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As a business owner purchasing insurance for your company, not knowing the difference between claims-made and occurrence policies could prove to be a costly mistake. And whether you purchase a claims-made or occurrence policy will have a definite effect on not only how much you are paying for your coverage, but also what the lifecycle of your coverage will look like.
As far as some most common business insurance types are concerned, professional liability and directors & officers policies tend to be claims-made while most general liability contracts fall into the occurrence category.
Let’s take a look at what these two terms actually mean for you and the coverage that you’re purchasing.
What is an Occurrence Policy?
An occurrence policy will cover claims related to activities or events that occurred while your policy was in effect. Even if your policy expired or you canceled it, the claim would be covered if the event happened during the policy period. As a result, an occurrence form addresses those incidents that took place during a 12-month policy period but may not have surfaced as a claim until after the expiration date.
What is a Claims-Made Policy?
When you buy a claims-made policy, you will be covered if both the event and the claim arise while the policy is active and are reported during that time period. If you do not add the expired term to the subsequent policy period, you will lose coverage for any previously unknown claim that took place during the prior policy cycle. Therefore, all renewals must be properly structured to insure the historical business activities under a claims-made contract.
This is known as insuring “prior acts.” If this step is not taken, any coverage continuity will be severed resulting in protection gaps. Consequently, a claims-made contract must expand the coverage period and include historical events by increasing the policy term to reflect multiple years. This can be done through the use of a Prior Acts Endorsement or Retroactive Date Endorsement.
Another option you have is buying an extension for “tail coverage.” This is an amendment to an expired claims-made policy that will enhance your contract to include incidents that happened while your policy was active even if the claims are filed after your policy has expired. However, it should be noted that this is issued for a finite period of time, usually 3-5 years after the policy expires.
Understanding How Limits Work
When the time comes to purchase your insurance policy, you need to decide on an aggregate limit. An aggregate limit refers to the maximum amount of coverage that an insurer is willing to provide for the accumulation of paid losses during the policy period. In essence, you need to be thinking about how much coverage you want to have available.
Let’s take a look at the differences between occurrence and claims-made policy limits and how they work.
Policy limits are dedicated exclusively to incidents that fall within the defined 12-month policy term. Only those claims that are triggered by events that occur during the policy term, and ultimately paid, will erode the available policy limits. It is important to note that defense costs are typically provided outside of the policy limits and do not impact the available amount of insurance. Occurrence policy limits will, however, refresh every year at renewal.
Therefore, if your limit is $1 million and $500,000 was paid in claims during the prior policy year, your renewal limit would also be $1 million. However, you would still have $500,000 remaining on the expired policy for any new claims that are subsequently reported. As a result, you may have policy limits available for future use to insure historical unknown claims that surface.
The key aspect of determining claims-made limits is whether the policy addresses prior activities. In addition, unlike an occurrence form, these insurance contracts typically include defense costs within the declared limit. Therefore as policies renew, the policy limit could be stretched to insure longer periods of time beyond the 12 months and defense costs would erode the available amount of insurance.
Consequently, if you purchase a $1 million claims-made policy and $500,000 in claims were paid that year, any future claims reported after the expiration date should be insured by the subsequent renewal through a Full Prior Acts Endorsement or a Retroactive Date Endorsement, as we mentioned earlier.
As a result, your renewal policy limit would cover both the historical unknown claims from the prior policy as well as any incidents that surface during the current year. In this regard, your current claims-made policy is protecting you for a period of time longer than 12 months.
Unlike an occurrence policy, you do not have any residual limits protecting you for historical incidents under the expired policy. You are obligated to use your current policy limit to insure any unknown historical claims. However, if you secured “tail coverage” under your expired policy, then your historical unknown claims would be addressed and your current policy limit would not be affected.
Claims-made plans typically develop premiums for the ensuing policy year claims, while an occurrence contract will price for both claims reported for the coming year as well as future years. As a result, you should consider the following premium dynamics:
- Step Rates for Claims-Made Policies: When it comes to claims-made, both the incident and the reported claim must take place during the coverage period. This means that the risk of loss in the first year of the policy is fairly small and, therefore, the first-year premiums for claims-made coverage are usually less expensive. As you continue to renew your insurance policy, the period of coverage expands via a Full Prior Acts or Retroactive Date endorsement, thus exposing the insurance company to more risk. For the first four years of a claims-made policy, the premiums will change incrementally because past activities are included, which is called the claims-made step factor.
- Mature Rates: The risk of loss will normally level off by the fifth year of claims-made coverage, meaning that the claims-made step factor has reached a mature rate. Mature claims-made rates and regular rates for occurrence coverage end up costing about the same.
Claims Made vs. Occurrence Insurance Policy: Pros and Cons
Even when you understand the advantages and disadvantages that claims-made and occurrence policies offer, it’s hard to say that one type of policy is better in any way than the other. The real truth of the matter is that the only way to decide on which type you’re going to buy is to see which one better fits the needs of your business.
Convenience: One of the main advantages of occurrence policies is that there is less work involved in owning and maintaining them. This means that if you ever switch your insurance carrier, you won’t have to worry about being covered for claims related to incidents that occurred while you were being insured by someone else.
Claims-made policies are a bit more problematic if you switch insurers or cancel your policy. If you do end up switching to a new carrier, as previously stated, you need to purchase a Retroactive Date or a Prior Acts Endorsement, or possibly “tail coverage” to protect yourself. If you do nothing, protection for any historical claims that surface will disappear and you will be uninsured.
Coverage: Occurrence policies also offer greater peace of mind since the limit is applied to only a 12-month period. Conversely, your claims made limit could be exhausted sooner since it could apply to multiple years of risk.
Cost: Even if the limits are identical, occurrence policies are providing more coverage because the aggregating limits do apply to future claims, which is why they will be more expensive. But as we mentioned earlier, once you’ve been purchasing a claims-made policy for at least five years, this new mature policy rate will probably cost as much as a regular occurrence rate.
Conclusion: The characteristics of each policy type point to the fact that there is no simple answer in choosing which route to take. Administrative efficiencies, premium costs, and residual risks all contribute to the decision-making process when comparing occurrence to claims-made policies. Compounding this further is the fact that the insurance marketplace may ultimately dictate the type of policy form that is available.
It should be stressed that all businesses have unique insurance needs and that regardless of your company’s size, nature of your operations, and maturity, you should consult with experienced insurance experts and discuss whether claims-made or occurrence insurance policies best fit your company’s risk profile and coverage needs. If you need more help or information about protecting your business, you can reach out to our team of expert brokers to learn more.
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