What is a claims made basis insurance contract?
A claims made basis insurance contract is a special type of agreement between an insurance company and a person or business they are insuring. This contract says the insurance company will pay money to the insured party, but only if certain things happen.
The most important part is that the insurance company will only pay if a claim gets made while the insurance contract is active. A “claim” is when the insured tells the insurance company that something bad happened that the insurance is supposed to cover. The insured party is “making a claim” to get money from the insurance company.
It’s all about timing
With a claims made basis insurance contract, it doesn’t matter as much when the bad thing actually happened. What matters is if the insured tells the insurance company about it while the contract is still in effect.
Let’s say there was a contract that lasted all of 2022. Maybe something bad happened in 2021. But if the insured waited until 2022 to tell the insurance company about it, the claim would still get covered. The insurance company would still have to pay because the claim got made during the time the contract was active.
On the other hand, if something bad happens in 2022 but the insured doesn’t tell the insurance company until 2023 after the contract ends, that claim wouldn’t get covered. The insurance company wouldn’t have to pay anything for that, even though the event happened while the contract was active.
How is this different from other insurance?
Most other types of insurance contracts are “occurrence” based. That means the timing of when the bad thing happens is what matters most, not when the insured tells the company about it.
Going back to our example, let’s say the contract is occurrence based and lasts through 2022 like before. If something bad happens in 2022, the insurance company has to cover it even if the insured doesn’t say anything until 2023. Since the event “occurred” during 2022, it’s covered.
And if something happened in 2021 before the contract started, the insurance company wouldn’t cover it, even if the insured made the claim in 2022 while the policy was active. The event itself has to happen while the policy is in effect.
Why does this difference matter?
The big thing about claims made policies is that they can help keep costs down for the insured. Occurrence policies often cost more because the insurance company is on the hook for a longer time. Even after the policy ends, they might still have to pay for things that happened while it was active.
With a claims made policy, the insurance company can “close its books” on that contract once it ends. They don’t have to worry about claims coming in for events that happened during the policy term. This means the insurance company is taking on less risk, so they can charge less for the insurance.
Watch out for the gaps!
The tricky part with claims made policies is making sure there aren’t any gaps in coverage. The insured has to be extra careful when switching between policies or insurance companies.
Mind the gap between policies
If a claims made policy ends on December 31st and the new one doesn’t start until January 2nd, that leaves a gap on January 1st. If something happens that day, there might not be any insurance to cover it, even if a claim gets made later on during the new policy.
To avoid this, the insured has to make sure the new policy starts right when the old one ends. Some policies are even written to overlap by a day to prevent these gaps.
Careful when changing insurance companies
Switching insurers with a claims made policy can also be risky. Let’s say the insured has Company A in 2022 and switches to Company B in 2023.
If something bad happens in late 2022, the insured might not find out about it right away to make a claim. If they don’t find out and tell Company A before that policy ends, Company A won’t cover it. When they do find out in 2023 and tell Company B, Company B won’t cover it either since it happened before their policy started.
To avoid this, when switching between claims made policies, it’s smart to get “tail coverage” from the old company. This extends the time you can make claims for things that happened during the old policy term. That way there won’t be any gaps.
How much will the insurance company pay?
Just like most insurance contracts, claims made policies have a set limit on how much the insurer will pay out. This is the maximum amount of money the insured can get for claims made during the policy period.
For example, the contract might say the limit is $1 million. If the insured makes a claim for $500,000, the insurance company would pay that since it’s less than the limit. But if there’s a claim for $2 million, the insurance company would only be on the hook for $1 million. The insured would have to pay the extra $1 million themselves.
Per claim vs aggregate limits
Some claims made policies have “per claim” limits. Others have “aggregate” limits. Here’s the difference:
A “per claim” limit is the most the insurance company will pay for any single claim. If the policy has a $1 million per claim limit, the insurer would pay up to $1 million for each individual claim that’s made.
An “aggregate” limit is the total amount the insurer will pay for all claims together during the whole policy period. If there’s a $2 million aggregate limit, that’s the maximum the insurance company will pay in total, even if there are lots of claims that would add up to more than that.
Policies can have both per claim and aggregate limits. This puts a cap on how much the insurance company could have to pay for a really big claim, and for lots of claims in total.
When are claims made policies used?
These types of policies are pretty common for a few types of insurance:
Errors and omissions insurance
Errors and omissions insurance, also called E&O or professional liability insurance, covers you if your clients claim you made a mistake in your professional services. This could be things like giving bad advice, making a clerical error, or missing a deadline.
These policies are often claims made because problems might not come to light until way after the work is done. The mistake could happen in one policy period but not get discovered until years later. With a claims made policy, as long as the claim itself is made while the insurance is active, it can be covered.
Directors and officers insurance
Directors and officers insurance, or D&O insurance, protects company leaders if they get sued for things they do as part of their jobs running the company.
These are also often claims made because lawsuits might get filed a long time after the thing that sparked the lawsuit happened. As long as the company leaders tell the insurance company about the claim while the D&O policy is in force, it can be covered even if the actions in question happened earlier.
Medical malpractice insurance
Another common type of claims made policy is medical malpractice insurance for doctors and other healthcare professionals. This covers them if a patient sues claiming they got harmed by negligent treatment.
Like the other types, problems might not be apparent until well after the doctor treats the patient. The doctor might have seen the patient years ago, but the patient can still make a claim if the policy is still active. That’s why claims made coverage is common for medical malpractice.
