What Is an Occurrence-Based Policy vs. a Claims-Made Policy?
A liability insurance policy helps pay for expenses related to a loss suffered by another person or business that occurred on your property or because of your negligence, error or omission. It covers your legal defense, as well as any costs you must pay to remediate the damage you caused. Some liability policies will even pay for reputation recovery or other crisis response.
But all of that depends on whether you have coverage for the claim at the time it’s made. Let’s look at the two main types of liability coverage: occurrence-based and claims-made.
It’s all about the timing
When establishing a liability policy, you’ll have to choose whether coverage will be on an occurrence or claims-made basis. The coverage difference between the two depends entirely on timing — when the alleged incident occurred and when the claim or lawsuit was filed.
An occurrence-based liability policy applies to claims made for incidents that occurred during the policy term, even if the policy has lapsed by the time the lawsuit is filed. If you had an active occurrence policy when the incident happened, it will cover the claim even if it is filed after the policy has expired.
There are two important qualifications for claims-made policies. A claims-made policy will only cover claims that are filed during the policy term, and it will only apply to incidents that occur during the active policy period.
Most liability policies are written on a claims-made basis, usually due to cost. For an additional fee, however, you may be able to choose a “retroactive date” for your policy. A retroactive date, also called “prior acts” coverage, provides coverage for incidents that occurred before your policy’s start date.
For example, say you have a policy active from Jan. 1, 2022 through Dec. 31, 2022, and you opted for a retroactive date of July 1, 2021. A claim comes in for an incident that happened in August 2021. Even though your policy didn’t start until January 2022, you would still be covered because the event happened after your set retroactive date.
Selecting prior acts coverage is usually a wise move whenever you are (a) changing liability policies or (b) purchasing liability coverage for the first time, even though you’ve been in business for a while.
If you’re considering prior acts coverage, there are a few factors to keep in mind:
- Backdating your policy to an earlier date will ensure you are covered if someone makes a claim for an old incident under your new claims-made policy.
- If you are purchasing liability protection for the first time and request a retroactive date, expect your motives to be scrutinized to make sure you are not suddenly purchasing liability coverage to address a claim you suspect is coming.
- A retroactive date is more expensive. Higher premiums are justified because of the additional risk the insurance company is assuming.
- In the long run, it is generally more financially prudent to purchase liability insurance when first starting a business.
- Once you select a retroactive date, it remains the same every year the claims-made policy is renewed, offering you protection from the current policy expiration date backward. If you allow the policy to lapse, all coverage is lost, and a new retroactive date would need to be selected and paid for through a new policy.
Another option for extending the time covered by a liability policy is what’s known as “tail coverage.” Whereas retroactive coverage extends protection to prior acts, tail coverage protects against claims that pop up after your liability policy term ends.
This is an attractive option if you are closing your business but are concerned that someone may file a claim after you have canceled your policy. It may also provide a protective buffer when switching to a new policy.
- The extended period of protection begins after the original policy period ends, and it typically lasts for 30 to 60 days.
- Longer buffers, even up to a year or more, are possible for an additional cost.
- An “unlimited tail” may also be available to cover any future claims for incidents that occurred when the policy was active. This option is typically a set percentage in excess of your last year’s premium, such as 175%.
- Tail coverage is a one-time fee.
- It does not cover incidents that occur after the primary policy ends. In other words, you would not be compensated for any incidents that happen during the tail coverage period.
Pros and cons
What are the factors you should consider when choosing one type of policy over another?
Cost — Occurrence-based policies are typically more expensive, but their protection continues even after the policy lapses and the limits remain as originally set. Claims-made policies can be less expensive, but they only cover incidents that both occur and are reported during the policy term.
- Claims-made premiums often become more expensive because the policy covers greater periods of time each year, back to the retroactive date. The increase in premiums continues until the policy matures, generally after five to seven years. This is when a loss pattern is established and the premium stabilizes.
- If you keep the same claims-made policy for several years and then decide to end that coverage with a tail, the total cost paid will be similar to what you would have paid for an occurrence-based policy covering the same time period.
- The cost of a tail might not be a factor if the policy offers free tail coverage for death, disability or permanent retirement.
- When considering a claims-made policy, the additional expense of retroactive dating and tail coverage must be factored in for fair comparison to the occurrence-based premium.
Flexibility — An occurrence-based policy keeps the same parameters as originally purchased, while a claims-made policy will apply changes to coverage or limits retroactively. This makes it possible to expand or add to your claims-made coverage in the future but still have it apply to previous policy years.
Portability — Claims-made coverage can shift from one insurance company to another by transferring the prior policy’s retroactive date and adding it to the new claims-made policy. However, as with any policy change, you should carefully review the details to ensure that no exclusions or important coverage is lost even though the coverage dates remain the same.
Portability isn’t an issue for occurrence-based policies. Since it is permanent, an occurrence-based policy will cover any claims made while it was in effect, even years later.
Choosing the right type of policy
There’s a lot to consider with the differences in cost, timing and coverage between occurrence-based and claims-made policies. Your insurance professional can help you decide which type of liability insurance gives you the best protection at your price point. The key is to minimize any gaps so you have the most complete coverage for your premium.
Timothy G. Russell, CPCU
trussell [at] therussellagency [dot] com
The Russell Agency, LLC
317 Pequot Avenue
PO Box 528
Southport, CT 06890
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