Legal Malpractice Insurance: The Prior Acts Conundrum

Legal Malpractice Insurance: The Prior Acts Conundrum

All legal malpractice and other pro-fessional liability policies are “claims-made”, whereby coverage is trig-gered by the filing of a claim against the insured lawyer or other profes-sional, i.e., the lawyer must have in-surance in place on the date that the claim is made, for it to be eligible for coverage.

However, such policies are more ac-curately called “claims-made and re-ported”, which means that the claim must be made against you during the current policy period, i.e., while you have a policy in effect with that insurer, and you must report the claim to your insurer during same policy period in which it was made, i.e., your current policy period.

Further, with basic claims-made and reported coverage, the wrongful act underlying a claim must also have occurred during the current policy period.

Prior Acts Coverage

To be covered for claims arising out of wrongful acts that occurred prior to the current policy period, a firm must have Prior Acts coverage, a/k/a Retroactive coverage, which covers alleged malpractice committed before the current policy’s inception date.

Prior Acts coverage is essential, because malpractice claims generally aren’t filed until 1 – 4 several years after the alleged wrongdoing. Without it, the firm’s current policy – the one it has in place when it receives the claim – won’t provide coverage, since the wrongful acts that gave rise to the claim occurred before the inception date.

Every claims-made policy has a Prior Acts or Retroactive Date, which is usually on the Declarations (first) page of the policy. Insurers won’t provide prior acts coverage when a firm buys its first malpractice policy, so for that policy, the Prior Acts Date will be the same as the policy inception date. However, once a firm buys a policy and renews it without letting it lapse, its insurer will offer it prior acts coverage back to the inception date of its first policy, i.e., in the firm’s second year of coverage, it’ll have one year of prior acts coverage, in its third year, it’ll have two years of prior acts coverage, etc.

Then, if the firm is sued for work it did on or after the inception date of its first policy, and before the inception date of its current policy, and it reports the claim to its insurer during its current policy period, its Prior Acts coverage will obligate its insurer to protect it (sub-ject to policy exclusions, etc.)

Conversely, if a firm doesn’t renew its policy one year, then it’ll lose all of its Prior Acts coverage; the next policy it buys will cover any errors or omissions it commits only on or after the inception date. For example, if a firm was insured from Jan. 1, 2000 – January 1, 2016, but didn’t renew or buy Extended Reporting Period coverage, then starting at 12:01 AM on January 1, 2016, it would no longer be insured for claims arising out of er-rors or omissions it committed before then. Even if it bought coverage on Jan. 2, 2016, that policy would cover it only for any errors or omissions it commits between that date and Jan. 2, 2017.

Prior Acts Coverage Gaps

However, even if a firm has Prior Acts coverage, gaps can occur that will leave it unpro-tected if it incurs a claim.

This claim scenario that we discussed previously illustrates how a coverage gap is cre-ated if a firm switches insurers: the Great law firm bought a legal malpractice policy from Big Insurer effective January 1, 2012 – December 31, 2012, and renewed it for January 1, 2013 – December 31, 2013, and January 1, 2014 – December 31, 2014, but switched to Huge Insurer on January 1, 2015.

A Great lawyer represented client Smith from February 15, 2013 – May 1, 2014. On March 5, 2015, Smith notified the Great firm that he planned to sue it for malpractice. The firm reported the claim to Big Insurer on March 9, 2015.

Will Big Insurer provide coverage?

Previously, we presented three conditions that must be met for a claim to trigger cover-age under a claims-made policy:

1) The wrongful act(s) that gave rise to the claim must have occurred on or after the policy’s retroactive date – the date you began uninterrupted coverage with your insurer. 2) The claim must be made against you during the current policy period, i.e., while you have a policy in effect with that insurer.
3) You must report the claim to your insurer during same policy period in which it was made, i.e., your current policy period.

Let’s apply them to this scenario:

Condition #1: the wrongful act(s) that gave rise to the claim occurred between February 15, 2013 – May 1, 2014, the period of representation, which is after the policy’s retro-active date of January 1, 2012. Pass.
Condition #2: the claim was made on March 5, 2015, which was after the Great firm had terminated its coverage with Big Insurer. Fail.
Condition #3: The Great firm reported the claim to Big Insurer on March 9, 2015, which is after it had terminated its policy. Fail.

Can the Great firm obtain coverage by reporting the claim under the 60-day grace per-iod that most insurers allow after a claims-made policy is terminated? No, because this would’ve allowed it to report this claim by March 2, 2015, but it didn’t report it until March 9, 2015. Fail.

Conclusion: the claim isn’t covered under Great firm’s legal malpractice policy with Big Insurer.

It then reported the claim to its new carrier, Huge Insurer; will it provide coverage?

Let’s apply the three-condition test:

Condition #1: the wrongful act(s) that gave rise to the claim occurred between February 15, 2013 – May 1, 2014, the period of representation, which is before the Great firm’s policy’s retroactive date of January 1, 2015, its first date of coverage with Huge Insurer. Fail.

Conclusion: no coverage.

The Great firm thus has no coverage for this claim under either its prior or current pol-icy, so it will have to fund its defense and any monetary settlement out of its and/or its partners’ assets.

Avoiding Prior Acts Coverage Gaps

Here’s how the firm could have avoided this coverage gap:

I. Buy an Extended Reporting Period (ERP) endorsement from its former insurer (Big Insurer), which would allow it to report claims for 1 – 5 years or in perpetuity after ter-minating its coverage, depending on which option it buys.

The endorsement “applies only to claims first made against you and first reported to us on or after the policy termination date” – December 31, 2014 in this example – and “the claim (must arise out of) an act or omission occurring prior to the end of the Policy Per-iod”, – again, December 31, 2014 – and on or after the policy’s retroactive date – Janu-ary 1, 2012 in this example.

What would’ve happened if the Great firm had bought the ERP endorsement, even for one year?  Let’s apply the 3-condition test:

Condition #1: the wrongful act(s) that gave rise to the claim occurred between Febru-ary 15, 2013 – May 1, 2014, the period of representation, which is after the policy’s retro-active date of January 1, 2012. Pass.
Condition #2: the claim was made on March 5, 2015, after the Great firm’s policy ter-mination date of December 31, 2014, but the 1-year ERP extends the period in which the policy will cover claims made against it to January 1, 2015 – December 31, 2015. Pass.
Condition #3: The firm reported the claim to Big Insurer on March 9, 2015, which be-cause it bought the ERP, is within the allowable reporting period of January 1, 2015 – December 31, 2015. Pass.

Conclusion: assuming no policy exclusions, etc., apply, this claim is covered under the Great firm’s legal malpractice policy with Big Insurer.

However, ERP coverage is expensive, typically 125% of the annual premium for a one year ERP, rising to 300% for a perpetual ERP.

Also, whatever limit is left on the expiring policy carries over to the ERP. If/when that limit is exhausted by defense costs and indemnity payments made by Big Insurer to resolve malpractice claims, the Great firm will have no further coverage under that policy, even if it bought a multi-year ERP that still has years to go. In other words, buying an ERP doesn’t buy fresh policy limits.

Further, the Great firm would still have to buy a policy to cover it for any malpractice that it commits after 12/31/14.

II. Buy Prior Acts coverage from its new carrier, Huge Insurer, which resets the policy retroactive date to before the inception of coverage, i.e., back to when the Great firm first had continuous coverage, which is January 1, 2012, when it bought its first legal malpractice policy from Big Insurer.

This would be the retroactive date of its policy with Huge insurer, if it bought Prior Acts coverage; without Prior Acts coverage, the policy’s retroactive date would be the same as its inception date: January 1, 2015.

Now let’s apply the 3-condition test to the above claim scenario:
Condition #1: the wrongful act(s) that gave rise to the claim occurred between Febru-ary 15, 2013 – May 1, 2014, which is on or after the policy’s retroactive date of January 1, 2012. Pass.
Condition #2: the claim was made on March 5, 2015, during the current policy period of January 1, 2015 – December 31, 2015. Pass.
Condition #3: The firm reported the claim to Huge Insurer on March 9, 2015, which is during the same policy period in which it was made. Pass.

Conclusion: the Great law firm is covered for this claim is under its policy with Huge Insurer, subject to any policy exclusions, etc.

Further, Prior Acts coverage costs less than an ERP, and is generally the better choice for law firms that switch malpractice insurers.

Note: Insurers won’t provide Prior Acts coverage unless the insured attests that it’s un-aware of any pending claims against it, or of any incidents that could lead to a claim, i.e., an adverse outcome or a missed statute of limitations. If it is aware of a pending or po-tential claim, it must disclose that on its application, and the new insurer won’t cover it.

Thus, Huge Insurer would deny coverage for the above claim if client Smith had threat-ened to sue the Great firm for malpractice prior to 1/1/15, Great’s first day of coverage with Huge, or if the Great attorney who worked with Smith knew before that date that he/she had made an error that could result in Smith making a claim.

In either case, the Great firm should have immediately reported Smith’s threatened suit or the attorney’s error to Big Insurer, its malpractice insurer at the time.

Known v. Unknown Prior Acts

Keep in mind that even if you switch insurers and the new insurer gives you Prior Acts coverage back to the inception date of the first policy you ever purchased, it will cover only unknown prior wrongful acts, not known prior wrongful acts, i.e., those that a firm knew about before the inception date of its first policy with that insurer.

Every claims-made policy has a Prior Knowledge Condition, which excludes coverage for ‘known prior wrongful acts’.

Here’s an example from Darwin National’s policy:

“…It is a condition precedent to coverage that the Wrongful Act upon which the Claim is based occurred…

  1. during the Policy Period; or
  2. on or after the Retroactive Date and prior to the Policy Period, provided that…prior to the inception date of the first policy issued by the Insurer if continuously renewed, no Insured had any basis (1) to believe that any Insured had breached a professional duty; or (2) to foresee that any such Wrongful Act or Related Act or Omission might reasonably be expected to be the basis of a Claim against any Insured;” (emphasis added)

Without such a policy provision, attorneys could remain uninsured until they committed a wrongful act, and then rush to buy a policy before their client filed a claim.

To prevent that, every malpractice insurer’s application requires a firm to disclose any known claim, or any known wrongful act that could lead to a claim. If the firm discloses a known claim or wrongful act, and later seeks coverage for it, the insurer can deny cov-erage under its policy’s Prior Knowledge Condition. If the firm doesn’t disclose it, and later seeks coverage for it, then the insurer can either deny coverage under the Prior Knowledge Condition, or seek to rescind the policy, due to material misrepresentation.

To protect your firm, report all actual and potential claims to your current insurer before the policy period ends, and you switch to the new insurer.

However, there’s no protection against a rogue partner who doesn’t disclose a potential claim. This creates a gap in coverage if the firm switches insurers, even if it gets full prior acts coverage from the new insurer.

We’ll illustrate using the above example, whereby the Great law firm bought three one-year legal malpractice policies from Big Insurer for January 1, 2012 – December 31, 2015, then switched to Huge Insurer on January 1, 2015.

A Great lawyer represented client Smith from February 15, 2013 – May 1, 2014. On October 4, 2014, Smith notified his Great lawyer that he planned to sue it for malprac-tice.

However, the attorney didn’t tell anyone at the firm about it, so it was never reported to Big Insurer before the firm’s last policy with it terminated on 12/31/14, and it wasn’t re-ported on the firm’s application to its new carrier, Huge Insurer.

On 4/1/15, Smith sued the Great firm, but Big Insurer denied coverage, since its policy with firm had expired on 12/31/14, and the firm didn’t renew. Huge Insurer denied cov-erage, even though the wrongful acts had occurred after the firm’s Prior Acts date of 1/1/12, because Smith’s attorney knew about the potential claim on 10/4/14, before the inception date of its first policy with Huge, which was 1/1/15, i.e., it was a known prior wrongful act, and was thus excluded by the policy’s Prior Knowledge Condition.

The firm would be covered if it had bought an ERP (‘tail’ coverage) from its former insurer, but as noted, that costs much more than buying prior acts coverage from the new insurer, so few firms do it.

That’s the Prior Acts conundrum: a gap in coverage can occur even if a firm has full Prior Acts coverage, if a rogue attorney hides a potential claim. 

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About Curtis Cooper

Curtis Cooper is principal of Lawyers Insurance Group – Broker For Great Law Firms, which helps attorneys optimize their malpractice coverage. Contact him by phone: (202) 802-6415, or email: ccooper “at” lawyersinsurer.com.