Claims-made policies are the most common form of coverage available for professional liability. These policies provide coverage to professionals for claims made during the life of the policy irrespective of the date of the acts or omissions giving rise to the claim. Given the focus on when a claim is actually made, insurers seek to avoid the moral hazard of an uninsured professional running out to buy claims-made coverage once it becomes aware of an act or omission that may give rise to a claim in the future. Insurers seek to avoid this problem by requiring specific representations in the application for insurance about the insured’s knowledge of any potential claims or through an exclusion barring coverage for claims based on any prior acts known by an insured that could give rise to a claim. Although there are several ways for professionals to preserve coverage when it obtains such information, this post will focus on the “prior knowledge” exclusion contained in the policy in question.
In Executive Risk v. Pepper Hamilton LLP, a law firm represented a student loan servicer that allegedly misrepresented information that made certificates backed by the underlying loans more attractive to potential investors. The law firm became aware of this fraud as well as two lawsuits filed against its client, the loan servicer, several months before it applied for the policy in question. The law firm did not disclose this information to any of its professional liability insurers.
The primary claims-made policy contained a “prior knowledge” exclusion “for any act, error, omission, circumstance….occurring prior to the effective date of the policy if any insured at the effective date knew or could have reasonably forseen that [it] might be the basis of a claim.” The lower court held that the insured’s subjective belief that it might be sued was not sufficient to trigger the exclusion in the absence of some actual wrongdoing by the firm.
In an interesting procedural twist, the New York Court of Appeals, the state’s highest court, interpreted the policy according to Pennsylvania law. It rejected the “subjective” analysis made by the lower court and held as a matter of law that the law firm knew of acts that occurred before the policy’s effective date “which they could have forseen to be the basis of a claim.” In addition, the court rejected the suggestion that this “prior knowledge” exclusion required that the known act involve actual wrongful conduct on the part of the insured. Instead, the key inquiry is whether that insured knew of acts that could form the basis of a claim. The bottom line is that the excess carrier successfully argued that the “prior knowledge”exclusion contained in the primary policy barred coverage, a point seemingly never pressed by the primary insurer in the first instance!
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