Don’t get ‘wipsawed’ by your liability insurer

INSURANCE INSIGHTS

Under a claims-made-and-reported policy, the consequences of a delay in reporting can be disastrous, namely a complete loss of coverage. This article focuses on one of the most common scenarios where late notice occurs, and describes several protocols that policyholders can put in place to ensure that claims are timely reported.

The "Whipsaw" Scenario

The following is the classic "whipsaw" scenario: Assume that a policyholder has in effect an annual claims-made-and-reported policy (e.g., a professional liability policy, a directors and officers policy, or an employment practices liability policy). This policy promises to defend and indemnify a "claim" that is (1) "first made" against the policyholder during the policy term, and (2) "reported" to the insurer during the policy term.

The policy broadly defines the term "claim" to mean not only a judicial proceeding, but also a "demand for monetary or non-monetary relief." The policy also includes a provision stating that all claims arising out of the same or a series of related facts are deemed a single claim.

During the term of this policy, the policyholder receives a letter (or even an email) that makes an allegation of wrongdoing and demands some form of relief. For example, the letter might demand that the policyholder pay a sum of money, make the claimant whole, or work for free to correct a problem. Having received only a demand letter, not a lawsuit, it does not occur to the policyholder to report this communication to its liability insurer.

Time passes, and the policy in effect when the letter was received expires. During the term of the policyholder's subsequent policy, the claimant files a lawsuit making the same allegations as those made in the earlier letter. The policyholder tenders the defense of the lawsuit under the subsequent policy.

This scenario will almost inevitably result in a coverage denial. The insurer will explain that its policies expressly condition coverage upon a claim being "first made" and "reported" during the same policy term. The insurer will also point to the provision in its policies stating that all claims arising out of the same or related facts are deemed a single claim. The insurer will then contend that neither of its policies afford any coverage because even though the "claim" was "first made" during the term of the first policy, it was not "reported" until the term of the second policy.

The consequences are extremely harsh. Despite having consecutive policies in effect, both when the claimant's demand letter was received and when the lawsuit was filed, the policyholder entirely forfeits coverage because it failed to report the demand letter, i.e., the "claim," during the term of the first policy. See, e.g., Westrec Marina Management, Inc. v. Arrowood Indemnity Co., 163 Cal. App. 4th 1387 (2008) (failure to report a claimant's letter demanding settlement of an employment claim led to a forfeiture of coverage for the claimant's lawsuit reported during a subsequent policy period).

Avoiding The "Whipsaw"

There are three practical and straightforward protocols that policyholders can put in place to avoid the late reporting of a claim under a claims-made-and-reported policy.

First, it is essential that a policyholder carefully read the policy's terms and conditions. As noted, claims-made-and-reported policies will often define "claim" very broadly to include not only lawsuits, but also a written "demand" which may include a letter or an email. See, e.g., Westrec, 163 Cal. App. 4th at 1393 (letter demanding settlement met the policy definition of claim); Presidio Wealth Mgmt., LLC v. Columbia Cas. Co., 2014 U.S. Dist. LEXIS 47001, **22-23 (N.D. Cal. April 3, 2014) (email from investor demanding to be "made whole" held to be a claim). Moreover, the definition of a "claim" may include demands for both "monetary" and "non-monetary" relief. See, e.g., Phoenix Ins. Co. v. Sukut Constr. Co., 136 Cal. App. 3d 673, 677-78 (1982) (request by a client that his attorney work "without pay" to cure problems constituted a claim).

Second, a policyholder should have in place an internal procedure for immediately directing any communication that may qualify as a "claim" to a point person with responsibility for insurance tenders. In-house counsel or risk managers are obvious candidates for this role. This can be particularly challenging in a larger organization, but is an essential procedure to avoid any "claim" slipping through the cracks. Upon receipt of any communication demanding relief of any kind, this question should be asked: Does this communication meet any of our insurance policies' definition of a "claim"?

Lastly, any communication that does meet the policy's definition of a "claim" should be reported immediately to the insurer in compliance with the policy's reporting conditions. In no event should the claim be reported beyond the policy's reporting period, which typically expires either at the end of the policy term, or a short period of time thereafter (e.g., a grace period of 30, 45 or 60 days).

Timely reporting is absolutely imperative since insurers in California, and in most other states, allow policyholders no leeway whatsoever for the late reporting of a claim under a claims-made-and-reported policy. Moreover, while the California Supreme Court has yet to address the question of late notice under claims-made-and-reported policies, several intermediate appellate courts have enforced such policies' reporting conditions. See, e.g., Pacific Employers Ins. Co. v. Superior Court, 221 Cal. App. 3d 1348 (1990).

Like a whipsaw, a claims-made-and-reported insurance policy can be an extremely dangerous instrument if handled improperly. It remains to be seen whether the California Supreme Court may eventually conclude such policies are subject to the notice-prejudice rule which reflects a public policy of this state, or the statutory law disfavoring forfeitures (Civil Code Section 3275). In the meantime, by following the protocols described above, policyholders can increase the likelihood that any communication qualifying as a "claim" will be timely reported to their insurer.