Prior Acts Coverage – Insurance Coverage for Your Past Activities
For the last 18 months or so, the Professional Liability insurance markets (along with many other insurance markets) have been “hardening,” industry jargon for premiums increasing and/or coverage decreasing. Basically, the deals for the consumer are getting less favorable. As a result, many professionals are looking for ways to get their premiums closer to where they were at the previous year’s renewal.
Some choose to increase their deductible or SIR (Self-Insured Retention)- not a bad idea. Others consider reducing their limits- not a good idea, since that reduction applies to all the work they’ve spent premium dollars covering in the past as well. And every once in a while, you have a client that inquires about eliminating their prior-acts coverage.
Let’s say a friend came to you and said, hey, I need your help this weekend. I’m trying to lighten the weight of my car to improve fuel economy, so I’ve decided to pull out the airbags. And the seat belts. And the entire braking system. Can I borrow a wrench?
Eliminating Prior Acts coverage to reduce premium is an awful idea. Here’s why.
Most Errors & Omissions coverage is written on a claims-made basis. This means that the policy in place when a claim is made is the coverage that applies to that claim. That said, in every imaginable scenario the act that claim is based on occurred in the past. It’s possible that it was earlier the same policy year, but chances are it was prior to the most recent renewal, and in some cases it occurred many years, even decades, earlier.
Claims-made policies account for this by applying a “Prior Acts (a.k.a. Retro) Date”. Acts/errors that occur after that date are covered. Note that if a policy has no specified Prior Acts date, then they have what is referred to as Full Prior Acts (FPA)- the entire history of the insured entity is covered, back to its (or its predecessor’s) creation date.
The reason that eliminating Prior Acts coverage reduces premium is because of the way that coverage is applied. This involves another factor unique to underwriting a claims-made policy: step-rate adjustments.
Since claims-made policies are designed to address exposure from the current point in time, backwards to the policy’s Prior Acts date, every step forward in time adds exposure back to that date- the window of coverage gets larger every day. This is referred to as step-rate, and policy pricing is adjusted for this at renewal time.
As an example, if a new law firm is created, and they purchase a policy with a Prior Acts date of the day coverage goes into effect, they are purchasing coverage from that date until the expiration of the policy (in most cases, 12 months). Since the insurance carrier is covering their work starting that day, there is no exposure prior to that date. The exposure grows every day from that point forward.
When that policy renews in 12 months, the underwriter is now accounting both for the next 12 months, and for the previous 12 months. By the time this second policy expires, there will be twice the exposure that there was when the first policy expired, so pricing is adjusted to account for it- i.e. it gets more expensive.
Over time, step-rate adjustments diminish (as after the first year the covered period/exposure doubles, after the second year it only increases by 50%, and so on), usually evening out after five to seven years, depending on the insurance carrier.
When Prior Acts coverage is eliminated from a policy, the premium can be diminished greatly- just as greatly as the coverage that policy is providing, which is now very little. Not only does the insured waste all the premium dollars they’ve spent through the years covering their Prior Acts, but they’ve also now exposed themselves to any errors that might have occurred prior to their most recent renewal. Without purchasing an Extended Reporting Period at the same time (which is almost always more expensive than simply maintaining their Prior Acts), they are neutering their policy’s ability to protect them.
Times are hard, as is this market, and finding ways to cut expenses is on everyone’s mind. Increase your deductible if you can. Reduce your limits if you must. But unless the alternative is closing your doors, make sure you leave your Prior Acts coverage intact.
Or return my wrench before you go for a drive.
About the Author
Raffi Kodikian is a Vice President and Lawyers Professional Liability Practice Leader with Founders Professional. Raffi assists retail insurance agents across the Country with securing professional liability insurance solutions for law firms of all sizes. Raffi can be reached at Raffi.Kodikian@founderspro.com.