts with other policy types where the trigger for coverage is the date the incident happened. Claims-made policies are a key component within Insurance Law and Risk Management, designed to offer a more predictable risk profile for insurers, particularly for long-tail liabilities. For coverage to apply under a claims-made policy, the claim must be reported to the insurer while the policy is in effect, or within a specified "extended reporting period" after the policy expires.

History and Origin

The widespread adoption of the claims-made policy form largely emerged from a period of significant challenge for the insurance industry in the 1970s and 1980s. Prior to this, most liability coverage was written on an "occurrence" basis, which covered incidents that occurred during the policy period, regardless of when the claim was reported. However, the rise of mass toxic tort litigation, particularly involving substances like asbestos and diethylstilbestrol, revealed a severe flaw in this structure. Insurers found themselves liable for claims stemming from exposures that had occurred decades earlier, under policies whose premiums were set without anticipating such long-delayed and extensive liabilities.⁵ This created immense uncertainty and financial strain.

To address this "long tail" problem, insurers shifted towards the claims-made policy. This form had existed for some time but became the standard for many types of liability insurance. The move allowed insurers to better manage their financial exposure by limiting coverage to claims reported within a current policy term, thereby improving their ability to set accurate premium rates and conduct effective underwriting.

Key Takeaways

• A claims-made policy covers claims first made and reported during the active policy period.
• The incident causing the claim must generally have occurred on or after a specified retroactive date.
• These policies are prevalent in professional liability and errors and omissions insurance.
• Without proper "tail coverage" or an "extended reporting period," discontinuing a claims-made policy can leave gaps for future claims arising from past incidents.
• They offer insurers greater predictability in risk assessment compared to occurrence-based policies.

Interpreting the Claims-Made Policy

Interpreting a claims-made policy requires careful attention to its specific terms, particularly the policy period and any stated retroactive date. The core principle is that the "trigger" for coverage is the date the claim is first made against the insured, and subsequently reported to the insurer.⁴ If a claim arises from an incident that happened years ago but is only now being asserted, a current claims-made policy will respond, provided the incident occurred after the policy's retroactive date and the claim is reported while the policy is active.

This mechanism fundamentally shifts the exposure from the insurer of the period when the incident occurred to the insurer of the period when the claim is made. This characteristic is critical for professionals, as allegations of negligence or misconduct can often surface long after the professional services were rendered. Understanding the coverage trigger and how it interacts with policy continuity is essential for maintaining consistent protection.

Hypothetical Example

Consider an independent financial advisor, Sarah, who has carried a claims-made professional liability policy since January 1, 2020, with her insurer, ABC Company. Her policy has a retroactive date of January 1, 2020.

In March 2023, a former client, Mr. Jones, files a lawsuit against Sarah, alleging that advice she provided in October 2020 led to significant financial losses. Since Sarah's claims-made policy with ABC Company is still active in March 2023 (when the claim is made) and the alleged incident in October 2020 occurred after her policy's retroactive date, her current claims-made policy with ABC Company would likely provide coverage for the defense and potential damages, up to her policy limits.

Now, imagine Sarah decides to retire on December 31, 2023, and does not purchase tail coverage. If Mr. Jones had waited until January 15, 2024, to file his lawsuit, Sarah's claims-made policy would no longer be active, and she would not have coverage for that claim, despite the incident occurring while she was insured. This highlights the importance of maintaining continuous coverage or securing an extended reporting period.

Practical Applications

Claims-made policies are widely used for types of insurance where the potential for delayed claims is significant. The most common applications include:

• Professional Liability Insurance: This is often referred to as Errors and Omissions Insurance (E&O). Professionals such as doctors, lawyers, accountants, consultants, and real estate agents typically purchase claims-made policies to protect against claims arising from alleged negligence, errors, or omissions in their professional services.³
• Directors and Officers Insurance (D&O): This covers corporate directors and officers against claims alleging wrongful acts in their management capacity. Directors and Officers Insurance policies are almost universally written on a claims-made basis due to the potential for lawsuits related to corporate decisions to emerge long after the decisions were made.
• Employment Practices Liability Insurance (EPLI): This type of policy covers employers against claims made by employees alleging wrongful termination, discrimination, harassment, and other employment-related issues.
• Cyber Liability Insurance: Given the evolving nature of cyber threats and the potential for data breaches to be discovered long after they occur, many cyber liability policies are structured as claims-made policies.

The prevalence of claims-made policies in these areas reflects an industry-wide effort by actuarial science to manage the inherent "long tail" exposure of such risks, where the full extent of liability may not be known for many years.

Limitations and Criticisms

While claims-made policies offer advantages to insurers in terms of predictability, they come with specific limitations and criticisms for the insured. A primary concern is the potential for a "coverage gap" if the policyholder discontinues coverage without purchasing a tail policy or if they switch insurers without securing adequate "prior acts coverage." If a claim is made after the policy has lapsed, even if the incident occurred during the policy period, there will be no coverage.

Critics also point to the complexity of claims-made policy language, which can lead to confusion regarding what constitutes a "claim" and when it is "made." Early in the development of claims-made forms, issues arose from poor standardization and varying court interpretations, which sometimes diluted the original intent of achieving actuarial certainty.² Additionally, for some policies, the annual aggregate limit does not reset each year, potentially leading to lower overall coverage over the policy's lifetime compared to an occurrence-based policy.¹ Policyholders must be diligent in understanding their specific policy terms and maintaining continuous coverage to avoid uninsured liabilities.

Claims-Made Policy vs. Occurrence Policy

The fundamental difference between a claims-made policy and an occurrence policy lies in the event that triggers coverage:

The confusion often arises because both policy types relate to events and claims. However, the critical distinction for a claims-made policy is the timing of the claim itself, whereas for an occurrence policy, it is the timing of the underlying event.

FAQs

Q1: What happens if I switch from a claims-made policy to another insurer?

When switching from one claims-made policy to another, it's crucial to ensure continuous coverage for past acts. Your new policy should ideally provide "prior acts coverage" back to your original retroactive date. If it doesn't, or if there's a gap in coverage, you might need to purchase a "tail" or extended reporting period from your previous insurer to cover claims that may arise in the future from incidents that occurred during their policy term.

Q2: What is a retroactive date in a claims-made policy?

A retroactive date is a specific date stated in a claims-made policy. The policy will only cover claims arising from incidents that occurred on or after this date. Its purpose is to prevent coverage for liabilities that existed before the policy's inception or a continuous coverage period. Maintaining the same retroactive date when renewing or switching policies is vital to avoid uninsured exposures for past work.

Q3: Why is "tail coverage" necessary with a claims-made policy?

Tail coverage, also known as an extended reporting period (ERP), is necessary when you cancel or do not renew a claims-made policy. It allows you to report claims that are made after the policy has expired, but which arise from incidents that occurred while the claims-made policy was active. Without tail coverage, you would be unprotected if a claim surfaces after your policy has lapsed, even if the incident happened when you were covered.