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Why Your Retroactive Date Matters

Generally speaking, professional liability (also known as Errors and Omissions or E&O) insurance provides coverage for claims arising out of acts, errors or omissions in rendering professional services. When considering E&O insurance one very important consideration beyond the basic scope of professional services covered is the extent of prior acts coverage afforded by the policy. With very rare exceptions, for the past several decades E&O insurance has been written exclusively on a "claims made" rather than an "occurrence" basis.

Your automobile liability policy would be typical example of an occurrence policy form. For instance, if during your policy period you caused a car accident, coverage would be triggered by that occurrence, regardless of when the actual lawsuit was ultimately filed against you.

By contrast, under a claims made policy coverage is not triggered by the accident or wrongful act, error or omission, but rather by the reporting of a claim or potential claim within the policy period. In addition there is, in a sense, an occurrence requirement in that the act, error or omission that gave rise to the claim must have occurred on or after the retroactive or prior acts date of coverage. Normally, this is the date from which the insured has had continuous, uninterrupted claims made coverage. This is why it is critical to obtain and maintain E&O insurance from the very inception of a professional practice.

The reasoning behind the industry-wide reluctance of underwriters to insure prior coverage gaps is the perceived moral hazard of allowing insureds to delay purchasing coverage for years until such time as the need for insurance becomes pressing and apparent. Insurers would thus become subject to adverse selection which can significantly skew the actuarial projections underwriters rely upon to maintain financially sound and sustainable insurance programs. In addition, underwriters generally consider professionals who neglect to secure appropriate insurance coverages as lacking in judgment and an appropriate sense of professional responsibility, making such practitioners less desirable as potential insureds.

Another important aspect of claims made coverage is the fact that the exposure under the policy is constantly expanding. For example, consider a professional who started his practice in the year 2000 and obtained claims made coverage at that time. During the first year of coverage the risk of a claim is quite low in that the insured would have to make a mistake, which would then have to be discovered and cause damage and result in a suit all within the first year.

For this reason first year claims made policies typically cost less than policies issued in subsequent years. The exposure under this same professional's current policy, years down the road, would have grown to encompass all the real or imagined errors or omissions contained within that practitioner's entire body of work over many years in practice.

In light of this expanding exposure, insurers apply "step-rate" prior acts factors in calculating renewal premiums. The application of these factors result in higher and higher premiums assuming all other factors remain constant. Ultimately, however, these step-rates do level off when the policy is deemed to have reached maturity. For most carriers, step rate increases are applied during the first 3 to 7 years of coverage. After that, whether the insured has 10 years or a 100 years of prior acts coverage, the premium would remain constant.

A final consideration with respect to "claims made" policies is the need for extended reporting period or "tail" coverage once the practitioner retires or otherwise ceases to practice. As noted above, coverage under an E&O policy is only triggered by a claim being made against the insured and reported to the carrier within the policy period. Thus, if an expiring policy is not replaced with a new in-force renewal policy, all coverage for claims which may arise out of the insured's prior work ceases.

A tail endorsement resolves this problem by extending the claims reporting period beyond the policy's normal expiration date. The cost of such an endorsement can range from absolutely nothing to 500% or more of the expiring policy's full annual premium. Moreover, the duration of the extended reporting period provided by a tail endorsement could be as little as 30 days to as much as an unlimited period. So it pays to carefully consider a carrier's tail options, especially as an insured approaches retirement age.

Hopefully, this article has helped to disperse some of the fog surrounding the topic of prior acts coverage under a claims made policy. For more information or clarification, please do not hesitate to contact us at your convenience.