Subtle Problems with Extended Reporting Coverage — and Creative Solutions

For specialty line insurance policies such as directors and officers liability, professional liability, cyber liability etc., claims made insurance policies are the most common type of policy issued. They are complex, and depending on the definition of claim, as well as whether or not it’s a claims made and reported form, the policies can be extremely dangerous.

What follows is the third installment of a three-part series on the complexities inherent in claims made policies with extended reporting provisions (ERPS).

The first article, It’s Just a Name Change and Other ‘ERPS’, published in the May 22, 2023, edition of Insurance Journal, addressed various problems that may arise when the need for an ERP is triggered because a client decides to simply change the name of their business — or the organizational change to the business — and the differences between the two. The second installment, published in IJ’s June 5 magazine edition, took up where the previous one left off — with a discussion of the additional complexities involved when an ERP is triggered. This final article explores some of the subtler problems that may arise with extended reporting provisions.

Overall, many of the more common issues were explored in previous articles. That is not to say, however, that these are complete solutions. I have long been of the belief that extended reporting provisions, when invoked, are an incomplete solution for long-term protection. That is because one is taking a limit of liability and stretching it across at least one year and sometimes six years or more. The limits, thus, are never refreshed. So, if there are any claims during the extended reporting term, policy limits are being eroded. This could mean that policy limits could be extinguished by claim frequency, and the benefit of runoff would be lost when that happens before the term had even run out.

Eventually the ERP will expire. This means there is now a gap in coverage. Depending on the length of the original ERP, there still may be the potential for claims being made against the entity and/or its directors, officers, and/or senior managers for wrongful acts that took place long before the actual transaction triggering these coverage events.

For instance, for a construction company, the statute of limitations for construction defects is 10 years. Thus, should a three-year extended reporting provision expire, there could be several years where the directors and officers of the corporation are exposed to construction defect claims. In this case, the reporting provision is an incomplete solution. This may also expose the buyer to those claims depending on the sale, i.e., if with a stock sale, it took over the company. Would any indemnification agreement between buyer and seller still be enforceable at that point? The buyer may have some exposure to the injured party before the date of transaction, but trying to get funds from the seller several years after the transaction has closed may prove to be a problem.

I am not aware of an insurer that might extend the term when it expires, even if it is claim free. I am also unaware of any new insurer routinely willing to offer an additional extended reporting provision to take over.

A Creative Solution

It is possible to think outside the box. Consider the following hypothetical.

If company “A” is an excellent risk, a well-managed company with a good loss history, would that not be acceptable to any reasonable underwriter including honoring any prior act dates, etc. The answer would obviously be “yes.” What about company “B?” If company B is a good company, well-managed, good performance and has a good claim history, would that same insurer also like to write company B? Again, the answer is “yes.”

So why is it when company A buys company B — B is not a good risk? The perception now is that company B is a risky company, and the insurer will only pick up company B as a subsidiary on a go-forward basis. They will not provide coverage for any wrongful acts that took place before the transaction.

It doesn’t make sense, especially if they would write the company on its own standalone basis while honoring any prior act dates, etc. Why does the transaction suddenly make it a bad risk? This analysis becomes even more relevant if during the acquisition, the same staff and management is coming over, which would enhance the insurability of company A because they are getting experienced personnel and the continuity of the operation is more likely. It also shouldn’t matter if it’s a 100% asset sale as the selling entity will no longer exist.

This is possible and has been done. If the insurer likes company B and will write company B, there is no reason they shouldn’t be willing to write the acquired company either as a subsidiary or on an asset basis and still pick up all prior acts, etc. This would require unique endorsements to make it clear that the prior act exposures are being honored for the acquired company.

In addition, there would be a necessity for one other endorsement. The insurance policy for company A would still have a transaction provision that would clarify that if they acquire a company, that company is automatically covered, sometimes for only a specified period until the insurer is advised, but only for wrongful acts that took place after the transaction. Obviously, such a provision would have to be amended so as not to apply to the transaction in issue. Still, it is possible to do it and I did so frequently as a wholesale broker.

How to Close the Gap When an ERP Expires

A similar approach might be taken when an ERP is about to expire. As all professionals know, for the insurance company to write a new piece of business insured with another insurer, one of the industry trends since the 1970s has always been to honor the existing prior act dates, and/or prior pending litigation dates. If they are unwilling to do so, it is dangerous for the insured to change insurers.

Usually, the only reason a prior act date might not be honored is due to a poor loss history giving rise to a non-renewal of the policy or prior act date by the existing insurer, thus requiring the insured to buy an ERP. A new go-forward policy that is retroactive date inception would also be needed by such a non-renewal, even though there probably is no transaction triggering the need.

So, how can a policy holder or even a buyer be protected when the extended reporting term ends? What if there isn’t any “loss problem?” The basis for this is twofold, since traditionally no insured will move carriers unless all those prior act dates are honored. Those insurers wanted to make sure that there has always been coverage for prior acts for them to honor that date going forward.

Such is the case with an ERP about to expire as it operates similarly to a prior act date because it covers prior activities of the insured for a specified period, no differently than a policy would cover wrongful acts subject to the retroactive date of that policy. The insured has had the appropriate prior act coverage despite whether it’s based on a prior act provision in the existing policy, or the runoff provisions of an extended reporting provision.

Prior errors were covered. Should it matter that coverage was provided by an ERP rather than a prior act provision? Is it possible for an insurance company to extend a prior act date to pick up the same when the ERP expires?

The answer is yes, it has been done and becomes another creative think-outside-the-box solution.

Note: The above is the third and final installment in a series of articles addressing ERPs.