Liability Policy Triggers PDF

UNIVERSITY OF THE WITWATERSRAND SCHOOL OF BUSINESS SCIENCES BCOM. HONOURS INSURANCE AND RISK MANAGEMENT BUSE4024A Advanced Liability Insurance and Risk Management 2023 Lecturer: Ms P Spentzouris (Notes prepared by Dr Albert Z. Mushai) Lecture 4 LIABILITY POLICY TRIGGERS Liability insurance contracts...

UNIVERSITY OF THE WITWATERSRAND SCHOOL OF BUSINESS SCIENCES BCOM. HONOURS INSURANCE AND RISK MANAGEMENT BUSE4024A Advanced Liability Insurance and Risk Management 2023 Lecturer: Ms P Spentzouris (Notes prepared by Dr Albert Z. Mushai) Lecture 4 LIABILITY POLICY TRIGGERS Liability insurance contracts respond to claims in different ways depending on how the wording of the operative clause. Each liability insurance contract incorporates a so-called policy trigger. The trigger specifies how liability shall attach to the policy and how the policy responds to claims. There are several triggers used in liability insurance policies and each has different implications for the insurer and insured. Therefore, one of the most important things to understand when dealing with liability insurance issues is the policy trigger used in the policy in question. For purposes of analysis, there are three critical periods to the insurance of liability risks. These are: § § § The run-in period – this is the period before the inception of the contract of insurance. Understanding what happened during this period is important because the nature of liability risk is such that something may take place before the period of insurance that produces a claim during the insurance period. The period of insurance – typically this is the 12 months that the contract of insurance between inception and expiry. In first party insurance, a claim must occur in the period of insurance for it to be valid. In liability insurance, this is not necessarily the case; a lot depends on the available policy trigger. The run-off period – this is the period after the expiration of the period of insurance. It is possible for the cause of loss to take place during the period of insurance, but the claim only becomes manifest after the insurance policy has lapsed. These time phases are important in liability risk analysis because a risk can evolve through all of them before producing a claim in the run-off period. Consider a design of a bridge that is defective. If construction takes place using that defective design and the bridge looks fine and ready for use despite the defect in design, several questions arise e.g. has harm occurred or not? Is there a valid claim for purposes of compensation? It is possible for the bridge to be in use for years before the defect in the design causes a visible structural failure. Therefore, it is possible for insurance to take effect on something where the loss-causing act could have taken place years before. 1|Page Causation Basis In terms of this trigger, the events causing the loss must take place during the period of insurance. For instance, a new bridge is constructed and in the process of such construction, defective pillars are used. Some 2 years after completion, the pillars buckle and the bridge collapses. Under the causation basis of liability, the policy that was in place at the installation of the defective pillars must respond to the claim. Even if the bridge were to collapse after ten years, as long as the cause of the collapse is the defective pillars the policy that was in force at the point of installing the defective pillars pays the loss. Therefore, under the causation trigger, the operative word is cause. The trigger assumes that it is always possible to identify the cause of every loss in both space and time. Consequently, in situations where identifying the cause is difficult, the causation trigger becomes problematic. The causation trigger nullifies the run-in period for risk analysis purposes because as long as the cause is not in the period of insurance it will not respond to any claim. However, the trigger exposes the insurer to claims in both the period of insurance and the run-off period. Occurrence Basis Under the occurrence basis of liability, the damage or harm suffered by the 3rd party must take place or occur in the period of insurance if the insurer is to be liable. Under this trigger, it crucial to determine the date of occurrence of the damage suffered by the 3rd party. Occurrence of damage or harm is not the same thing as causation of harm. Outside the area of occupational disease, identifying a cause does not pose many challenges in most cases. However, determining the date of an occurrence is usually problematic. For example, in cases involving the gradual release of toxins into a water source identifying the date of occurrence is virtually impossible. Another area where determining the date of occurrence or whether an occurrence of harm has taken place is compensation for long latency injury. A look at case law from various jurisdictions on this issue illustrates the complexities involved. First, what constitutes damage is not always as straight forward. In the controversial English case of Rothwell v Chemical and Insulating Limited & Others [2008] 1 AC 281 the House of Lords ruled that pleural plaques did not constitute compensable damage. Pleural plaques are a condition that develops following exposure to asbestos. Although they are not a disease and do not affect the normal functioning of a human body their development means the person faces a higher risk of developing an asbestos disease like asbestosis or mesothelioma in future. Following the decision in Rothwell, the Scottish Parliament passed legislation in 2009 to reverse the ruling.1 In 2011, Northern Ireland followed the Scottish example and passed similar legislation to reverse the decision in Rothwell.2 Therefore, today Rothwell represents the law in England and Wales but not in Scotland and Northern Ireland. 1 2 The legislation in question is the Damages (Asbestos-related Conditions) (Scotland) Act, 2009 Asbestos-related Conditions (Northern Ireland) Act, 2011 2|Page Yet another problem with the occurrence trigger lies in determining when damage actually occurs. Nowhere is this more difficult than in the area of liability for long-latency occupational diseases.3 In the other English case of Bolton Metropolitan Borough Council v Municipal Mutual Insurance Limited [2006] 1 WLR 1492 a case which involved a public liability policy the insurer agreed to indemnify the insured in the event that it became liable for injury or illness which occurred during the currency of the policy. A 3rd party was exposed to asbestos fibres in the 1960s due to the insured’s (Bolton) negligence and was diagnosed with mesothelioma (an asbestos-related disease) in 1991 of which he died later that year. In the 1960s, Bolton’s public liability insurer was Ocean Accident & Guarantee. From 1979 to 1991, the insurer was Municipal Mutual. His widow sued Bolton who agreed to settle the claim. Bolton sought to recover indemnity from their public liability insurer (Municipal Mutual) the insurer on risk when the deceased developed mesothelioma. The insurer denied liability arguing that the claim occurred outside the policy period. According to the insurer the occurrence in this case was the exposure to asbestos in the 1960s some years before Municipal Mutual went on risk. The UK Appeal Court ruled against Municipal Mutual’s argument and held that they were liable because in this case damage occurred not when the deceased was exposed to asbestos but much later when he became fatally ill. The court went further to say that the argument that injury in such cases occurred when asbestos fibres were first inhaled was inconsistent with both principle and policy. Merely inhaling asbestos fibres does not create liability in the absence of personal injury. Thus, in accordance with this ruling, actionable injury does not occur upon mere exposure to toxic agents but much later when identifiable symptoms first occur. Typically, both the causation and occurrence wordings can expose an insurer to losses long after it has ceased to be on cover. The occurrence wording also provides coverage even when the cause of the loss lies outside the inception of the policy or when the eventual claim is filed after the expiration of the policy term. Occurrence wordings thus provide protection for a run-in period (i.e. events that took place before the policy was issued but where damage occurs in the period of insurance) and for a run-off period (i.e. cover for events that produce damage during the policy period but the eventual claim is filed outside or after the policy has expired). In the US, the question of what constitutes occurrence of harm for purposes of this trigger. US courts have held that the occurrence wording provides coverage for damage or harm that occurs during the policy period even if the actual claim is made after the policy has expired. Furthermore, it is a well-stablished principle in the US that the time of the occurrence is not when the wrongful act was committed but when the victim sustained harm.4 Of all the liability insurance policy triggers, the occurrence basis has given rise to the most complex interpretation and insurance practice problems. Up to this point, we have seen some of the interpretation problems associated with this trigger. The next thing is to examine the insurance 3 Most of the case law cited in this lecture comes from English law and for good reason. The UK has a developed body of case law on employer’s liability issues. Unlike most other countries including South Africa that banned common law actions in favour of workers’ compensation, the UK opted to let workers’ compensation and liability of the employer at common law co-exist since 1969. Therefore, while South Africa has virtually no case law on liability for bodily injury and disease, the UK is the opposite. 4 See for example: Thomas Guastello v AIG Specialty Insurance Co 2021 WL. 650878 (Cal. Ct. App, Feb 19, 2021 and Whittaker Corp. v Allianz Underwriters Inc 11 Cal. App. 4th 1236, 1241 (1992) 3|Page problems arising from this trigger. In Lecture 1 we pointed out that one of the main features of liability risk is that more often than not claims have a long tail. The long tail feature in liability claims induces the following problems: a) Pricing the risk (i.e. determining the right premium) becomes difficult because the available data used to price the risk lags behind the data used to evaluate the claim decades later. Insurance works on a simple model – premium collected must be adequate to cover expected claims. When a claim occurs decades after acceptance of the risk, it becomes difficult to set premiums that reflect expected claims. b) Because of the long delay between writing the risk and settling the last claim for any given period of insurance, there is uncertainty regarding the final cost of claims to the insurer of all claims traced back to when the policy incepted. Uncertainty complicates allocation of resources. c) Accounting difficulties also arise. It becomes difficult to assess amounts to set up as reserves for future claims. In addition, it also becomes difficult to determine appropriate provisions to cover outstanding claims. In addition, the insurer may not know how long it needs to keep those provisions in its books. Confronted with these accounting issues, measuring results (profitability) for any given financial year also becomes difficult. d) The effects of inflation and increases in the size of court awards (or damages which often exceed investment earnings on reserves and provisions) worsen the situation further. e) The longer the size of the tail of the claim, the higher the risk that by the time the claim comes up for settlement, legislation, scientific knowledge and public awareness could have changed thereby increasing the insurer’s liability beyond that anticipated at the time of issuing the policy decades ago. For example, failure to predict future claims from asbestos resulted in the collapse of over 100 insurers in the US between 1988 and 1990. The problems that nearly caused the collapse of Lloyd’s of London were rooted in long latency liability risks. The occurrence trigger is vulnerable to all the above problems because it has no mechanism of reducing the length of the tail. It will continue to provide coverage long after the policy has expired as long as the occurrence of harm is traceable to the time when the policy was in force. Consequently, this trigger does not bring finality to the insurer’s liability. Manifestation Basis The manifestation wording deems damage or injury to have occurred when the insured first becomes aware of such damage. Usually, the awareness by the insured coincides with the injured 3rd party’s awareness of injury or damage. In the earlier example of a bridge constructed using defective pillars, the loss will be deemed to have become manifest when the bridge collapses because that is the point at which the insured becomes aware of such damage. Coincidentally, the owners of the bridge can only become aware of the damage at that point as well. The manifestation trigger has not provided any notable practical problems for insurers although its use has been limited. In addition, very few liability insurance contracts use this trigger in practice. 4|Page Claims Made Basis The claim’s made trigger is of recent origin having entered the market in the early 1980s. Given the problems arising from the occurrence trigger’s failure to mitigate the long tail problem, insurers faced pressure to develop a trigger that attempts to address these problems at least in part. This led to the development of the claims made wording. Initially, courts and lawmakers did not warm up to this wording. For example, the wording was banned in countries such as France, Belgium and Spain in the early 1990s. The contracts were also invalid in Switzerland. In 1974, the Swiss Federal Supreme Court held that in 3rd party liability insurance, only the time the damage is caused constitutes a reasonable criterion for assigning liability. Under the claims made basis of liability, the insurance in force at the time a claim is made by the injured 3rd party against the insured pays the claim. Unlike the occurrence wording that seeks to establish the date of occurrence, the claims made wording uses an easier and more objective determinant of liability i.e., the making of the claim by the third party against the insured as a proxy for causation or occurrence. The insurer is liable for the loss only if the victim files his claim against the insured during the insurance contract period. Since such an action forms the tailpiece of the liability claims process, the claim’s made principle does not provide coverage for any run-off period, it only covers the run-in component of the claim. Accordingly, a major advantage of the claim’s made basis is that it significantly reduces the tail of liability claims. However, the run-in coverage provided under claims made can be substantial since it does not matter when the act or damage that gave rise to the claim actually occurred. Under claims made, the meaning of claim is much clearer than is the case under the occurrence wording. Earlier we saw that under the occurrence wording, even conceptualizing something seemingly straightforward as what constitutes harm often results in complex problems e.g., the problem with pleural plaques. Unlike the occurrence wording, claims made does not provide continuous coverage. Once the period of insurance lapses and there is no claim made against the insured, the liability of the insurer terminates at that point unless the policy has an extended reporting period. One major requirement under claims made is that the insured must notify the insurer of any circumstance that may lead to a real claim in the future. In reality this requirement constitutes a secondary trigger under the claims made principle in addition to the actual making of the claim by a 3rd party. What constitutes a circumstance for purposes of notification is not easy to define. Additionally, claims made policies also contain an extended reporting period i.e., a short period after the end of the contract term. The extended reporting period is actually an extension of the policy period since the insurer is liable for all claims made against the insured within that period. In HLB Kidsons v Lloyd’s Underwriters [2007] EWHC 1951 the court provided useful insights on the so-called circumstance notification clause in claims made policies. The court formulated the following guidelines for dealing with the so-called circumstance notification cases: (1) The requirement to give notice as soon as practicable is a condition precedent to the insured’s right to recover under the policy and failure to give such notice by the insured 5|Page entitled the insurer to repudiate liability regardless of whether or not the insurer suffered any prejudice. (2) A circumstance that may give rise to a claim is one which when evaluated created a reasonable and appreciable possibility (but not necessarily a probability or likelihood) that it would produce a loss. The risk of loss has to be real not imagined. (3) Notice of a circumstance has to be clear and unambiguous. (4) Courts interpret the notification clause from a narrow as opposed to a broad or liberal perspective. Given the foregoing, one may be inclined to ask; what constitutes a claim in the context of claims made policies? A claim is a demand for money or services or an assertion of rights. Therefore, the word ‘claim’ in this context may encompass any of the following: (a) The happening of circumstances of fact which may give rise to injury and its consequential liability. (b) The happening of circumstances of fact which may or are likely to give rise to a claim. (c) Notification to the insured by the 3rd party of circumstances of fact which are likely to give rise to a claim. (d) Notification to the insured by the 3rd party of circumstances of fact which may give rise to a claim i.e., mere allegations; and (e) The institution of either civil or arbitration proceedings against the insured by the 3rd party. The purpose of the notification clause is to make the insurer aware of all circumstances surrounding the substantive claim thus allowing the insurer as dominis litis (i.e., the person truly and directly interested in the action) to investigate the same at the earliest possible time. The term “circumstances” should therefore be understood to mean events that occur during the policy period that are in all reasonableness likely to give rise to a claim or damage in the future (Schoorens & van Schoubroeck, 1998). The approach taken in the UK regarding the circumstances notification clause in claims made policies is different from that followed in Australia and New Zealand. In East End Real Estate Pty Ltd v C.E. Heath Casualty & General Ltd [1991] 25 NSWLR 400 (Australia), it was held that S.54 of the Australian Insurance Contracts Act 1984 prevented an insurer from refusing to pay a claim purely because the insured failed to notify the insurer within the policy period if the insurer had suffered no prejudice. Therefore, in Australia and New Zealand, the scope of the circumstance notification requirement is narrow compared to the UK. This is because in the UK, the insurer can repudiate a claim for failure to notify of a circumstance even if that failure results in no prejudice to the insurer. In Australia and New Zealand, it is a requirement that the insurer must show that it suffered prejudice. It is not always easy to determine what a circumstance is for purposes of notification to the insurer. In Euro Pools Plc v Royal and Sun Alliance Plc [2019] EWCA Civ. 808 the court pointed out that ‘circumstance’ in the context of an insurance policy is a broad term. All it requires is a reasonable expectation that the circumstance in question may result in a claim for which there may be legal liability under the policy. The insured need not understand or appreciate the cause or causes of the problem that may give rise to a claim. It is sufficient to appreciate the problem in general terms 6|Page as long as there is a reasonable possibility that those problems could create a claim falling within the scope of the existing policy in future. Conclusion Unlike first party insurance policies that link insurance to specific perils, liability insurance policies specify the way a policy responds to consequences of wrongdoing by the insured. The trigger words are occurrence, manifestation, causation or claims made. Each of these words have different consequences and implications for the insured and the insurer. Additionally, each of these words has been adjudicated by courts in different jurisdictions. By far, the word occurrence has caused a lot of legal controversy. Occurrence wordings provide continuous coverage implying that the insurer remains on risk even after the policy has been terminated. This is because, if a claim is filed subsequent to the termination of the policy, there is a chance of the insurer being liable for it if it is traced to an occurrence happening in the period of insurance. Claims made contracts on the other hand attempt to avoid the perpetual coverage provided under occurrence wordings by making the liability of the insurer dependent on the making of the claim by the 3rd party against the insured. If the claim is not made in the period of insurance, there is no prospect of the insurer being liable for any claim made after the policy has terminated except in cases where the policy has an extended reporting period or where the claim relates to a circumstance that happened during the period of insurance for which the insurer received notification. It is not common to find liability insurance policies written on manifestation or causation basis. For some classes of liability insurance like professional indemnity insurance, the universal approach is to write these on claims made basis. The occurrence wording is not used in PI policies mainly because of the nature of PI claims. PI claims do not fit the occurrence terminology since most of them relate to professional advice or acts that do not fit a specific location or time. AZM-Feb-2022 PS- Feb-2023 7|Page