We recently talked about claims-made and occurrence policies, discussing why businesses need to know the differences between these two policy types. This time around, we are going to be focusing in on claims-made policies, because prior acts coverage is something that every business that purchases a claims-made policy needs to understand.
In order to understand the significance of prior acts coverage, we need to first understand claims-made policies. If you need to buy startup insurance, especially if your company is a venture-backed startup, two of the most common necessary policies you will have to buy – errors & omissions and directors & officers – are typically claims-made policies.
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A claims-made policy will provide coverage in the case of a claim if both the claim arises while the policy is active and the event that sparked the claim also occurred during that time period. When you have purchased a claims-made policy, you need to take the policy renewal process very seriously, because it’s important to structure your renewals properly so that there are no gaps in your coverage under the claims-made contract.
If you fail to do so, or you want to be sure that you are covered for acts that might have taken place before you purchased your coverage, then you are going to need prior acts coverage.
Understanding Prior Acts Coverage
When you purchase a claims-made policy, the insurer will provide coverage for any liability or malpractice claims that occurred and were reported during the policy period. However, if the claim doesn’t arise in the same year as the actual malpractice misstep occurred (which isn’t uncommon), you won’t be covered by your claims-made policy. In such a case, you would need to obtain prior acts coverage.
To understand what prior acts coverage is and how it works, we first need to understand what a retroactive coverage date is and why policies have them. The retroactive coverage date defines limitations for your prior acts coverage.
When you purchase a claims-made policy, you are not covered for any acts of malpractice that might have occurred before the retroactive coverage date that is defined on your claims-made policy. The retroactive coverage date is usually the policy inception date of the first policy that you purchased, in the instance that you have been maintaining your coverage continuously without gaps since first purchasing your policy.
Even if the claim was made and reported during the policy term, if act in question occurred before the retroactive coverage date, you still wouldn’t be covered. Therefore, you would need to purchase prior acts coverage to provide protection for such incidents that occurred before you purchased your claims-made policy.
The Importance of Maintaining Continuous Coverage
Every professional liability insurance policy includes a “prior acts date.” This is essentially the starting line after which representations and activities will be considered as covered in the future.
Obviously, the best thing to do, in order to avoid potential gaps in coverage, is to make sure that your company is maintaining continuous coverage with your insurer so that no matter how many policies you have purchased, all of them will relate back to the original prior acts date.
This way, no matter how many years have passed since the first prior acts date, the current policy would provide coverage for claims that arise from events that occurred prior to the year in which the claim is made and reported, provided that the incident occurred after the initial prior acts date.
However, there are times when it is in the best interest of your company to change carriers, because of better pricing or more complete coverage, for example. In such instances, you could be facing gaps in your coverage, since your new policy would have a prior acts date that starts when the policy with your former carrier ends. This is a perfect example of a situation in which you would need to buy prior acts coverage in order to provide coverage for work that you have done before the prior acts date of your brand new policy.
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D&O and E&O Coverage Considerations
In the case of VC-funded startups, the management structure of these companies becomes fairly complex and involves a greater number of stakeholders. These changes in an organization’s structure open startups up to a greater potential number of D&O claims.
It isn’t uncommon for months and even years to pass after a wrongful act by a company executive has been committed before legal proceedings begin. This is why many D&O exposures are considered long-tail risks, meaning that a significant amount of time can pass between the act that created the liability and the legal recognition of the liability.
When purchasing a directors & officers policy, it’s important to take the time to understand all of the key conditions and possible exclusions that can determine the breadth of coverage your policy will provide. In most cases, a D&O policy will provide retrospective coverage for acts that were committed before the policy was purchased, as long as the insurer was notified of the wrongful act within the policy’s current period.
Many D&O policies are issued with unlimited retroactive cover, however, there are insurers that do limit exposure by enforcing a prior acts date, which is why it’s important to be fully aware of the coverage limits (if any) that your policy stipulates.
D&O policies often include significant exclusions, among them a prior or pending litigation exclusion. If this exclusion is included, then the insurer will not provide cover for claims that company management knew about before the policy’s inception and ones they should have reported in past policy periods. In such instances, a prior/pending litigation date will be enforced, excluding coverage for claims that relate to litigation that commenced prior to the stated date.
So for example, if a claim was filed against your company before this date and was later amended to include members of your management team, indemnity will be denied to your directors and officers as a result of the exclusion.
For these reasons, it’s important for board members and other company executives to be very prudent when securing a D&O policy. Most importantly, they should be very familiar with the claims-made reporting conditions that are offered to them and, whenever possible, they should insist on an unlimited retroactive date.
Professional liability policies operate very similarly, in the sense that they are almost always written on a claims-made basis. And just as is the case with D&O claims, the time between the act itself and when it becomes known can be months or years. One particularly tricky liability is pollution, given that the act itself can span years and that laws related to pollution could change significantly over that duration of time.
This is why the importance of maintaining your coverage should be reiterated. When purchasing D&O and E&O policies, it’s vital to maintain your original prior acts date even when switching carriers to make sure that you are covered for all acts that occurred after the original coverage date so that you are not resetting that date every time you renew your policies.
If you need help understanding the nuances of claims-made policies such as D&O and E&O and the significance and need for prior acts coverage, feel free to reach out to one of our licensed, expert brokers at any time.
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Directors and officers insurance protects your company’s management should they be personally exposed to liability claims for the business decisions and actions they made while running the business. The directors and officers policy, which usually protects the company as well, will cover the legal fees, settlements, and all other related costs that stem from allegations of breach of fiduciary duty, misrepresentation, or errors & omissions brought against your company’s board of directors or officers.