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• Claims Made Policies
• The Problem
• Recommendation

2 Section 9 of the Insurance Law Reform Act 1977 and claims made policies

33 SECTION 9 OF THE INSURANCE LAW REFORM ACT 1977 reads as follows:

9 Time limits on claims under contracts of insurance

(1) A provision of a contract of insurance prescribing any manner in which or any limit of time within which notice of any claim by the insured under such contract must be given or prescribing any limit of time within which any suit or action by the insured must be brought shall

(a) If that contract of insurance is embodied in a life policy and the claim, suit, or action relates to the death of the insured, not bind the insured; and

(b) In any other case, bind the insured only if in the opinion of the arbitrator or Court determining the claim the insurer has in the particular circumstances been so prejudiced by the failure of the insured to comply with such provision that it would be inequitable if such provision were not to bind the insured.

(2) Where

(a) The insured under any contract of insurance to which subsection (1) (b) of this section applies fails to give notice of any claim in any manner or within any limit of time prescribed by the contract; and

(b) The cost of repairing, replacing, or reinstating any property when it falls to be met is greater than that which would have applied if the notice had been given in the manner or within the time so prescribed,

that greater cost shall not constitute prejudice to the insurer for the purposes of subsection (1)(b) of this section, but the insurer shall not be obliged to apply or pay in repairing, replacing, or reinstating the property a greater sum than that for which he would have been liable if the notice of claim had been given in the manner or within the time so prescribed.

34 Section 9 was enacted on the recommendation of the Contracts and Commercial Law Reform Committee (Aspects of Insurance Law, 1975, para 21). It is based on s 27 of the Instruments Act 1958 (Victoria). It overrides contractual time-bars in all policies of life insurance and in other policies where the insurer suffers no prejudice as a result of the delay.

35 In general, we consider that s 9 has been operating satisfactorily. However, recent decisions of the Court of Appeal and High Court have revealed problems in applying s 9 to “claims made” insurance policies. This chapter discusses these problems and recommends reform of s 9 in order to resolve them.

Claims made policies

36 Claims made policies are typically used for professional indemnity and company directors’ and officers’ indemnity insurance. These policies provide indemnity to the insured in respect of claims made against the insured by third parties during the currency of the policy. The insured may therefore be covered for claims arising from errors or omissions which occurred before the policy came into force, as it is the claim of the third party, rather than the error or omission of the insured, which must fall within the period of time covered by the policy. Some policies require not only that the claim be made by the third party against the insured during the policy period but also that the insurer be notified of the claim within that period. Such policies are known as “claims made and notified” policies. It is common for both claims made and claims made and notified policies to contain a provision which gives cover in situations where the insured notifies the insurer of potential claims during the currency of the policy, even if the third party claim is not actually made until after the policy expires. Such a provision is variously described as a “deeming clause” or a “circumstances notification clause” or an “extension provision”.

37 A typical deeming or circumstances notification clause would read as follows:

If during the term of the policy the insured becomes aware of any circumstance which may subsequently give rise to a claim against the insured and shall during the term of the policy give written notice to the insurer of the circumstance, then any such claim which may subsequently be made against the insured arising out of such circumstances shall be deemed to have been made during the term of this policy.

This kind of provision is intended to protect the insured whose policy expires after the insured becomes aware that a third party is likely to make a claim, but before any claim is received. Without such a provision the insured may fall between two stools: the insured is not covered under the earlier policy but is obliged to disclose the possibility of a claim to the insurer under the later policy. That insurer may or may not be prepared to accept the risk of indemnifying against such a claim if it eventuates (Legh-Jones, 1997, para 28.69).

38 The promise of the insurer under a claims made or claims made and notified policy does not extend to liability to indemnify for errors or omissions of the insured which, even if they occurred during the currency of the policy, only become apparent after the policy expired. Where indemnity is provided for errors or omissions of the insured during the currency of the policy (“occurrence policies”), rather than in respect of claims made against the insured during such currency, the insurer’s contractual liability under the policy continues until such time as all possible claims are time-barred. In this context it should be kept in mind that the Limitation Act 1950 may not bar claims based on breach of fiduciary duties. For this reason, occurrence policies are said to have a “long tail” and are consequently less attractive to underwriters. The Supreme Court of Michigan explained the position lucidly in the 1984 case of Stine v Continental Casualty Company 349 NW 2d 127 (Mich 1984) 127:

There is greater public familiarity with the “occurrence” type of policy than with the “claims made” type, largely because automobile insurance liability policies are “occurrence” policies, although other perils are covered in such policies as well. Coverage in an “occurrence” policy is provided no matter when the claim is made, subject, of course, to contractual and statutory notice and limitations of actions provisions, providing the act complained of occurred during the policy period. Because the insurer’s liability in such policies ordinarily relates to a definite, easily identifiable and notorious event such as an automobile accident, a fire, a slip and fall injury, or a ship collision, the insurer is ordinarily able to conduct a prompt investigation of the incident and make an early assessment of related injuries and damages with the result that actuarial considerations permit relative certainty in estimating loss ratios, establishing reserves, and fixing premium rates.
“Claims made”, or “discovery” policies, on the other hand, are of relatively recent origin and were developed primarily to deal with situations in which the error, omission, or negligent act is difficult to pinpoint and may have occurred over an extended period of time. In the case of a “claims made” policy written to cover professional liability, the error or omission may be a discrete act or failure to act, or it may consist of a lengthy process and remain latent and undiscoverable for a number of years. Examples include a physician’s mis-diagnosis, an attorney’s fraudulent concealment, or an architect’s defective design. From an underwriting perspective, occurrence policies are unrealistic for such risks because of the long or open “tail” exposure which results. When the “event” intended to be covered cannot easily be fixed and the liability for the consequent injury extends long into the future, often well after expiration of the policy, considerations of inflation, upward spiralling jury awards, and legislative and judicial adoption of newly developing concepts of tort law mean that actuarial factors, including fixing premium rates and establishing adequate reserves, are highly speculative. The result, logically, is the establishment of a premium rate schedule sufficiently high to accommodate “worst scenario” jury verdicts returned years after the error, omission, or negligent act.
“Claims made” policies meet such difficulties by enabling the insurer to underwrite the risk, compute the premiums, and establish reserves with greater accuracy, safe in the assumption that liability will be limited to claims actually made during the term of the policy for which the premium is computed. When the policy term expires, the insurer knows exactly what its exposure is, at least in terms of the nature and number of “claims made”. As a result, the insurer is better able to predict the limits of its exposure and more accurately estimate the premium rate schedule necessary to accommodate the risk undertaken. (131)

The problem

39 In Sinclair Horder O’Malley & Co v National Insurance Co of NZ Ltd [1995] 2 NZLR 257 the Court of Appeal applied s 9 to an extension provision in a claims made policy. The consequence was that the insurer could therefore avoid liability only if it could demonstrate that it had been prejudiced by the failure to give notice. Although three judgments were given, each based on different reasons, the court was unanimous in deciding that the case be remitted to the High Court for a further hearing to determine whether the insurer had in fact been prejudiced by the delay. Sinclair Horder has subsequently been applied to a claims made and notified policy: Bradley West Clarke List v Keeman (1997) 9 ANZ Ins Cas 76,742.

40 The legal effect of Sinclair Horder is to change in a fundamental way the promise made by the insurer to the insured. The insurer’s purpose of knowing where it stands at the end of the period of cover is defeated because of the possibility of future claims that the insurer can resist only if it can establish prejudice (for discussion see Campbell, 1997, 104).

RECOMMENDATION

41 The Law Commission considers that this is an unsatisfactory outcome and one that changes the bargain in a way that is unfair to insurers. Accordingly, we recommend that s 9 of the Insurance Law Reform Act 1977 should be amended by the addition of these new subsections (3) and (4) (see pages 59–81 for our complete draft Insurance Law Reform Amendment Act and commentary):

(3) Subsection (1)(b) does not apply to a provision of a claims made policy that defines the period within which claims made against the insured or claims arising out of circumstances notified to the insurer are within the risk accepted by the insurer under the policy.
(4) In this section claims made policy means a contract of insurance in which the period during which liability for claims against the insured is within the risk accepted by the insurer is defined by reference to the time when such claims are made or claims or circumstances which may give rise to a claim are notified to the insurer.

Note that the proposed subsection (3) is by its terms carefully confined to the definition of the risk. It will still be possible for an insured to invoke s 9 in respect of a delay in notifying within the period of cover. In some United States jurisdictions the courts themselves have evolved a “notice prejudice” rule which has roughly the same effect as s 9. Commencing with the 1989 decision in Burns v International Insurance Company (ND Cal 1989) 709 F Supp 187, there have been a number of cases in which it has been held that the notice prejudice rule should not apply to claims made policies (see Chamberlain, 1992).