Avoiding Gaps in Coverage When Changing Insurance Carriers
Imagine you are a risk-management decision-maker who has successfully transferred your firm's errors and omissions (E&O) and malpractice professional liability insurance to a new carrier that has acknowledged your organization's stellar claim history by providing a considerable premium savings. On the other end of the spectrum, perhaps you are the risk-manager of a non-profit organization and you are relieved that you were able to secure new organizational and management liability insurance after the prior insurer declined to renew because of claims alleging misconduct by a volunteer and inadequate oversight by the board.
Unfortunately, these feelings of self-satisfaction are likely to be fleeting because a change in insurance carriers may actually create surprising gaps in coverage for unwary policyholders. Often, however, the potential hazards may be avoided by carefully coordinating the expiring and replacement insurance coverage and by identifying circumstances that can give rise to future claims.
Understanding Claims-Made Policies
Some of the types of coverage that are most sensitive to a corporation, a professional organization (whether a corporation or a partnership), or an individual manager, director or officer generally are written on a "claims made and reported" basis (or simply, claims-made policies.) Typical claims-made coverage includes directors and officers (D&O) liability; fiduciary liability; professional liability (including E&O and malpractice); non-profit organizational liability (including coverage for managerial liability because of employee/volunteer sexual misconduct); private equity, venture capital and investment company organizational liability; and media liability. These types of coverage frequently apply to "bet-the-company" or "bet-your-reputation" claims that require the attention of officers, managers, directors or owners.
So, what is it about claims-made policies that creates risks for policyholders when transferring coverage from one insurer to another? Generally, these policies provide coverage for "claims" arising out of "wrongful acts" (defined differently from policy to policy) that are made against an insured and reported to the insurance company during the relevant policy period. Claims may include, but are not limited to, written demands for damages, lawsuits, arbitration demands and some types of investigations. Typically, claims-made policies incorporate protections (such as a short period for reporting claims after the policy period expires) to provide for the small subset of claims that are brought during the waning days of a policy period and that the policyholder is not able to report before the end of that policy period. Given how simple this looks, it might not seem that there is much risk in changing insurance carriers. After all, a claim against an insured is covered by the policy that is in effect when that claim is brought. But these policies are not as straightforward as they may first appear, because claims-made policies typically contain several terms and/or exclusions that can create a gap in coverage when changing insurance carriers.
If you look at the declarations page in one of your organization's claims-made policies, you will see a date often identified as the "retroactive date" or "prior and/or pending date" (the "retro date" for simplicity's sake). If your organization has kept the same insurance carrier continuously over an extended time, the retro date may reach a decade or more into the past. If your company has gone public, implemented an ESOP or undergone some other significant change in structure, the date of that event often will be identified as the retro date. The retro date is in the declarations section of your insurance policy for a reason: it is tied to a provision typically found in either the conditions or the exclusions portion that generally states that the policy does not apply to claims arising out of or relating to (in whole or in part) the same wrongful acts as were alleged in a claim brought prior to the retro date. If your company has had the same insurer for a decade and has not undergone any major change in corporate structure, it is easy to take the retro date for granted because it is unlikely that a claim brought today will involve the same alleged wrongful acts that were at issue in a claim brought many years ago.
If you change insurers, however, the new insurance carrier initially may be unwilling to offer the retro date provided by your prior insurer. A carrier that is new to your insurance program will sometimes request a new retro date that is the same as the beginning date of your new policy. The rationale is that the insurer does not want to be liable for claims that are related to earlier claims that were covered under a prior policy. While the insurer's concerns may be understandable, changing retro dates can create gaps in coverage and should be avoided. The possible consequences of changing a retro date may extend beyond just the insurance policy that contains it, particularly if the change is made to a primary policy that underlies excess policies that incorporate the terms of the primary policy. Fortunately, however, it often is possible to convince a new insurer to maintain the retro date contained in the expiring insurance policy, particularly if the policyholder is not undergoing a change in organizational structure and has a strong claim history. If not, there may be other solutions as discussed below.
Beware of Prior-Acts Exclusions
If your organization is moving a line of claims-made policies to a new insurer because the prior insurer declined to renew coverage or sought a sizeable premium increase—for example, due to adverse claims experience or because your company is in a challenged industry—it may face the imposition of a "prior-acts" exclusion. Depending on the particular wording, this exclusion seeks to bar coverage for claims arising out of, involving or based on wrongful acts committed before the start of the new policy period. This exclusion can take a number of forms. For example, it might apply to all claims arising out of any prior wrongful acts or to claims arising out of some identified sub-group of prior wrongful acts. The ultimate effect of this exclusion is to change the nature of the coverage into something that is more like "occurrence-based" coverage insofar as the policy arguably now provides coverage only for claims arising out of wrongful acts that were committed during the policy period of the insurance issued by the new insurer. In nearly every situation, it is in a policyholder's best interest to avoid the imposition of a prior-acts exclusion.
If, however, it is not possible to negotiate the elimination of a prior-acts exclusion, it may be possible to limit the application of the exclusion to a more discrete universe of claims and/or acts. For example, if your organization expects future claims because of an identifiable transaction or series of transactions, it may be possible to negotiate the limitation of the prior-acts exclusion to claims arising out of that particular transaction. The crafting of a limited prior-acts exclusion requires considerable care and attention to the possible implications of what may seem like formulaic wording. Too often, we have seen situations in which what appeared to the policyholder to be an adequately worded limited prior-acts exclusion was interpreted by an insurance company far more unfavorably than the policyholder or other insureds (usually individual officers or directors) had expected. The cost of getting the language right pales next to the small fortune it can cost a corporate or individual insured to dispute an insurer's interpretation of a limited prior-acts exclusion. When negotiating a prior-acts exclusion that is limited to specific prior acts, seemingly minor details in wording should not be ignored because a disagreement can lead to a dispute with an insurer and the high cost of defending or settling claims may wind up coming out of your own pocket.
Take Precautions to Minimize Risk
Although policyholders are not without ways to minimize their risk, self-protection requires timely action. Language varies, but claims-made policies typically contain a provision allowing an insured to give its insurer notice of circumstances that may reasonably be expected to give rise to a claim of the type covered under the relevant insurance policy. In principle, providing a notice of circumstances "locks in" coverage for claims arising out of the alleged wrongful acts identified therein. As such, if a policyholder is aware of a possible wrongful act that may run afoul of a retro date or a prior-acts exclusion in a new insurance policy, it can attempt to preserve coverage for claims involving that possible wrongful act by providing a notice of circumstances under the soon-to-expire insurance policy. Practical difficulty, however, lies in providing the proper balance of specificity and generality in a notice of circumstances so that it satisfies an insurer while providing the policyholder with enough flexibility in dealing with unexpected claims. Also, circumstances for which notice was provided under a prior policy likely will need to be disclosed on an application for new coverage, and a policyholder should be aware that coverage for claims related to those circumstances may be excluded under the new coverage. Thus, before submitting a notice of circumstances shortly before the expiration of an insurance policy, diligence and careful reflection must be used in identifying what to include in the notice, crafting the scope of the notice and assessing the possible consequences of the notice on new insurance coverage.
In addition, claims-made policies almost universally give the policyholder the right to purchase an additional extended reporting period in the event of the termination or non-renewal of the current insurance policy. Under an extended reporting period, claims made during that period arising out of wrongful acts committed prior to the original expiration date should be covered under the terms of the expiring insurance policy. An extended reporting period, however, is not indefinite. The length of the available period is typically identified in the relevant insurance policy, although it may be possible to negotiate a longer period. Moreover, the option to purchase an extended reporting period must be exercised within the time defined by the relevant insurance policy. In addition, the purchase of an extended reporting period requires the payment of an additional premium, which is generally stated in the insurance policy and may be a multiple of the premium of the expiring policy.
Changing carriers in claims-made insurance programs is not a routine exercise. The process requires careful consideration of the benefits of the competing available policy terms, the pricing, and the health and reputation of the relevant insurance carriers. But the analysis does not end there. In order to avoid unexpected gaps in coverage, it is imperative that a risk-management decision-maker take into careful consideration possible gaps in protection that might arise, assess the best measures for addressing those gaps and take proactive measures to close them before it is too late.