Question: What is the difference between a "claims made" and an "occurrence" policy?
Business insurance policies are often offered in two forms. One is the claims made policy and the other is the occurrence policy. Before agreeing to purchase business insurance, the business owner should understand the differences between the two types of policies. A good insurance professional can direct you to the appropriate type of policy.
The work you do at your business will survive into the future. For example, if you are contractor and build a wall, that wall will exist long after you have retired from your business, closed it, sold it or passed it on. In a perfect world, we as business owners know of potential claims against us immediately or shortly after completing work for a customer. In the real world, claims arise years or decades after we completed work. Take the wall in the example above. Eight years later the wall allows water in and, upon inspection, it is alleged your work was negligently performed at the time the wall was constructed. How does your business insurance handle a claim for so long ago?
It depends on the types of coverage you chose and whether the policies were claims made or occurrence policies.
Claims Made Policies
As the name indicates, Claims Made Policies provide coverage for claims made in the period the policy is in force. Claims made policies provide coverage only so long as the insured continues to pay premiums for the initial policy and any subsequent renewals.
Once premiums stop the coverage stops for any claims not known or made to the insurance company during the coverage period.
What this means to the business owner is that there is a risk of an unknown or unreported claim being made long after the policy period and not being covered because the claim was made outside of the coverage period.
To continue coverage after the coverage period, the business owner must purchase "a tail." Tail coverage (or, the Extended Reporting Endorsement) is an endorsement that extends the claims reporting period after the policy is ended. Tail coverage must be purchased to continue any risk protection afforded under the policy. Tail coverage can be expensive and can prove to be an unaffordable expense when winding down.
If you move from one insurer to the next with claims made coverage you must purchase tail coverage or your new insurer must include a prior acts endorsement. The new insurer assumes coverage for the prior acts occurring in the other carrier's coverage period.
Occurrence coverage is, in my opinion (and others differ), the better option for the business owner.
Occurrence coverage is insurance that provides coverage for the act when it occurs - regardless of when it is reported. If you had coverage under an occurrence policy in 2000 and the claim is reported today (they just found the defect in the wall, like the example above, for example)then the claim is covered.
Claims Made vs. Occurrence - Which to Choose?
When looking briefly at the differences one may ask why they would ever choose a claims made policy. Here are the differences:
- Premium Cost - Claims made policies are much cheaper than occurrence policies. The premium difference can be as much as 35-50.
- Coverage Amount - Under an occurrence policy, coverage is the amount of coverage under the policy in the year of the occurrence. This means that, while you have coverage, it will be much lower than your current limits because coverage limits carried in the past are usually lower than current coverage limits because they were not increased for inflation, claims costs, and the growth of your business. A claims made policy covers you at the level of insurance you have when the claim is made.
- Long Term Cost - Claims made policies may be cheaper over the long term and provide better coverage. Every year the business will pay an additional 35 - 50 in premiums for an occurrence policy. That additional premium over time and invested will be substantially more than the cost of tail coverage at the end of claims made coverage and provide coverage at the coverage levels in place when the claim is made and not, perhaps, coverage amounts the business had in place fifteen years ago.
- Choice of Insurers - In other articles on this site, I stress that the business owner will want to develop a long-term relationship when working with their insurer. But, problems arise and insurers leave markets. When that happens, businesses with claims made coverage need to find another insurer and pay for a prior acts endorsement. Under occurrence coverage, leaving one insurer for another is easier.
- Type of Business - Certain businesses must have occurrence policies or have a risk policy in place that guarantees the purchase of prior acts endorsements and tail coverage without fail. Construction businesses where defects are not uncovered for years are good candidates for this coverage. Other businesses have a much lower risk of claims occurring much past the transaction with the customer and can choose claims made coverage.
- Availability- Occurrence coverage may not be available in your state, industry, or profession. It may be prohibitively expensive. Claims made coverage is more readily available.
Understanding the differences is critical to risk management at your business.