General liability coverage is insurance that responds to sums that the policyholder is legally obligated to pay as damages because of bodily injury or property damage to third parties (and generally will also include either a duty to defend such claims or to reimburse defense costs). Thus, general liability coverage would respond to such tort claims as slip-and-fall lawsuits and product liability exposures. In addition, most such policies also cover certain enumerated personal or advertising injury offenses (such as defamation or disparagement).
Most general liability policies are written on an “occurrence” basis. An occurrence-based general liability policy is triggered to respond by bodily injury or property damage taking place during its policy period, regardless of when the claim is made against a policyholder. Given multi-year statutes of limitations for many torts and the possibility of latent injuries, this means that it is frequently a prior year’s occurrence policy (or policies, for long-term injury claims) that responds to a claim that comes in during the current year.
But general liability coverage can also be purchased on a “claims-made” basis. Unlike an occurrence policy, a claims-made policy is triggered by a claim being made against the policyholder during the policy period, even if the injury took place before the policy period. Most claims-made coverage is actually “claims-made-and-reported” coverage, which requires that the claim not only be first made against the policyholder during the policy period, but that it also be reported to the insurance company during that period (or a short grace period). Another important feature of claims-made coverage is the retroactive date (usually called the “retro date”), which is generally set as the first date on which the policyholder purchased claims-made coverage, and which remains the same as that coverage is renewed. Claims-made policies generally will not respond to claims arising out of injuries (or in some cases, acts or omissions) prior to the retro date.
Claims-made coverage is often less expensive than occurrence-based coverage. Thus, in today’s hardening insurance market, policyholders who currently have occurrence-based policies may be looking into switching to a claims-made program, in order to save premium dollars. This post contains a list of key considerations for policyholders contemplating a switch from occurrence-based general liability policies to claims-made policies, both as to the differences in the coverage under each, and as to issues that should be addressed when switching from one type of program to another.
1. Claims-made policies generally have more stringent notice requirements: Under a claims-made-and-reported policy, the notice requirements generally are enforced more strictly than in occurrence policies. This is an area where policyholders can lose coverage if they are not very careful.
For example, an aspect of claims-made notice requirements that frequently causes problems for policyholders is that the policy requires notice when the claim was “first made,” and most policies have provisions: 1) defining a claim to include not only a formal lawsuit but also a demand letter, government investigation, and other less obvious communications, and 2) stating that claims arising out of the same facts and circumstances are deemed a single claim, all made at the time of the first such claim. Thus, if a policyholder receives what at first appears to be a baseless, minor, or inconsequential demand during one policy period, and fails to give notice of it, it can thereby lose coverage for any lawsuits that later arise out of the same alleged facts and circumstances.
Another frequent issue arises when “claim” is defined broadly, for example, to include any written demand for monetary or nonmonetary relief, and such a demand is made in the course of other communications that do not on their face appear to implicate insurance coverage. Such communications may be received by a department at the policyholder in which the personnel are unfamiliar with the notice requirements of the company’s insurance policies.
Policyholders with claims-made coverage therefore need to review the definition of “claim” under the policy and make sure that they have processes in place to capture and provide notice of anything that could be a “claim.” With a product manufacturer, for example, this could mean making sure that those reviewing warranty claims seeking replacement of defective products are aware that any allegation of bodily injury or property damage referenced in connection with such a claim potentially implicates insurance notice requirements. Similarly, an allegation of harm from the policyholder’s products or work may first arise in the context of a billing dispute—the personnel handling those disputes should be trained to recognize when an allegation made by a customer could implicate insurance coverage.
2. Cost savings in claims-made policies compared to occurrence policies decrease over time: Claims-made policies generally have lower premiums than occurrence policies, but that difference can be exaggerated in the initial years after a switch to claims-made coverage. As described above, a claims-made policy generally requires that the claim be made and reported during the policy period, and the injury take place after the retro date. The retro date is typically set as the start date of the policyholder’s first claims-made policy and remains the same as the coverage is renewed. As a result, in the first year of claims-made coverage, the insurance company only has exposure for claims that are made, reported, and involve injury, all taking place within a single year. Once the claims-made coverage has been in place many years, however, the insurance company’s exposure is greater: the claims still must be made and reported during that policy year, but the pool of claims includes those with injury at any time back to the retro date, which is now years in the past. In light of that additional exposure, the yearly premium for a claims-made program that has been in place for many years will be higher than the premium was in the first year, even if there are no other changes to the coverage. So while the cost of a claims-made policy is still likely to be less than that of an occurrence policy, the price difference will not continue to be as great as in the first year.
3. New exclusions added at renewal of a claims-made policy become universally applicable immediately: If a new exclusion is added to a claims-made policy at renewal, it will immediately apply to any future claims that fall within its prohibition. By contrast, if a new exclusion is added at renewal to an occurrence program, it will not necessarily apply to all the future claims that come in: because of statutes of limitations and the possibilities of latent injury claims, at least some of the new claims that come in are likely to involve injury triggering coverage under older policies, before the exclusion was added. Thus, it is easier for insurance companies to add, and take immediate advantage of, new exclusions when the coverage is claims-made.
Some commentators will point out that the same effect can work the other way as well, with broadened coverage or amendments that raise policy limits applying to all new claims immediately under claims-made policies, while under occurrence policies claims involving injury in prior years would not have the advantage of any such broadening of coverage. This effect is tempered, however, by the fact that any significant broadening of coverage under a claims-made program (particularly increased limits) is often accompanied by a new retro date applicable to the expanded coverage. If, for example, a policyholder purchases higher limits at renewal, the insurance company usually will add language that the retro date applicable to that additional coverage is the date those increased limits were first purchased, even if the retro date for the remainder of the coverage is many years before.
4. There are additional considerations when switching carriers on a claims-made program: As discussed above, if a policyholder continues to renew its claims-made coverage, the retro date will continue to be the date the first such policy incepted. If the policyholder decides to switch insurance companies, it will need to make sure the new insurance company will adopt the original retro date. Otherwise, the new insurance company likely will set the retro date under its policies as the date of the first claims-made policy it sold to the policyholder. This could create a significant gap in coverage for claims that come in during the policy period of the new insurance company alleging injury that took place under the policies of the old insurance company: unless the new insurer agrees to adopt the original retro date, such a claim would not be covered under either policy.
5. Depending on how the retro date is defined, a policyholder may need to purchase “tail” coverage in connection with a switch from occurrence to claims-made coverage: The discussion above has assumed that the retro date for the claims-made coverage is based on the time of the injury. It is possible that the claims-made retro date could be based on some other event, which could precede the injury (such as the acts or the “occurrence” that causes the injury—for example, the creation of a defect that later leads to injury). If that is the case, there could be a gap in coverage: the policyholder could have a claim where the new claims-made coverage does not apply because the relevant event precedes its retro date, but the old occurrence policy does not apply because the injury did not happen until after its policy period. Policyholders may be able to close this gap by purchasing “discontinued operations” coverage, which is a form of “tail” coverage for occurrence policies. This, of course, adds to the cost of the transition from occurrence to claims-made.
6. If the policyholder ever wants to switch back from claims-made coverage to occurrence coverage, it will need “tail” coverage to avoid gaps in coverage: If the policyholder later decides to switch back to occurrence coverage from claims-made coverage, it must take steps to avoid a major gap in coverage. Switching from a claims-made to an occurrence program, without more, creates a gap in coverage: There would be no coverage under either policy for any claims that came in after the switch to occurrence coverage, which allege injury taking place before the switch. The new occurrence coverage would not apply because occurrence policies are triggered by injury during the policy period, and here the injury preceded the occurrence coverage. The old claims-made coverage would not apply because the claim was not made until after the end of the claims-made policy period. And such a situation is by no means rare: due to multi-year statutes of limitations and latent injury torts, there is commonly a lag between when the injury takes place and when the resulting claim is made. As a result, a policyholder considering a switch from claims-made to occurrence coverage should seek to purchase “tail” coverage (in this context called an “extended reporting period”) for its last claims-made policy.
A switch from occurrence-based to claims-made general liability coverage is a significant alteration of a policyholder’s insurance program. Policyholders contemplating such a change should make sure they understand the ramifications of the switch and the steps they should take to avoid gaps in, or forfeitures of, coverage.
While this post discusses issues arising with claims-made general liability insurance in particular, similar issues arise with other types of insurance that are sold on a claims-made basis. For example, “Directors & Officers” and “Employment Practices Liability” insurance are both typically sold on a claims-made basis, without the option of occurrence-based coverage. Many of the points above about dealing with claims-made coverage apply to those coverages as well, such as the importance of making sure processes are in place to capture and report any “claims” that may implicate those policies.