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How Does a Claims-Made Insurance Policy Work?

A recent case decided by the Court of Appeals of the Commonwealth of Kentucky helps to answer this question.  The name of the case is Darwin National Assurance Company v Kentucky State University, and it was decided in March, 2021.

Are There Different Types of Business Insurance Policies?

There are generally two different types of business insurance policies.  The first is an occurrence policy and the second is a claims-made policy.  What is the difference?

What is an Occurrence Policy?

An occurrence policy covers conduct that occurred during the policy coverage period, irrespective of when the insured files a claim.  For example, let us assume that a business has a general liability policy that runs from January 1, 2020, to January 1, 2021.  This is called the “policy coverage period”.  Let us also assume that a customer enters the business premises on July 1, 2020, slips and falls and breaks his arm.  Finally, let us assume that the customer files a lawsuit against the business on July 1, 2022.

This claim will be covered under the occurrence policy because the incident giving rise to the claim occurred during the policy coverage period.  It does not matter that the claim was not filed during the policy coverage period and, in fact, was not filed until two years after the accident and 18 months after the expiration of the policy coverage period.

What is a Claims-Made Policy?

A claims-made policy covers claims that arise during the policy coverage period.  A claims-made policy often contains what is called a “retroactive date”.  Conduct that occurs before the retroactive date cannot give rise to a covered claim, even if the claim is first asserted against the insured during the policy coverage period.

In addition, a claims-made policy will require that the claim be reported to the insurance company within the policy coverage period or, if allowed by the policy, within a short period of time after the expiration of the policy coverage period.

To illustrate, let us assume that a business has a claims-made errors and omissions policy.  The policy coverage period runs from January 1, 2020, to January 1, 2021.  Let us also assume that the policy has a “retroactive date” of January 1, 2019, and that the policy requires that claims be reported to the insurance company either during the policy coverage period or within sixty days after the expiration of the policy coverage period.  Now, let us assume that the business is served with a lawsuit on March 1, 2020, alleging negligence that took place on July 1, 2019.

Assuming that the business did not have prior notice of the claim, the date of the claim is March 1, 2020, when the business was served with the lawsuit.  So, the claim falls within the policy coverage period.  In addition, the conduct that gave rise to the claim took place after the retroactive date.  Based on these facts, the claim should be covered under the policy.

However, whether the claim will actually be covered depends upon when the business gives notice to the insurance company.  As long as notice is given on or before March 1, 2021, which is sixty days after the expiration of the policy coverage period, the claim will be covered.  This was the issue in the Darwin case. 

The Facts of the Darwin Case

Kentucky State University (KSU) had purchased a professional liability insurance policy (the Policy) from an insurance company formerly known as Darwin National Assurance Company (Darwin).  The policy coverage period was July 1, 2014, to July 1, 2015.  The Policy covered KSU for “wrongful acts relating to employment practices”.

Further, the Policy provided that a claim was deemed to have occurred on the first day that KSU received notice of the claim and that KSU was required to report the claim to Darwin “as soon as practicable” after it received notice of the claim, but, in no event, later than ninety days after the expiration of the policy coverage period.  The Policy was a claims-made policy.

On September 2, 2015, two former employees of KSU sued KSU for wrongful termination.  The court’s opinion does not state the dates upon which the former employees were actually terminated.  However, it does state that, prior to filing their lawsuit, the former employees filed a claim with the US Equal Employment Opportunity Commission (EEOC) and that KSU was given notice of the EEOC proceeding on June 23, 2015.  KSU gave written notice of the lawsuit to Darwin on October 2, 2015.  In responding to the claim there were a number of questions that Darwin had to answer.

First Fact

First, it had to determine when the former employees were “wrongfully” terminated.  The court does not discuss this issue, so we have to assume that the former employees were either terminated during the policy coverage period or after the Policy’s retroactive date if the Policy had a retroactive date.  The court’s opinion does not mention a retroactive date.  In any event, since the court does not mention the date of termination, we have to assume that it was not an issue.

Second Fact

Second, Darwin had to determine when the claim accrued.  In this case, there are two options.  The first is June 23, 2015, when the former employees filed their claim with the EEOC.  That date is within the policy coverage period.  The second option would be September 2, 2015, when the former employees filed their lawsuit.  That date is not within the policy coverage period.  It is clear from the posture of the case that Darwin determined that the date of the claim was June 23, 2015, within the policy coverage period.

Finally, Darwin had to determine whether KSU gave notice of the claim within the time frame required by the Policy.  KSU gave written notice of the lawsuit to Darwin on October 2, 2015.  That was 93 days after the expiration of the policy coverage period on July 1, 2015.  Since the Policy required that notice be given no later than ninety days after the expiration of the policy coverage period, Darwin denied the claim for failure to provide timely notice.  This lawsuit followed.

Why Did KSU Sue Darwin?

The short answer is that KSU sued Darwin because everybody sues when they are unhappy in a business relationship.  However, this case would seem to be cut and dry.  KSU did not give notice to Darwin of the claim either during the policy coverage period or within ninety days after the expiration of the policy coverage period, as the Policy required.  Had the Policy been an occurrence policy, the late notice would not have mattered.

Under an occurrence policy, the only issue is whether the conduct giving rise to the claim occurred during the policy coverage period.  It would not matter when the former employees filed their claim against KSU or when KSU gave notice of the claim to Darwin.  As long as the former employees were “wrongfully” terminated during the policy coverage period, the claim would be covered.

But the Policy was not an occurrence policy; it was a claims-made policy, and the basic requirements of a claims-made policy are that the claim arise during the policy coverage period and that the insured give notice to the insurance company during the policy coverage period or any extra time provided by the policy.  The Policy gave KSU an extra ninety days to report a claim.  But KSU did not report the claim either within the policy coverage period or during the extra ninety days.

KSU sued Darwin, notwithstanding its failure to comply with the notice requirements of the Policy, by claiming that its claim was subject to the “notice-prejudice rule”.  The trial court agreed with KSU and entered summary judgment in its favor and ordered Darwin to cover the claim.  Darwin appealed.

What is the Notice-Prejudice Rule?

The “notice-prejudice rule” is a common law theory that requires an insurance company to prove that it has been prejudiced by the late notice of a claim.  In this case, according to KSU, Darwin had to prove that it could not properly defend against the claim because notice of the claim was three days late.

Is a Claims-Made Policy Subject to the Notice-Prejudice Rule?

The Kentucky Court of Appeals said that this is a case of first impression in Kentucky.  That means that no appellate court in Kentucky had previously ruled on this issue.  So, this court would be making new law in Kentucky.  This fact highlights an important point that we have made in several previous articles.  An insurance policy is a contract, and its interpretation is a matter of state law.  And the law of one state may be different than the law of another state.  While the court in this case looked to the law of other jurisdictions for guidance, it was not obligated to follow the law of any other state.  And no other state is obligated to follow its holding in this case.

So, What Did the Court Do?

Because the court had no Kentucky precedent, it looked to the Restatement of Liability Insurance for guidance.  Section 35(2) of the Restatement provides that:

With respect to claims first reported after the conclusion of the claim-reporting period in a claims-made-and-reported policy, the failure of the insured to satisfy the claim-reporting condition in the policy excuses an insurer from performance under the policy without regard to prejudice, except when:

a) The policy does not contain an extended reporting period;

b) The claim at issue is made too close to the end of the policy period to allow the insured a reasonable time to satisfy the condition; and

c) The insured reports the claim to the insurer within a reasonable time.

The court found that none of the exceptions in the Restatement applied.  The Policy did contain an extended reporting period.  KSU had 90 days after the expiration of the policy coverage period to report a claim to Darwin.  The claim at issue was not made too close to the end of the policy coverage period.  KSU received notice of the claim no later than June 23, 2015, which may have been only 7 days before the expiration of the policy coverage period, but was more than 90 days before the expiration of the extended reporting period.  As a result, the court found that KSU did not report the claim within a reasonable time.

In addition, the court found that there are policy reasons why the “notice-prejudice rule” should not apply to a claims-made policy.  First, the court said that an insurance company manages its risks based on the type of policy that it issues.  A claims-made policy is a way for an insurance company to limit its exposure.  It knows that, if a claim is not submitted by a certain date, there can be no claims under the policy.

On the other hand, because an occurrence policy does not require that a claim be reported to the insurance company within the policy coverage period, the company’s exposure extends as long as the statute of limitations for claims under the policy.  And, depending upon the nature of a claim, the statute of limitations can extend for as long as twenty years.  As a result, the premiums for a claims-made policy are substantially less than the premiums for an occurrence policy.  The court said that Darwin was entitled to the benefit of the bargain it made when it issued a claims-made policy to KSU.

Second, the court said that applying the “notice-prejudice rule” to a claims-made policy would rewrite the Policy.  Darwin and KSU negotiated a contract that required KSU to report a claim within a specific time frame.  And Darwin set KSU’s premiums accordingly.  Ignoring the reporting requirement would change the nature of the contract.  This is especially true when the insurance company offers an insured the ability to purchase an extension of the reporting period, which is often the case with a claims-made policy.

In the instance case, Darwin offered KSU the option of buying a three-year extended reporting period for an additional premium.  KSU declined that option.  It would be unfair to Darwin if the court granted KSU a policy option that KSU chose to not purchase.

For the foregoing reasons, the court reversed the decision of the trial court, declared that Darwin had obligation to defend KSU and ordered the trial court to enter summary judgment in favor of Darwin.

What is the Moral of the Story?

The moral of the story is that it is not enough for a business to simply have insurance.  The business must have the right insurance.  Can the business get by with a claims-made policy that provides less protection but costs less?  Or does the business need the enhanced protection of an occurrence policy even though it costs more?

In addition, insurance is complicated, and even a sophisticated business owner may not be able to understand the terms and provisions of an insurance policy.  The best way to ensure that a business is fully protected and gets the insurance that it needs is to consult with an experienced and independent insurance agent.

For a review of your insurance needs, contact RMC Group at 239-298-8210 or [email protected].