Liability insurance determines coverage using two different approaches known as claims-made policy and occurrence policy. Typically, insurance programs include both policies as part of their risk management provisions. However, each policy is triggered by different events when a liability occurs.
Under a claims-made insurance policy, coverage is triggered by the date the insured first becomes aware of the liability and notifies the insurer of a claim.
From that date onwards the insurer’s policy in force should defend and settle the insured’s claim. On the contrary, under an occurrence policy, coverage is triggered when the liability occurs. Hence, the liability is the occurrence that determines when the liability coverage applies.
Apart from this major difference, the two policies differ also in their retroactive force. A claims-made policy acts retroactively providing coverage for claims that are made today for events that have occurred in the past. In contrast, an occurrence policy does not provide coverage for prior acts. For example, a claims-made policy will respond to an incident that has been reported during the policy term with effective date 1/1/2009 and retroactive date 1/1/2006. Instead, an occurrence policy will respond to an incident that has occurred during the policy period, regardless of the date it was reported.
Both policies have advantages and disadvantages, which do not depend solely on the type of insurance coverage, but also on the broader circumstances that may occur.
The main advantage of a claims-made policy is that, unlike in the occurrence policy, the coverage limits are adjusted on current rates, and therefore, the risk of being underinsured is limited. Also, in the context of its retroactive force, previous exceptions and unapproved coverage may be expanded with topped up basis limits. This is applicable regardless if the insured was previously on a claim-made or an occurrence policy.
However, as the claims-made policy is triggered when the insurer is notified of the liability, there is always the risk that the date of the incident is more recent than the retroactive date of the policy. In this case, the insurer has no obligation to cover for the liability. For the claims-made policy to take effect, the incident that triggers the claim has to fall after the retroactive date of the policy.
On the other hand, occurrence policies function like checking accounts. The insured may claim for lapsed policies against incidents that occurred while those policies where in force. Unlike in claims-made policies, coverage of occurrence policies remains locked as long as the insurer remains in business.
However, the estimated period between an occurrence and court resolution is 20 years. If during these 20 years the insurer is no longer in business, occurrence policies are not valid and the insured cannot claim against past incidents. In this case, it makes sense for the insured to change insurer every few years in order to allocate the occurrence risk. In addition, the coverage limits of occurrence policies are not adjusted on current exposure rates because it is difficult to estimate exposures that will occur after 20 years. Therefore, the risk of being underinsured is very likely.
In general, for occurrence policy, it is highly recommended that higher limits are purchased in order to meet the exposures that may be ruled at court after 20 years or so. Therefore, it makes sense to choose a limit that is in excess of the coverage paid today. In contrast, for a claim-made policy choosing even lower limits is a reasonable strategy considering that court resolution occurs within 7 years.