Risk managers ultimately must determine the extent to which the enterprise will seek to transfer risks to insurers, in whole or in part. In so doing, they must consider not only the ability to control risks, but also the ability to recover from others for losses sustained with respect to risks that have been assumed by the corporation and not insured. Only then can a meaningful determination be made as to the likely ultimate cost to the enterprise of assuming untransferred risks, as compared to attempting to transfer them to others through insurance.

To this end, it behooves risk managers to better understand the rationale of a “claims made first” policy form as a positive insurance goal. It is a goal, unfortunately, that many brokers have turned their back on without attempting to formulate thoughts and language to make this form an effective and useful answer to the economic needs of the world of insurance.

A claims made policy is one that provides insurance coverage for claims that are first made during the policy period. Under a claims made policy, the carrier is better able to price the next year’s risk based on the quantification of the current year’s losses and the ability to match liability exposure with current and developing tort law.

By way of contrast, an occurrence policy is one that provides insurance coverage for claims that arise during the policy period even if the claim is made after the end of the policy period. The problem is that “occurrence claim experience” is not as accurate a predictor of future underwriting experience as “claims made experience” because the former but not the latter suffers from temporal distortion occasioned by delay between policy trigger (occurrence) and notice to the carrier that a claim has been made. A problem may exist for many years before the carrier can realize that the problem may affect underwriting assumptions that went into premium calculation. Under the occurrence form, the policies have already been written and the premiums collected. Under the claims made form, premium rates can be adjusted on revived policies that will respond to future claims.

Today, we see claims being made in the United States based upon events that happened 20, 30 or even 40 years ago. With that in mind, it is most important that we focus our attention on the asbestos, mass tort and products liability insurance experience; the risk of miscalculating the actual loss is much greater for mass exposure tort claims than under a claims made first policy because the policy periods remain open and, therefore, loss experience cannot be determined as immediately and as accurately. It is a given that on an actuarial basis, the occurrence policies are not as accurate as the claims made policies.

Most significant is the ability of the risk manager and the underwriter to properly fix a premium on a claims made policy using current loss information. No longer must an insurer consider the “incurred but not reported” category of claims, for he or she knows during each year of the policy those claims that have been made during the period, without concern for claims incurred of which he or she has no knowledge. Following an initial year of account, the insured and the insurer, armed with the actual facts, now can negotiate policy renewal based upon actual claim and loss history incurred and attempt to fix a rate of premium for renewal without the hazards of an inappropriate assumption as regards unreported losses. If the claim experience of the insured has been good, then an appropriate premium adjustment can be made; conversely, if claim experience has been high, then premiums can be adjusted accordingly, with actual knowledge on the part of the risk manager for the insured as to the sound basis of such premium adjustment.

Moreover, the ability of the insurer to review actual claim experience of all insureds affords that insurer an opportunity to know its loss experience with respect to all of its claims made accounts on an annual basis.

The Wall Street Journal recently reported an estimated $38 billion shortfall in asbestos and environmental reserves. There were 30 insurer insolvencies in 2001, 38 in 2002 and 13 in 2003. The global and American industrial society, in a complex world, requires an approach which will be responsive in terms of reasonable expectations to insurers and insurance customers, with guidance from regulators, in achieving stability and actuarial acuity.

Sol Kroll is a veteran insurance attorney based in New York. He has published many articles, particularly on the subject of claims-made regulation on nonadmitted insurance.