Claims Made Coverage Death Trap
You could be unknowingly walking your client into a claims-made black hole.
I couldn’t believe what my agent just told me.
I was reviewing a directors & officers submission they just sent me. Good financials. Clean loss runs. So far so good. But one document caught my eye; a quick note regarding five open lawsuits against the insured.
I scanned the loss runs again to make sure they were clean. Yep, no losses, and the date showed that the loss runs were pulled pretty recently.
How does a company carrying D&O have five active lawsuits and 0 claims?
I went back to the agent. Turns out the insured never reported the claim. They weren’t sure if there would be coverage or not.
To be fair to the insured, this is a pretty common heuristic that many of us use when deciding to file claims. You ever dinged your car and asked, “should I report this? I need to check my deductible first. No reason to file and make my rates go up when I’m going to be the only one that pays anyway.”
It’s worth noting here that D&O insurance is very, very different from personal auto insurance, but I digress.
It’s what my agent said last that almost made me crap myself; “They didn’t want to report the lawsuits and start a claim.”
That’s…..not how claims work, at least not in claims-made coverages.
And getting this wrong means; not only does the insured not have coverage for that particular matter, but ANYTHING that’s related to that particular matter will also be barred from coverage.
This is the coverage death trap, the claims-made black hole that insureds and agents alike unknowingly walk into. In this article we’ll break down how claims-made coverages ACTUALLY work and why you should always report claims, even if you think there’s no coverage.
Warning; this article is going to get technical, but if you’ll bear with me I promise you’ll see how ALL claims-made coverages have these particular black holes. By the end you’ll be able to walk through a claims-made policy and show why all known matters need to be reported immediately, without delay and as soon as practicable.
What is a claim?
Remember what this agent said; the insured didn’t want to report the lawsuits and start a claim?
Well buddy, I got news for you; the claim’s already started, and the time to report is ticking.
To illustrate, let’s look at a generic definition of a claim within a claims-made policy:
CLAIM
“Claim” means any written demand for monetary damages or non-monetary relief, any civil proceeding commenced by the service of a complaint or similar pleading, or any formal administrative or regulatory proceeding commenced by the filing of a notice of charges or similar document, against any Insured for a Wrongful Act. A Claim shall be deemed first made when any Insured first receives notice of such demand or proceeding, regardless of when such Claim is reported to the Insurer.
Ask yourself; when the insured was served a lawsuit, did this constitute a claim? Yes, a formal complaint was filed against them. And it doesn’t matter if the complaint demanded monetary or non-monetary damages, it’s still a claim.
But what’s really important for us, and something my agent missed, was the fact that the claim is deemed first made “...WHEN ANY INSURED FIRST RECEIVED NOTICE…”
The claim doesn’t start when the insured decides to report. The claim starts when the insured receives notice of a demand alleging the insured committed a wrongful act.
Speaking of wrongful act, what’s the typical definition of a wrongful act for a D&O policy. Is it pretty broad?
WRONGFUL ACT
“Wrongful Act” means any actual or alleged act, error, omission, misstatement, misleading statement, neglect, or breach of duty committed or attempted by an Insured Person in their capacity as such, or any matter claimed against an Insured Person solely by reason of their serving in such capacity.
My goodness, that’s an INCREDIBLY broad definition. ANY actual or alleged….yes, the insured being sued for damages is most likely going to satisfy the definition of a wrongful act.
Ok, we’ve established that the D&O claim started when the insured receives the suit against them. Does the policy specify when they have to report it?
You bet it does:
REPORTING PROVISION
As a condition precedent to coverage under this Policy, the Insured shall provide written notice to the Insurer of any Claim as soon as practicable after any Insured first becomes aware of such Claim, and in no event later than the expiration of the Policy Period or any applicable Extended Reporting Period. Failure to provide timely notice as required herein may result in the forfeiture of coverage to the extent the Insurer is prejudiced by such delay.
You might read this and think, “Ok, well as long as I report before the end of the policy period I’ll still get coverage. Shoot, I can buy an Extended Reporting Period if I want to give myself even more time to think about it!”
2 things. First, “as soon as practicable”, means exactly that. Yes, technically you have until the end of the current policy period, but it’s not recommended that you use that because:
Secondly, the carrier might be prejudiced by your delay. That last part of the Reporting Provision is how carriers can deny claims even if you reported within the policy period. If they can demonstrate that your withholding the claim prejudiced them, then they’re off the hook.
Now we’ve established that:
Claims start when the insured becomes aware of the Wrongful Act Wrongful Act definition is exceedingly broad for D&O policies Reporting Provisions dictate that the insured must report said claim “as soon as practicable”
What happens when… the claim goes unreported?
It goes where all unreported claims go: the eternal abyss of coverage-less matters.
Unreported Claims —> Black Holes
“Lucas, I hear what you’re saying, and shoot, I guess the stuff we didn’t report just isn’t going to get covered. But the next time something develops we’ll definitely make sure that we report as soon as practicable.”
I’m glad, but unfortunately… those unreported claims didn’t just fall into the galaxy, drifting into oblivion all by themselves. Those unreported claims inadvertently turned into black holes affecting future claims in a way you nor your insured has appreciated.
I have 2 more definitions for us to review, perhaps the most important, consequential, and sadly overlooked parts of a claims-made policy. Please bear with me as we get a little bit more technical.
KNOWN MATTER
This Policy does not apply to any Claim based upon, arising out of, or in any way related to any Wrongful Act, fact, circumstance, or situation of which any Insured had knowledge prior to the inception date of this Policy, if such Insured knew or reasonably could have anticipated that such Wrongful Act, fact, circumstance, or situation could give rise to a Claim under this Policy.
You can’t bring previously known matters to a current policy. This makes a lot of sense admittedly. In the same way that you can’t buy a fire insurance policy on a burned out building and expect coverage, you can’t purchase a D&O policy and expect it to respond to claims from previously known matters. This is important to mention in case anyone thought they could switch their D&O carrier and have it respond to the unreported claims. Seems obvious, but worth reiterating.
The last definition we’ll look at is a doozy. It’s the killshot that turns unreported claims from previously known matters into black holes that carve out coverage for future, unknown matters, something both the insured and the agent are most likely expecting coverage for.
INTERRELATED WRONGFUL ACTS
“Interrelated Wrongful Acts” means all Wrongful Acts that have as a common nexus any fact, circumstance, situation, event, transaction, cause, or series of causally connected facts, circumstances, situations, events, transactions, or causes. All Claims arising out of Interrelated Wrongful Acts shall be deemed a single Claim first made on the date the earliest such Claim was first made, regardless of whether such related Claims are made during different Policy Periods.
Let’s say we have a mining company that carries a D&O policy. Due to their ignorance of how claims-made policies work they neglect to report to their D&O carrier that they received notice from an environmental regulatory agency that they’re being investigated due to alleged failures to comply with environmental regulations. The investigation takes months. Finally after a full year the agency concludes from their investigation that the mining company is in violation, and proceed to levy fines and penalties against them.
Shareholders of the mining company are incensed that the management team was operating outside of the bounds of the law, and through their negligence caused the company to incur fines and penalties that damaged their reputation and their return on investment. They bring suit against the management.
The management NOW decides to report this new claim, and is shocked to discover that the claim is being denied.
“Wait, this doesn’t make any sense! We reported the claim as soon as we were served. Why is this being denied?”
“Did you report the regulatory agency’s action against you as soon as practicable?”
“Well…no, we didn’t think there would be coverage.”
“Because you didn’t report the regulatory agency’s action against you in a timely manner, there’s no coverage.”
“That I understand, but this is a new claim, coming from new claimants, and we reported asap. What’s the deal?”
“This claim arose from a previously known matter that was never reported to us, and is barred from coverage. Per the definition of interrelated wrongful act, since this action taken by the shareholders is related to the regulatory agency’s action, the policy then bars us from covering this claim.”
Claims Made Death Trap Post Mortem
I want to note here that all of the definitions and provisions I made up here for the sake of this article exist in some way, shape, or form on each of your claims-made policies. That’s not just D&O policies, that also includes:
Employment Practices Liability policies
Fiduciary Liability policies
Errors & Omissions policies
Lawyers Professional Liability policies
Insurance Agent E&O policies
Anything and everything that is “claims-made”
This article began with the misnomer that claims start “when the insured reports”. Not only is that very, very incorrect, there’s an entire cascading effect that occurs when claims aren’t reported.
Unreported claim turns into a previously known matter.
All previously known matters are barred from coverage.
Anything Interrelated to that previously known matter is also barred from coverage
Ask yourself; does anyone appreciate the severity of these definitions put together? Forget the insureds; their job isn’t to read insurance policies. They purchase coverage expecting their carriers to protect them should any claims arise. Do they realize that previously known matters, should they meet the definition of a Wrongful Act, are not and will never be covered by any claims-made carrier?
Agents should know and appreciate these nuances, which again affect all claims-made policies. As uncomfortable as it may be, agents should consider how to disclose these coverage gaps to their claims-made clients:
At application— known matter disclosure review
At placement — reporting provision counseling, condition precedent explanation
At renewal — prior acts coverage gap audit
Remember that claims begin at receipt, not when the insured decides to notify the carrier.
Anytime the insured mentions receipt of action being taken against them for allegations of a Wrongful Act, have them report.
Even if the insured doesn’t think they need or want the carrier’s help, they need to report if, for no other reason, the insured doesn’t inadvertently create a black hole that bars coverage for any future Interrelated Wrongful Acts.
Until next time agents, stay bindin and grindin 🫡
This article is provided for educational and informational purposes only and does not constitute legal advice, insurance advice, or professional consulting of any kind. The policy definitions and provisions referenced herein are generic composite examples created for illustrative purposes only and are not drawn from or attributable to any specific carrier’s policy form. Actual policy language will vary by carrier, form, and endorsement, and coverage determinations depend on the specific facts and policy language applicable to each individual case. No attorney-client relationship, broker-client relationship, or any other professional relationship is created by reading or relying on this article. Nothing in this article should be construed as a characterization of the conduct, competence, or legal liability of any named party, firm, or individual. For specific questions regarding insurance coverage, policy language, claims handling, or professional liability exposure, readers should consult with competent coverage counsel and/or a licensed insurance professional in their jurisdiction. The views expressed are solely those of the author in his individual capacity and do not represent the views of his employer or any affiliated organization.