There are many choices in the commercial insurance marketplace when it comes to insurers and types of insurance policies. Often, these choices come with a wide range of pricing options. Because the options can vary so greatly, insureds often struggle to understand what the true value is of what they’re purchasing and whether some options are worth the bigger price tag.
For those with specialty risks, such as doctors, other healthcare providers and public entities, three types of commercial liability insurance policies are typically available: occurrence, claims-made and claims-paid. Each has advantages and disadvantages, and it would be a mistake to simply choose an insurance policy based on price without understanding what is being purchased.
Let’s examine some of the intricacies of the three forms.
The occurrence form is the most common liability policy available. An occurrence policy is one in which the insurer provides coverage for damages that the insured is legally obligated to pay if the occurrence takes place during the policy period, coverage applies and the insured was not aware of the incident or claim prior to coverage being bound.
This is the broadest coverage available. An occurrence may happen before or during the current policy period, but as long as the damages occur during a policy period in which coverage was purchased, coverage would apply. Accordingly, claims may be made during the policy period or for any time thereafter.
Occurrence policies very often respond to claims filed many years after a policy has either expired or even when an insured changes carriers. As such, occurrence policies can often be more expensive than their claims-made and claims-paid counterparts.
A claims-made policy is very commonly used for specialty risks. This policy is one in which the insurer provides coverage for claims that are made during the policy period, regardless of when the incident occurred.* Most professional, errors and omissions (E&O), directors and officers (D&O), and employment practice liability policies are written on these forms.
As with occurrence forms, this coverage also depends on the timing of the claim itself. A claims-made policy will only respond to a claim that is made during the policy period—regardless of when the incident occurred.*
Claims-made policies are often the only choice insureds have for certain lines of coverage. However, many insureds opt for a claims-made policy for its benefits, which typically include lower premiums (the insurer is covering a limited, defined period), and knowing for certain that their current insurer will be the one who responds to a claim when the claim is actually filed.
However, it is critically important to understand what constitutes a “claim” under this type of policy, because once the definition of a claim is met, insureds have a contractual duty to respond to the insurer. This aspect of a claims-made policy brings with it stringent reporting requirements. Hence, not only does a claims-made policy reduce the time in which an insured has coverage, it also adds administration responsibilities that insureds sometimes find intrusive and burdensome.
A claims-paid policy is also commonly used for healthcare-related and public entity risks. This policy is one in which the insurer only provides coverage for claims that are actually paid during the policy period.
Under a claims-paid policy, it doesn’t matter when a claim is filed or when the incident that brings rise to the claim occurs (both of which are highly important on other policies). It only matters that the claim is paid during the policy year. This is very important to note because often insureds have exposures that could exist both before the current policy period and after the policy period.
Very restrictive in nature, a claims-paid policy is almost always less expensive than a claims-made or occurrence policy. It is also the least common of the three policy types discussed here.
Claims-paid policies can leave insureds in a tough spot if they want to cancel coverage or change carriers. Insureds cannot simply cancel their policies or change insurers while a claim is pending or if an incident has taken place that they are aware of that could give rise to a claim, unless they’re willing to pay claims out of their own pocket. This makes it extremely difficult to hold the insurer accountable for their pricing and/or underwriting methods.
Under a claims-paid policy, the only way to make a change in insurance providers while guarding against being uninsured would be to purchase an extended reporting period (i.e., “tail” coverage) from their existing carrier upon exiting the relationship. This option can often add significant costs. Another option would be to buy “nose” coverage from the new insurer to ensure coverage exists without any gaps, again adding additional costs. Hence, while claims-paid policies look attractive up front, it’s important to understand that the initial savings often come with hidden costs later.
Making Real-World Sense of Policy Types
Exploring a single scenario to see how each type of policy responds—or doesn’t—is a useful exercise for understanding the benefits and challenges of each policy type. Consider the following example:
On July 1, 2016, the insured local township’s police officer is involved in a traffic stop that subsequently ends in the arrest of the motorist. On Jan. 15, 2018, the apprehended individual files a claim against the township for excessive use of force. The insured township files the claim with its insurer on Feb. 1, 2018. Ultimately, the incident is resolved and damages are awarded to the plaintiff on Jan. 10, 2019.
How will each policy respond?
Occurrence Policy. The policy that was in place on July 1, 2016 (1/1/16 – 1/1/17), the date of the occurrence, will be the policy that responds. This is true regardless of whether the insured was still covered by the carrier both when the lawsuit was filed on Feb. 1, 2018, or when the claim was eventually paid on Jan. 1, 2019.
The insured benefits from the peace of mind, knowing that coverage existed at the time of the event and that coverage will apply regardless of who the present insurer is and the time of the resolution.
Claims-Made Policy. Under a claims-made policy, once the definition of a claim is met and, as required, the insured reports the claim to the insurer, the policy that is in place on that reporting date will be the policy that responds. For this example that date is Feb. 1, 2018 (1/1/18 – 1/1/19).
This policy will remain the policy that responds regardless of when the claim is eventually paid or settled. This policy will also be the one that responds even if the insured moves to a different insurer—so long as the claim was filed and acknowledged by the carrier prior to 1/1/19.
Claims-Paid Policy. In this example, the claim was paid on Jan. 10, 2019. Thus, the policy that will respond is the Jan. 1, 2019 (1/1/19 to 1/1/20), policy. Under a claims-paid policy, the policy that is in place when the claim is paid is always the policy that responds.
What’s important to think about in this example is that if the insured were to consider changing carriers or canceling coverage after the claim was first reported (and prior to the settlement), the insured would be financially responsible for the entire claim, including both defense and indemnity costs. In addition, the insured would be responsible for any other known and unresolved claims or incidents that occurred while the policy was in effect.
What options do insureds have in these cases? They can remain with the insurer until the claim is settled and/or closed—which could take a long time. Keep in mind, an insured could be at the mercy of the insurer during this period. The next option would be to change carriers if an insured chose to do so. This decision brings forth the risk of assuming 100 percent financial responsibility for defense and indemnity for any and all open claims or incidents. The last option would be to commit to changing carriers and to pay for tail or nose coverage to address any open and existing risks.
As you can see, the three policy types reviewed here are noticeably different. All three have different policy years that could respond to this specific example.
Up front, a claims-paid policy certainly could look attractive, offering the benefit of lower premiums. However, if the insured wants to cancel or change carriers at any time, the difficulty, risk and added expense may not be worth the initial perceived savings.
Your local Hylant insurance expert is always ready to help you explore your options and make recommendations aligned with your organization’s risk management goals.
The above information does not constitute advice. Always contact your insurance broker or trusted adviser for insurance-related questions.
* For simplicity and brevity, retro dates of inception and extended reporting periods are not discussed here. Ask your risk adviser for more information, if interested.