WHAT YOU DON’T KNOW CAN HURT YOU.
As an investor, especially a commercial buyer or general contractor, there are some things you should definitely be aware of regarding your liability insurance. The same holds true if you are a licensed Realtor or mortgage professional with Errors and Omissions coverage.
When purchasing an insurance policy, especially general and professional liability, there are two different types of policy forms to choose from; ‘Occurrence’ and ‘Claims-Made’. While as a consumer you may have never heard of either of these insurance terms, they can have a huge impact on how (or even if) you are covered when a loss occurs.
‘Occurrence’ forms cover losses that happen (occur) during the time that the policy itself is actually in force. The loss can be reported months or years later after you have switched companies or the policy is no longer in effect, the key is when the loss actually happened. If it occurred while the policy is in force, when it is actually reported in the future is irrelevant. Occurrence forms, in the opinion of this author, are more valuable because they respond to claims brought about years later.
A ‘claims-made’ policy differs in that it only covers claims that are made while the policy is in force. For example, if a ‘claims-made’ policy expired on February 1st and a claim was submitted for work performed on January 1st, there is no coverage because it was made outside of the policy’s effective term.
As the name indicates, ‘claims-made’ policies provide coverage only for those claims made during the time the policy is in force. These policies provide coverage only so long as you continue to pay premiums for the initial policy and any subsequent renewals. Once premiums stop, the coverage also stops for any claims not known or made to the insurance company during the coverage period. What this means is that there is a risk of an unknown or unreported claim being made long after the policy period expires and it not being covered because the claim was made outside of the coverage period.
As you may imagine, moving from one type of policy to the other can be difficult – and dangerous. A claims-made form is okay is the right situations, but it has no guarantee of continued insurability, so if you are, for some reason, cancelled by an insurance company or you decide to shop prices and you switch to another policy to save money, you may not have coverage in the future for work or activities performed in the past. Some important aspects of ‘claims-made’ policies that you should be aware of include:
• the retrospective date;
• extended reporting periods, also known as ‘tail’ coverage (explained below).
If you do move from one insurer to the next with ‘claims-made’ coverage, you must (should) purchase tail coverage or your new insurer must (should) include a prior acts endorsement. With this endorsement, the new insurer assumes coverage for the prior acts occurring in the other carrier’s coverage period. Generally speaking, ‘claims-made’ policies usually cost less than an ‘occurrence-form’ policy, but you run the risk of not being covered for a potential claim because you didn’t discover it until after your policy expired. As with all other aspects of insurance, the decision is a gamble or calculated risk that you as the insured party must make, and you will usually pay a higher premium in order to lower your risk.
‘Tail coverage’, which may cost more if you want to purchase it, picks up where a claims-made policy leaves off, covering occurrences that happened while the policy was effective, but claimed after the policy expired. As a result, the combination of a claims-made policy and tail coverage looks very much like an occurrence policy, with one critical difference. When an occurrence policy expires, the premiums stop while the coverage (on occurrences that happen during the policy period) continues indefinitely. Tail coverage, on the other hand, is something you purchase after your claims-made policy expires, and you continue to pay for it until you decide that the risk of discovering an old occurrence no longer outweighs the cost of the tail coverage premium.
Full tail coverage (which can sometimes be up to 200% of the policy’s original annual premium) is essential when you retire from business or when you change insurers or policies. When changing insurers, you must carefully consider the ‘true cost’ of cheaper coverage (due to its limited exposure) against the other cost of purchasing “tail” coverage from your old carrier.
Basic ‘tail coverage’ is sometimes free of charge but covers only those claims that have been reported during the policy period or 60 to 90 days thereafter and while the original limit is not yet exhausted. Supplemental ‘tail coverage’ must be purchased to cover claims that were not reported during this period. Both coverages apply only to claims stemming from injuries or damage that occurred during the policy period back to the retroactive date. It does not cover claims that occurred prior to such date, nor those occurring after the policy expires.
To put it more simply, the cost of an ‘occurrence’ policy is higher, but fixed, whereas the cost of a claims-made/tail coverage combination is initially lower, but of longer duration and potentially of higher total cost. The decision of which to buy effectively hinges on the nature of your perceived risks.
If your business or work is such that any liability is immediately apparent – and thus claimable – you are probably safe with a claims-made policy. However, if your potential liability can go undetected for a long period of time, such as with a company that pours residential foundations which may fail three years in the future, then you may be best served with an occurrence policy.
‘Occurrence’ coverage, as’ already mentioned, is insurance that provides coverage for the act when it occurs – regardless of when it is reported. If you had coverage under an occurrence policy in 2005 and the claim is reported today (the foundation dropped, improper wiring caused a fire, etc) then the claim is covered.
‘Claims-Made’ versus ‘Occurrence’ – Which Policy Type Should You Choose?
To most insurance consumers, especially those concerned with only the price alone, this whole topic can be more than a little confusing. In an effort to simplify the decision-making process of which policy type is right for you, you should look at the major differences below.
• Premium Cost – ‘Claims-made’ policies are often much less expensive than ‘occurrence-based’ policies. The premium difference can be negligible or, depending upon the carrier, it may be as much as 50% or more.
• Coverage Amount – Under an occurrence policy, coverage is the amount of coverage under the policy in the year of the occurrence. So, if you were just starting out in business or you were trying to save money and you opted for only $100,000 of coverage versus the standard $1,000,000 used by most policies, you may be under-insured against a claim (and legal fees) arising in the future for you work or activities performed in the past. A ‘claims-made’ policy covers you at the level of insurance you have when the claim is made.
• Long Term Cost – If you begin with a ‘claims-made’ policy from the start, it may be cheaper in the long-term if you maintain this claims-made coverage from now on as you may save a great deal in annual premium each year over an ‘occurrence’ policy. However, if you begin with an ‘occurrence’ form, you should make certain that your initial limits of coverage are adequate to cover any future claims that may arise years from now. You may pay more in premiums, but you have the peace of mind in knowing that you will always be covered against losses occurring during this policy period.
• Choice of Insurers – This is more important that it may first appear. Believe it or not, insurers can and do go out of business for any number of reasons. It is uncommon, but it does happen. If you elect coverage from an insurer with a lower AM-Best financial rating, there is a chance that the insurer may become insolvent and that it may not be around to address any claim that may be filed against your policy in the future – which means that you are uninsured. If you have purchased an ‘occurrence’ form from a lower-rated insurer and that insurer becomes insolvent three years after your policy expires, and then a claim resulting from a latent-defect is made in the fourth year, you have no insurance protection at all.
• Type of Business – Certain businesses or industries must have occurrence policies or have a risk policy in place that guarantees the purchase of prior acts endorsements and tail coverage without fail. Construction businesses (including ‘rehabbing’ and remodeling) where defects may not be discovered for years, are good examples of candidates for this type of coverage. Other businesses have a much lower risk of claims occurring much past the transaction with the customer (such as a mechanic) and can safely choose ‘claims-made’ coverage.
• Availability – Since ‘occurrence’ coverage keeps the insurer ‘on the hook’ for future claims for an indefinite period of time, they are obviously less inclined to offer this type of coverage form, especially for specific high-risk industries like automobile manufacturing where product recalls, costing hundreds of millions of dollars, may occur many years after the policy is out of force and no premiums have been paid. While ‘occurrence’ forms are still available, ‘claims made’ policies are what are normally issued by most insurance carriers these days.
If you have questions, or you would like to speak with someone regarding liability insurance or exposure, please feel free to call our offices at (800) 299-8994 or (512) 986-6124 and we will be happy to answer any questions that you may have.