The Downside of “Claims Made” Insurance Policies

Timing is everything with these policies.

Ananda Church of Self-Realization v. American International Surplus Line Insurance Company, 2003 WL 205126 (Cal. App. 2003)

Background. An adult female (Kathy) experienced a pattern of sexually offensive language and conduct while employed by a religious organization (the “church”). She sued her employer, as well as two ministers who were responsible for the offensive conduct, on the basis of sex discrimination, sexual harassment, wrongful dismissal, battery, and emotional distress. The church carried “premises liability” and “directors and officers” insurance, and it turned the lawsuit over to its insurer. The insurer claimed that the lawsuit was not covered under the church’s policy and it declined to provide a legal defense or indemnify the church against any damages. The church hired it own attorneys, but to no avail—a jury found the church and ministers liable. One of the ministers was assessed general damages of $300,000 plus punitive damages of $1 million, the second minister was assessed damages of $30,000, and the church was assessed damages of $300,000 based on negligent supervision.

The church promptly declared bankruptcy and the case was settled during the course of bankruptcy proceedings. The church then sued its insurance company for its refusal to defend or indemnify the church for Kathy’s lawsuit. The insurer insisted that it had no duty to defend or indemnify the church. A trial court agreed with the insurer and dismissed the lawsuit. The church appealed.

The court’s ruling. A state appeals court began its opinion by noting that

a liability insurer owes a broad duty to defend its insured against claims that create a potential for indemnity. The insurer must defend a suit which potentially seeks damages within the coverage of the policy. Implicit in this rule is the principle that the duty to defend is broader than the duty to indemnify; an insurer may owe a duty to defend its insured in an action in which no damages ultimately are awarded.

The court noted that whether an insurer owes a duty to defend usually is determined by comparing the allegations in a lawsuit with the terms of the insurance policy. An insurer is under a duty to defend a claim “whenever the allegations of a lawsuit would support a recovery upon a risk covered by the policy.” On the other hand, if an insurance policy provides no potential basis for coverage, the insurer “is under no duty to defend an action against the insured.”

Directors and officers policy

The church claimed that it was an “insured” under its directors and officers insurance policy, and so the insurer wrongfully denied coverage. The court noted that “D & O” insurance policies “generally cover only the liability of corporate officers and directors or corporate reimbursement for payments made to indemnify them.” The church insisted that it, too, was covered by the policy because it was listed as a “named insured” on the title page of the policy. The church argued that this language took priority over the “tiny print” provisions elsewhere in the policy indicating that only officers and directors were covered. At the very least, the church asserted, there is a conflict or ambiguity on this point which had to be resolved in favor of the insured.

The court concluded that it was unnecessary for it to resolve this issue, since “there is no D & O coverage for another reason—namely, the policy provided coverage on a claims made basis and there was no claim made within the policy period.”

In general, most liability insurance policies are either “claims made” or “occurrence” policies. The court explained the difference as follows:

A “claims made” policy limits coverage to claims made against the insured during the policy period. Under a “claims made” policy, the insurer is responsible for loss resulting from claims made during the policy period no matter when the liability-generating event took place. This is to be contrasted with an “occurrence” policy, which provides coverage for any acts or omissions that occur during the policy period, even though the actual claim may be made after the policy has expired.

Coverage under the church’s D & O policy expired eight months before Kathy filed her lawsuit, and so the court concluded that “the window of coverage expired well before Kathy’s claim ever materialized.”

The church insisted that the policy’s “claims made” language was “too small to read,” and contrary to its reasonable expectations of insurance coverage. The court rejected both contentions:

We have examined the print in the insurance policy in question. While the size of the print is small, it is, contrary to the church’s insinuations, readable without the aid of magnification. In any event, the church cites no authority holding that a court may rewrite an insuring clause of a policy more to the insured’s liking simply because its font size is deemed insufficiently large.

As for the church’s reasonable expectations, those come into play only if the policy language is ambiguous or subject to conflicting interpretations. Where no ambiguity or uncertainty in the policy exists, the insured cannot “reasonably” expect a defense and the reasonable expectations doctrine becomes immaterial. The church makes no reasoned argument that the “claims made” provision is ambiguous or uncertain.

The court also rejected the church’s argument that Kathy’s claim arose during the policy period because she made a formal complaint to a supervisor prior to the expiration of the insurance coverage. It observed, “The ordinary meaning of ‘claim’ in an insurance policy means an assertion of a legal right and includes within its meaning a money demand.” A complaint to one’s supervisor is not a “claim” in this sense. In defining a claim,

the law focuses on the claimant’s formal demands for payment and does not recognize a request for an explanation, the expression of dissatisfaction or disappointment, mere complaining, or the lodging of a grievance as a claim. There is no evidence Kathy ever formally demanded money or the performance of some service as an assertion of her legal rights. Her complaint about past mistreatment did not meet the “claim” requirement.

Premises liability

The church’s premises liability policy stated, “We, the company, agree to pay property damage or bodily injury to which this insurance applies and resulting from an occurrence arising out of the ownership, maintenance or use of the specifically described premises.” “Bodily Injury” was further defined as “bodily injury, sickness or disease sustained by a person including death resulting from an accident that causes actual physical impairment, other actual physical harm to the body tissues of a person.”

The insurer argued that there could be no potential coverage under the policy for Kathy’s complaint because (1) her alleged injury did not arise out of the church’s ownership, maintenance, or use of the premises, and (2) none of the wrongful conduct could be characterized as “resulting from an accident.” The appeals court agreed. It concluded, “Whether [the ministers’] acts were driven by bizarre theology, sexual lust, or both, they were not dependent on any specific locality for their perpetration. Indeed, many of the more egregious acts took place in secluded places away from the church. The fact that some of the acts may have occurred there is plainly insufficient to establish the requirement that the loss arise out of the church’s ownership, maintenance, or use of the premises.

The court also concluded that coverage under the premises liability policy required “bodily injury” caused by an “accident,” and no accident occurred. It noted that an accident is an “unintentional, unexpected, chance occurrence,” and none of the wrongful acts alleged in Kathy’s lawsuit “can be characterized as accidental.” Instead, they are based on intent or negligence. The lawsuit was clear that “all of the wrongful acts were committed knowingly and deliberately; all had as their object the pursuit of sexual gratification, which is a necessarily intentional act.” The court also rejected the church’s argument that the church’s “negligent supervision” was an accident covered under the policy.

Relevance to church treasurers. Many forms of liability insurance come in two forms: (1) occurrence policies, and (2) claims made policies. It is critical for church leaders to understand the difference. Occurrence policies only cover injuries that occur during the policy period, regardless of when a claim is made. A “claims made” policy covers injuries for which a claim is made during the policy period if the insured has continuously been insured with claims made policies with the same insurer since the injury occurred. Some insurers who offer claims made policies may agree to cover claims made during the current policy period for injuries occurring in the past when the insured carried insurance with another insurer. This is often referred to as “prior acts coverage.”

As this case illustrates, the main disadvantage of a claims made policy is that it only covers claims that are actually made while the insurance policy is in force. When such a policy expires or is terminated, for any reason, coverage ceases (even for claims that are later made for injuries occurring during the policy period). Further, coverage for prior claims is lost if a church switches from a claims made to an occurrence policy.

Church leaders should understand if each of their insurance coverages is a claims made or occurrence basis. If you have a claims made policy for any risk, then you should recognize that coverage for prior claims is lost if your church switches to an occurrence policy (or to another claims made policy without “prior acts” coverage). This can create a dangerous gap in coverage. Be alert to this risk whenever you are considering a change in policies.

Example. A church purchases “claims made” counseling insurance from Company A each year from 1999 through 2002. It switches to an “occurrence policy” with Company B on January 1, 2003. A lawsuit is brought against the church in 2003 for an alleged act of counseling malpractice that occurred in 2000. The church’s policy with Company A will not cover this claim, since the claim was not “made” during the policy period (even though it occurred during the policy period). Had the church not switched insurers in 2003, the claim would have been covered. Does the policy with Company B cover the claim? No, since the injury did not “occur” during the policy period (2003). As a result, there is no coverage for this claim. Note that the result would have been the same had the church purchased a claims made policy from Company B, unless it also purchased “prior acts” coverage. This example illustrates an important point. Churches should not switch from a claims made to an occurrence policy (with the same or a different insurer), or switch claims made insurers, without a clear understanding of the potential impact on insurance coverage.

This article first appeared in Church Treasurer Alert, November 2003.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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