Pitfalls of Claims-made Liability Policies

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Are you insured under a claims-made policy? Perhaps your company has purchased employee benefits liability coverage that applies on a claims-made basis. Or maybe your firm provides a professional service such as accounting or architectural design that is insured under a professional liability policy. Claims-made policies have a number of features in common. Yet, they are not all the same. Policies may differ in ways that may not be obvious to an insurance buyer.

Here are some things to watch out for when evaluating a policy or comparing one with another.

What is a Claim?

The meaning of the word claim can vary from one policy to another. Some policies, such as the claims-made version of the ISO general liability policy, don't define this term at all. When a term isn't defined, its meaning it open to interpretation. This is generally beneficial to the policyholder.

In many claims-made policies, a claim includes a written demand for damages or the service of a lawsuit. In some policies, the term may include, say, a written demand for arbitration or a criminal indictment. (Most liability policies don't cover criminal acts but some will cover the cost of defending you against certain criminal indictments if you are ultimately proven innocent of the charges.)

Coverage for Potential Claims

Some claims-made policies afford coverage for potential claims. A potential claim is an event or situation that has not yet generated a claim but that might result in a claim in the future.

For example, suppose you are a tax accountant and are insured for professional liability under an accountants professional liability policy. A client of yours sends you a letter complaining that you  botched her federal income tax return. She claims that you filed the return late and overlooked a major tax loophole.

As a result, she missed a tax write-off and had to pay a penalty and interest. She has not filed a lawsuit or demanded restitution.

If your policy provides coverage for potential claims, it will dictate how such events must be reported to your insurer. For instance, it might require you to provide immediate notice of any potential claim. In that case, you must notify your professional liability insurer of the client's letter right away. If the client later demands compensation or files a lawsuit, the claim should be covered.

When a Claim Must be Reported

Some claims-made policies (called claims-made-and-reported policies) stipulate that a claim must be made and reported during the policy period in order to be covered. Many policies are less restrictive, stating only that a claim must be reported as soon as possible. No matter what type of policy you have purchased, it is important to understand the claim reporting requirements. For instance, your policy may require that you send the insurer a copy of any demand, notice or complaint you have received. The policy may specify an address to which these items must be directed.

When is a Claim Considered "Made"?

Claims-made policies cover claims made during the policy period.

But when is a claim "made?" Some policies include a specific statement. For example, a claim may be "made" at the earlier of when: you or another insured receives notice (perhaps from the plaintiff's attorney), or when the insurer settles the claim.

Some policies don't specify when a claim is considered "made." Again, the absence of a specific provision generally benefits the policyholder. Typically, a claim is "made" when you receive a legal complaint or a letter demanding restitution. If you and or insurer disagree as to whether a claim has been made, you or your insurer can ask a court to resolve the debate.

Meaning of Professional Services

Many claims-made policies cover claims or suits that arise out of errors, omissions or negligence you commit while providing a professional service. For example, suppose you operate an accounting business and are insured under an accountants professional liability policy. The policy will describe the types of accounting services that are covered by the policy. The policy may contain a defined term called professional services. Alternatively, the services that are covered may be listed in the declarations or elsewhere in the policy.

Wherever the covered services are described, it is important to ensure that the description matches the activities your business performs. This is especially important if you offer services that others in your professional may not perform. Your insurance agent or attorney can help you determine whether the description of professional services in the policy is broad enough to meet your needs.

Punitive Damages

Many claims-made policies exclude coverage for punitive damages (also called exemplary damages). Punitive damages are designed to punish a wrongdoer for particularly bad behavior. Punitive damages differ from compensatory damages, which are intended to indemnify (reimburse) an injured party for losses he or she has sustained.

Laws regarding the insurability of punitive damages vary from state to state. Some states bar insurance that covers such damages while others do not. Some states permit the coverage of punitive damages under certain circumstances.

Some claims-made policies specifically cover punitive damages that result from unintended conduct in states where insurance of such damages is permitted by law.  Some policies are silent regarding punitive damages. While silence is better than an outright exclusion, wording that actually covers punitive damages is preferable.