Does the Discovery Provision Apply during the Extended Reporting Period?
Robert Bregman | March 1, 2002
This article examines an often-overlooked but critical variation in claims-made policies: whether the policy's discovery provision is operative during the time period covered by the ERP.
There is wide variation in the scope of coverage provided by extended reporting period (ERP) endorsements within claims-made policies. One often-overlooked but critical variation is whether the policy's discovery provision is operative during the time period covered by the ERP. (One key clarification before moving ahead: under some insurers' policy forms, the term "discovery provision" is used to refer to a provision that functions exactly like an ERP.)
A discovery provision in a claims-made policy allows an insured to report to the insurer "circumstances" or "incidents" that have taken place during the term of the policy, if such circumstances are likely to, but have not yet, given rise to a "formal" claim against an insured (i.e., receipt of a summons and complaint). If, after the claims-made policy has expired, those circumstances later give rise to a claim, coverage will apply regardless of how far in the future a "formal" claim is actually made against the insured.
Under a majority of the extended reporting period endorsements offered under claims-made policies, the discovery provision of the policy applies. However, this is not the case with a significant minority of insurers' policy forms. The purpose of this article is to explain why this distinction is critical.
A Claim Scenario Involving an Extended Reporting Endorsement
An employment practices liability policy expires on January 1, 2002, at which time the organization buys a 1-year ERP. On July 1, 2002, the organization first becomes aware of a wrongful act that took place while the policy was in force, which will probably, but has not yet, materialized into a formal claim. The insured reports these circumstances to its insurer the next day.
Under the wording of some insurers' ERP endorsements, the reporting of such circumstances would trigger coverage. However, under other insurers' ERP wording, no coverage would apply until the organization had a formal claim made against it. This difference is illustrated in Figure 1.
| Scenario #1: Discovery Provision Applies during ERP | ||||
| Policy period: | January 1, 2001—January 1, 2002 | |||
| Wrongful act\incident date: | July 1, 2001 | |||
| ERP period: | January 1, 2002—January 1, 2003 | |||
| Incident reported to insurer: | July 1, 2002 | |||
| Coverage available for "incident"? | Yes, because "incidents" that took place during the expired policy period, that are reported during ERP, are considered "claims." | |||
| Incident Takes Place | Incident Reported during ERP | |||
| X__________ | X__________ | X__________ | X__________ | X__________ |
| 1/1/01 | 7/1/01 | 1/1/02 | 7/1/02 | 1/1/03 |
| Scenario #2: Discovery Provision Does Not Apply during ERP | ||||
| Policy period: | January 1, 2001—January 1, 2002 | |||
| Wrongful act\incident date: | July 1, 2001 | |||
| ERP period: | January 1, 2002—January 1, 2003 | |||
| Incident reported to insurer: | July 1, 2002 | |||
| Coverage available for "incident"? | No, because "incidents" that took place during expired policy period, that are reported during ERP, are not considered "claims." | |||
| Incident Takes Place | Incident Reported during ERP | |||
| X__________ | X__________ | X__________ | X__________ | X__________ |
| 1/1/01 | 7/1/01 | 1/1/02 | 7/1/02 | 1/1/03 |
In Scenario #2, the insured would be compelled to continue purchasing ERPs until the incident developed into a formal claim. However, under most claims-made forms, an insured is permitted to buy only a single 1-year ERP. Given this constraint, the advantage of purchasing an ERP in which the policy's discovery provision is operative, is apparent.
The actual policy wording of these two approaches is illustrated in Figure 2.
| Discovery Provision Operative during ERP |
|---|
|
The INSURER shall pay on behalf of the DIRECTORS and OFFICERS any and all sums which they shall become legally obligated to pay as ULTIMATE NET LOSS … by reason of any WRONGFUL ACT which takes place during the COVERAGE PERIOD and is actually or allegedly caused, committed or attempted by the DIRECTORS or OFFICERS while acting in their respective capacities as DIRECTORS or OFFICERS, provided such ULTIMATE NET LOSS arises from a CLAIM first made against the DIRECTORS or OFFICERS during the POLICY PERIOD or during the DISCOVERY PERIOD, if purchased.
|
| Discovery Provision Not Operative during ERP |
|
This Policy shall pay the Loss of each and every Director or Officer of the Company arising from any Claim first made against the Directors or Officers during the Policy Period or the Extended Reporting Period (if applicable) for any actual or alleged Wrongful Act.…
|
A Key Caveat: No Coverage for Wrongful Acts Taking Place during the ERP
There is one key caveat associated with the operation of discovery provisions during ERPs: coverage does not apply if the wrongful act that gave rise to the claim, took place during the ERP, even if the incident is also reported to the insurer during the ERP. (Note the language in the AEGIS policy, above, indicating that for coverage to apply, the wrongful act must take place during the "coverage period.") Rather, under all ERPs, the wrongful act must always take place during the term of the expired or canceled policy. This is illustrated in Figure 3.
| Wrongful Act Takes Place during ERP: No Coverage Applies | |||
|---|---|---|---|
| Policy period: | January 1, 2001—January 1, 2002 | ||
| Incident date: | July 1, 2002 | ||
| ERP period: | January 1, 2002—January 1, 2003 | ||
| Incident reported to insurer: | July 1, 2002 | ||
| Coverage available for "incident"? | No, because "incidents" that took place during ERP, are not covered under any circumstances. | ||
| Incident Takes Place and is Reported | |||
| X______________ | X______________ | X______________ | X______________ |
| 1/1/01 | 1/1/02 | 7/1/02 | 1/1/03 |
Conclusion
By now, it should be apparent that an insured benefits significantly when a claims-made policy's discovery clause is operative during the term of an ERP provision. Accordingly, an ERP provision of this kind should always be insisted upon prior to the inception of a policy. On the other hand, assume that an insured has a policy in which the discovery provision is not operative during the ERP. Attempting to modify that policy so that its discovery provision will be applicable—but after that policy has expired or been canceled—is extremely difficult. Unfortunately, at this juncture, the insured has little or no negotiating leverage.
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