Reasons for a “Claims Made” trigger

On Page 4 of the Issue paper, you state “Given that PI claims can often be made a long period after the event or circumstance giving rise to the claim, insurers have not traditionally covered such risks under “occurrence” policies. This is because insurers find it difficult to account for their liabilities when they are not notified of the incident that may lead to a potential claim several years later….”. With all due respect, I would argue that the main reason for PI policies being on “Claims Made” trigger lies elsewhere. Liability claims can also often be made a long period after the event giving rise to the claim but most Liability policies are not written on “Claims Made” triggers.

There are specific reasons why certain risks (including P.I. /D&O) are written on a Claims Made trigger.

The main reason PI/D&O is on claims made is because, with most of the exposures covered by these policies, it is difficult to “pin down” the exact point in time when the loss (Injury/Damage/Financial loss) occurred. For example, a professional could give advice in 2003 and the client acts on that advice in 2004 and suffers a pecuniary loss in 2005. Furthermore, the loss could keep going up and down over a period of time. In such a case, when did the “loss occur”. It would be difficult to pin down the exact point in time when the loss occurred, if not impossible. Therefore, a “Claims Made” trigger is preferred rather than leaving it for the Courts to determine when the loss occurred and also to avoid the infamous “triple trigger” theory or similar type of scenario where multiple Policy periods (and Limits) may be exposed to a single claim.

On the other hand, Public and Products Liability policies only cover Injury and Damage (and not pure Pecuniary loss). Other than risks with latent injury or latent damage exposures, it is reasonably clear as to when the Injury/Damage occurred. Hence the reason why most Liability policies are written on “Occurrence” wordings, more correctly called “losses occurring” triggers (triggered by Injury/Damage occurring during the Policy period and not by Occurrences during the Policy period), because generally it is clear when the Injury or Damage occurred.

However, some Public and Products Liability policies are also written on “Claims Made” triggers. These are policies for risks with inherent latent exposures such as Products Liability for Pharmaceutical manufacturers, stockfeed manufacturers, fertiliser manufacturers, water authorities (such as Sydney Water) and paint manufacturers to name a few or some Public Liability exposures such as asbestos removal contractors, Electromagnetic Radiation exposures and Legionnaire’s disease exposures and so on.

Naturally, “Claims Made” wordings provide Insurers with the added benefit of shorter tail, more certainty about their loss reserves shortly after policy expiry, etc., it could not be said that this is the main reason for “Claims Made” trigger. If it was, why would not all long tail business be written on “Claims Made”? Why would P.I/D&O department of a company write business on “Claims Made” and why would Liability department of the same company write business on “Losses Occurring” and not “Claims Made” trigger?

Therefore, the main reason for PI/D&O being on Claims made wordings is because the types of exposures covered are such that it is difficult to pin down the exact point in time when the loss occurred.

If, as the issue paper argues, the reason for the claims made trigger was to enable insurers to better forecast their liabilities under the policies and set aside reserves for them, all Liability policies covering long tail exposures (Public and Products, CTP, Workers Compensation, etc.), and not just PI/D&O would be on claims made basis.
Real Impact of S54 decisions?

Whilst some Insurers may be voicing their dissatisfaction over the Court decisions involving S54 which went in favour of Insureds, it still does not hide the fact that those claims would have been indemnifiable under the Policy had the Insured notified the Insurer during the Policy period. In other words, the “loss” had already happened (by the Claim being made against the Insured or the Insured becoming aware of facts/circumstance which may give rise to a claim). It is only the failure of the Insured (to notify of the Claim or facts/circumstances to the Insurer during the Policy period) which even gave the Insurers a chance to argue for a denial of indemnity (argument which they lost due to operation of S54).

Theoretically speaking, if the PI risks were correctly rated, it would have allowed for those claims made against the Insured during the policy period as well as facts/circumstances which the Insured becomes aware during the period (even where the Claim or fact/circumstance was not notified during the period). When those claims should have been accounted for in the rating, why should PI underwriters derive a benefit purely because the Insured failed to notify the Claims (or facts/circumstances) during the Policy period?

Therefore, the only financial impact of S54 decisions against Insurers are that:

· Insurers have had to pay the costs of both parties in arguing indemnity; and
· Insurers have arguably lost the opportunity to charge a higher premium for subsequent policy periods (as the claims experience would not have reflected the claim which was not notified to the Insurer during the Policy period)

In other words, S54 decisions did not create new claims for Insurers (and thereby add to the cost of PI/D&O insurance). It just prevented the Insurers from denying indemnity and thereby take advantage of the failure of the Insured to notify the Insurer during the Policy period (because had the Insured made the notification, policy indemnity would have been available).

If the Insurer has not been prejudiced by the Insured’s failure to notify, why should the Insurers be allowed to take advantage of Insured’s failure to notify purely because of that failure?

One has to question any argument that S54 decisions have been instrumental in the price increases in the PI/D&O market. Surely, it is simply that the previous prices were inadequate and unsustainable. It would be farcical to argue that Insurers had allowed a discount expecting Insureds to fail to notify Claims (or facts/circumstances) during the Policy period and because this failure was remedied (for the Insureds), premiums had to increase. Simple fact of the matter is that, had it not been for the Insured’s failure to notify, the claims would have been covered under the policies.

Why is there a shortage of capacity and the premium increases?

Surely, this would have to be as a result of a combination of factors:

· Collapse of HIH, who were the leader in this market with a sizeable market share;
· The World Trade Centre terror incident which adversely effected the bottom line results of insurers and reinsurers resulting in shrinking of capacity in the market;
· Huge investment losses for some of the bigger players in the market resulting in S&P down grades resulting in further shrinking in the market capacity;
· New APRA guidelines regarding solvency, which means that you cannot write as much business as in the past with the same amount of capital.
· Increasing claims against professionals, both in frequency and quantum.

I believe market forces, over a period of time, will dictate the available capacity in the market. New capacity will surely come into the PI market if PI market was seen to be an area where money could be made for those who know what they are doing.

The root cause, however, unrelated to S54 decisions, surely must be that premiums were inadequate in the past and that they were not enough to cover increasing frequency and quantum of PI claims.

“Policy indemnity” issue Vs “Liability (to third party)” issue

Another point I would like to point out is that S54 is a “Policy indemnity issue” and not a “liability to third party” issue. Even if S54 were to be removed from ICA, the savings (which I doubt would be large) would only be for a short period. The brokers, knowing their clients will not have cover unless notification is made within the Policy period, are likely to tighten their procedures to ensure that Insureds notify within the Policy period. In other words, this is only a “band aid” solution and does not address what lies at the heart of the problem. Furthermore, as outlined later in this submission, amending S54 in “piece meal” style could result in other side effects which may not be difficult to foresee.

As S54 deals with Policy indemnity issues, by changing it, there will be no effect whatsoever on the number or amount of claims by third parties against the professionals which is a liability issue. As for shortage of PI capacity and the lack of affordability of PI insurance, I believe it should be fixed at the root cause of the problem. Some of the solutions may be:

· If PI is unaffordable, let the professionals raise their fees;
· Or through tort reform (such as Civil Liability Act);
· Professional associations start a program to raise the level of professionalism within their profession to reduce claims.

As for market capacity, this will take some time to correct itself. If PI/D&O is seen as a profitable market, I am sure the market capacity problem will quickly correct itself.

Possible side effects of amending S54

Personally, I am in favour of leaving S54 in its current form. I believe that, of the “Options for Reform” put forward by the Issues Paper, any other option could have other undesirable effects.

Option 2: As for failure to notify of “facts or circumstances” outside the period of cover, as far as I am aware, it is still OK for Insurers if they do not have a “deeming” provision in the policy. The Insureds have to rely on S40 to be able to notify of fact/circumstance during the Policy period to obtain policy indemnity. The Court decisions, so far, as I am aware, have not ruled that S40 is implied into the contract of insurance to enable S54 to provide relief to the Insured. In other words, as long as the Policy does not contain a “deeming provision”, the Insured must notify fact/circumstance during the Policy period to obtain cover.

However, it would make things clearer (rather than leave it to The High Court to decide on this issue if and when it reaches there) that Section 40 is not implied into the contract of insurance to enable Section 54 to come into operation. More broadly an amendment to ICA, not an amendment to Section 54, which states that no Section of ICA will be deemed to be implied into the contract of insurance unless the section specifically states so (such as Section 13 regarding the duty of the utmost good faith), may be necessary.

Option 3: It is obvious that most Insurers would argue for this option. To amend S54 to give relief (from S54) to “claims made” or “claims made and notified” policies may create an adverse effect in other Liability classes of insurance.

For example, Public and Products Liability insurers may start shifting away from “losses occurring” type of trigger to “claims made” trigger. Of course, market forces will come into play. However, if some insurers try to entice their clients onto a “claims made” trigger by offering substantial premium discounts, such a scenario is possible. Once an Insured goes onto a Claims made trigger, there are always gaps created in coverage when converting to other triggers such as “losses occurring” trigger. It should be remembered that whilst a “claims made” trigger is obviously the most advantageous trigger from an Insurer’s viewpoint, it would be the most disadvantageous trigger for Insureds and there needs to be a fair balance struck between the interests of Insurers and Insureds. Even if Liability Insurers do not try to shift to “Claims Made” triggers, Insurers could try to take advantage of amendments to S54 by requiring certain notification during the Policy period for cover to apply (for other classes of insurance than PI/D&O). An example could be Liability policies which require Occurrences (which may give rise to a claim in the future) to be notified during the Policy for cover to apply.

Option 4: Could create similar side effects as Option 2.

Does Section 54 provide an appropriate balance?

Considering the provisions of Subsection (2) and the fact that the Insurers are generally in a more superior position (in the absence of S54) than an Insured (both in terms of dealing with indemnity issues as part of their business as well as having greater financial resources available to them in any legal action between the two), I believe S54, in its current form, provides an appropriate balance. It strikes me as unfair if an Insurer is able to deny indemnity purely due to Insured’s failure to notify when the claim would be covered in the absence of such failure by the Insured. Insured’s failure or otherwise has no effect whatsoever on the subject matter of insurance (being legal liability of the Insured to pay compensation to a third party).It is simply a matter of an Insured submitting their claim (under the Policy) a little late.

Subsection enables the Insurer to refuse a claim if an act or omission of the Insured resulted in the loss being claimed. Furthermore, Subsection (1) allows a reduction of the claim by the amount the Insurer has been prejudiced. If this prejudice would take into account the opportunity lost to the Insurers to charge a higher premium in subsequent policy periods (which higher premium must be able to be substantiated with fair amount of accuracy including the method for calculating the higher premium) reflecting the worse claims experience (including the claim at hand), then I believe there is a fair balance provided as a result of the operation of S54.

S54 – To amend or not?

In my view, any “piece meal” amendment of S54, could create an environment where Insurers may try and exploit the amendments (as in the scenario above). Therefore, it should either be deleted in whole or retained in its current form.

To remove S54, it disturbs a fair balance between the Insurers and Insureds.

Why should Insurers be able to knock back a claim purely because Insured failed to do something unless that failure resulted in the claim or the Insurer has been prejudiced by that failure? Insurers should not be able to derive a “windfall” purely because Insured failed to do something which did not prejudice the Insurer.

Amending S54 to enable Insurers to deny indemnity in the even of Insured’s failure to notify would disturb this balance struck by the ICA and create a precedent where Insurers, from time to time, could expect some other amendments in their favour if they made a loud enough noise about it, especially if it coincides with reduction in the capacity available in the market (through other reasons unrelated to the ICA).

Removing S54 in its entirety would go against the basic principles of the Insurance Contracts Act. Amending it only for certain types of policies is also a “band aid” solution, which I do not believe addresses the problem and will not have a huge impact, especially when the brokers tighten their procedures to ensure that Insureds make the notifications during the Policy period.

Conclusion

Amending S54 to remove the remedy available to Insured who have failed to notify fact/circumstance or the claim made against them during the Policy period is only a “band aid” solution which deals with a “Policy indemnity” issue and not “Liability” issue and could create an environment for undesirable side effects.

In my view, S54 should be retained in its current format. However, an amendment to ICA, not an amendment to Section 54, which states that no Section of ICA will be deemed to be implied into the contract of insurance unless the section specifically states so (such as Section 13 regarding the duty of the utmost good faith), may be necessary to ensure that sections such as Section 40 will not be deemed to be implied into the contract of insurance which will enable Section 54 to come into operation.

Also, a specific provision could be included in S54 that the amount by which Insurer has been prejudiced (by the act or omission of the Insured) shall include the opportunity lost to Insurers to charge a higher premium for subsequent periods (being from the Policy period after the period at issue with the claim until the Policy period covering the time of the dispute between the Insurer and the Insured). However, this amount must be substantiated by the Insurer with internal rating manuals or guidelines which clearly can show what the additional premium would have been had the claim (or fact/circumstance) been correctly notified by the Insured at the time. Similarly, if the Insurer could show that they would have declined the risk had they known about the claim (the one which the Insured failed to notify), the Insurer should be allowed to refuse indemnity or reduce the claim to Nil.

Suggested Amendment to Section 40

I believe that Section 40 should be amended to provide a 30 day extended reporting period (for notification of claim made against the Insured as well as facts/ circumstances of which the Insured becomes aware). Some Insurers may start to remove extended reporting periods from their policy wordings which will leave an Insured who becomes aware or receives a claim right before Policy expiry with some potential difficulty.

Another point which needs consideration is that Section 40 may be vulnerable if the Insurers decided to remove the “notification” requirement from their policies and make them simply a “claims made” and not “claims made and notified” policies. The wording of Section 40 is clear in that it applies to “claims made and notified” policies. Therefore, if the notification requirement is removed from the policies, Section 40 may not come into operation. In such a case, Insureds would not be able to notify facts/circumstances to obtain cover. When the claim is made against them and they seek indemnity under that policy period, the “known circumstance” exclusion would come into effect to exclude the claim from policy indemnity.

The wording of subsection (1) of Section 40 may need to be amended to ensure that it applies to “claims made” policies and not just “claims made and notified” policies.