How is Coverage Defined?

Probably the most important decision you will need to make regarding liability insurance is how you will define your coverage.

The key question: Should a claim be covered by a policy that was in effect

• at the time the incident occurred, or
• at the time the claim was filed?

Time of occurrence. Traditionally, liability insurance has been based on the time of occurrence. This means the policy in effect at the time of the incident is responsible for handling any resulting claims — even if you are no longer with the insurance firm that originally provided coverage.

With this coverage, it is obviously critical to keep good track of your policies.

Linking coverage to occurrences, however, does have its downside. Unlike property claims, liability claims can be filed years after the actual occurrence — years that don't necessarily take into account inflation or today's the-sky's-the-limit attitude toward legal awards.

As a result, the limits you originally purchased for coverage may be too low for today. Moreover, time passage usually makes the actual date of an incident difficult to pin down — and responsibility for coverage that much more difficult to assign.

Claims-made. Claims-made insurance is an alternate way to establish liability coverage. With these policies, coverage is linked to the policy in force when a claim is filed and reported. This minimizes the tracking and claim inflation problems that can occur with occurrence policies.

To limit the total risk to the insurance company, claims-made policies do place some limits on when an incident had occurred in order to qualify for coverage. Typically, claims-made policies will cover incidents that occurred as long as seven years before the policy began. They also normally provide coverage of claims made shortly after the policy expires.

If a new claims-made policy refuses to extend coverage to occurrences far in the past, you may need to purchase coverage from your previous insurer. This is known as a supplemental ERP, or tail-end coverage.

Tail-end coverage does not tend to be a very good deal for a company, since the insurer typically knows you have nowhere else to turn for coverage. It can, however, be used to fill gaps in coverage that cannot be otherwise addressed.