Commercial Insurance 101 – Understanding Claims Made Policies
“I can’t wait to buy insurance!”
Who said that? Nobody, ever.
Let’s be honest — nobody enjoys paying for insurance. Insurance agents don’t even “love” paying premiums (or at least I have yet to meet one that’s professed their love of doing so). Insurers may not resist it as much because their job is to spot risks. Contrary to popular belief, insurers don’t expect you to love doing so either. However, if you own a business, one of the first things you should do not long after getting the keys to your new business is buy business insurance. Of course, you probably won’t love paying for it. What you (hopefully) do love though is your business, your family, financial stability, and enjoying the fruits of your labor. That should be enough for you to not only insure your business, but to ensure you’re protected both in the long term and short term.
One of the most important things to understand about commercial insurance policies is what’s called “claims-made policies.” If you own a business, you definitely need to understand this because if you don’t, it could cost you everything.
So what is claims-made policy? When you’re purchasing a standard business insurance policy, like professional liability insurance, you’ll likely be offered two options with it: a claims-made policy and an occurrence policy. Often, people who buy standard commercial policies not only don’t understand what that means, but unfortunately, there are plenty of agents who don’t even explain the guidelines for a claims-made policy. That issue is only heightened considering that most standard commercial policies are claims-made policies.
Although there are other variations of claims-made commercial policies, “Claims Made & Reported” policies are most common and pay for claims made during the time you hold your policy. That sounds simple enough, but it can get much more complicated than that. You need to know the specific time period in which a claim would need to be reported to your insurance company in order for it to be covered.
The Problem With Claims-Made Policies
The first aspect of commercial claims-made policies sound simple — they pay for claims made during the time you’re insured under them.
Sounds simple enough, but businesses can be sued long after they’ve finished work and after canceling insurance policies, and that’s the issue with these policies. Maybe the materials used in your products were identified as being dangerous, or maybe the structure your team erected was negligently constructed — and perhaps those problems didn’t arise until sometimes even years after work was done. This is what makes the difference between claims-made policies and occurrence policies essential to understand.
So what’s the problem? Although your policy would cover claims just like any kind of insurance policy would, there’s a common misunderstanding. In order for claims-made policies to cover claims you’re liable for, either because of negligence or something like faulty or dangerous materials, claims-made policies need to be active at two points:
- When the claim is reported to your insurer
- When you performed the work
For example, say you own a computer repair shop from 2009 to 2011. You buy a claims-made policy, which we’ll call Policy A, when you start your business, keep it active from 2009 to 2011, and then cancel it immediately after doing the work and/or buy a new claims-made policy. Six months later after closing shop, a claim is filed against you because you used defective/damaged parts during the time you were still covered by your Policy A (from 2009 to 2011.) Your claim won’t be covered even though you did the work while insured under Policy A because you don’t meet the two aforementioned guidelines.
All too often, a policyholder assumes Policy A would cover claims stemming from work done while insured under Policy A, even if they no longer have the policy. It wouldn’t, though, since you don’t meet both of the aforementioned requirements for claims to be covered under Policy A. Because Policy A is now cancelled, it’s not going to cover claims arising from work you did while insured under it.
Obviously, the chances of this happening depend on the type of work you do, so take that into consideration. Sometimes though, things just don’t go according to plan — the exact problem you can have with these types of policies.
The most important thing to remember when purchasing a claims-made policy is the risk you run in having a claim brought against you after the period in which you were insured. If your first claims-made policy is cancelled, thus not covering claims that stem from the time you were covered under that policy, you’d have to pay any damages out of your own pocket. If the claim is small enough, you may able to comfortably do that. However, there are obviously more drastic claims and lawsuits to beware of. Commercial claims that result in lawsuits usually aren’t for small amounts. People assume businesses have deep pockets, and they assume that even if you can’t pay for a judgment that they can own your business. What happens if you invented a product and it ended up with such severe defects that it caused a death in the future, resulting in you being sued for millions? That’s an unfortunate reality, and it does happen.
There’s luckily a way to prevent this. Hopefully, when you ended your initial policy, you got another policy immediately. If you previously had a claims-made policy, you can purchase Extended Reporting Endorsement (ERE) on your new policy (with any other insurer), also known as tail coverage. This extends your coverage period, although it can be very expensive.
The Pros and Cons
- Claims-made policies obviously have big drawbacks. However, they’re normally less expensive than some other similar commercial insurance products. If you plan on sticking with your insurance company for a while, buying a claims-made policy is the best way to go. Just remember that sometimes people become dissatisfied with their insurer.
- You may have every intention of staying with the insurer you bought Policy A from and keeping it for a long time, but maybe you cancel your policy for whatever reason. That may mean you switch insurers or cancel policies long before a claim is filed to your non-existent policy.
- If you have a claims-made policy with an insurer, experience a claim, and it’s covered, you’re likely going to see an increase in premiums at your next renewal. A common mistake would be cancelling that policy due to resulting increased premiums and buying a new policy from another insurer — setting you up for denied claims in the future if ones were made from when you were covered under your first claims-made policy. Odds are that after a claim under any kind of policy, you’ll experience a rate increase regardless of what insurer you use, so it’s likely pointless to switch insurers if you’re attempting to do so on price alone. Maybe you weren’t satisfied with your claims experience. Either way, if you switch insurers after that situation, you definitely should buy a policy with tail coverage.
- Since such claims and lawsuits can show up as far as years later, it may seem like a waste of money, but if a claim was made long after you shut down a business, you’d still be on the hook. That means you could end up shelling money out on insurance in order to maintain your policy, the intent being to avoid cancelling any policies and thus end up being sued long after you’ve closed up shop. Nobody likes to pay premiums anyways, but imagine paying for commercial insurance for years, even long after you’ve closed up shop. It may feel like a waste of money, but it’s simply a gamble to protect yourself just in case.
Most business owners greatly understand the concept of “time is money” and live by it. For that reason, insurers set strict guidelines and obviously want to avoid as many claim payouts as possible. If time is money and you didn’t appreciate that mentality beforehand, you’ll quickly understand it since these policies are all about timing, potentially costing you out of pocket for a denied claim. Unfortunately, though, you’d learn the hard way.