Pin the Tail on the ERE Written by: Todd Dashoff, ACAS, MAAA, ARM
Extended reporting endorsements (ERE) provide a period of additional coverage for eligible insurance claims reported after the expiration of a claims-made insurance policy, which covers claims reported during the policy term. The length of the additional period depends upon the terms of the policy, and can vary from one month to an unlimited period. While technically it is not a distinct policy but an endorsement to the expiring claims-made policy, an ERE is commonly referred to as a “tail policy”. This is largely because the ERE provides a new effective date and a renewed aggregate loss limit that cause it to function like a separate policy.
Most medical professional liability (MPL) policies for individual practitioners are written on a claims-made coverage form. A medical provider that ceases to purchase claims-made coverage may choose to obtain an ERE. As an alternative, the provider can request that his or her new insurer provide a policy with coverage for preexisting events, also known as “nose coverage”. One or the other of these two options is recommended, since the nature of the reporting pattern for MPL claims means that significant time may elapse between the date of the incident and the date that the claim is reported to an insurer, especially in the case of medical providers who deal with minors (i.e., OB/GYNs, pediatricians, etc).
Questions arose in the 1980’s with regard to the cost of purchasing an ERE in the event of the death, disability, or retirement (DDR) of an insured, since the cost of an ERE might be burdensome for a disabled or retired insured or for the estate of a deceased insured. In addition, if a provider died near the end of a policy period, the policy might expire before the estate had a chance to purchase an ERE, or there might be no estate in the case of a single practitioner, and both of these events would leave a potential claimant without recourse to be compensated for an event which had occurred prior to the provider’s death and for which the provider would otherwise be liable.
To address these concerns, claims-made policies, particularly for professional liability coverage, generally include a provision waiving the premium for an ERE in the event of an insured’s DDR. This waiver is known as a “free tail”, although the funding for such a benefit is built into the premium for the claims-made policy. Restrictions are often placed on the DDR benefit. For example, to qualify for a free tail in the event of disability, a sample policy states that the insured must be “permanently, wholly, and continuously disabled and prevented from performing any and every duty pertaining to the Professional Services which are part of the practice described in the Declarations of this policy”. In the event of retirement, insurers often require that the inbsured attain a certain age (e.g., age 55), and have been insured with the company for a set number of continuous coverage years (e.g., five) to qualify for the retirement-specific benefit.
State insurance departments typically require companies to carry a liability reserve to ensure that sufficient funds will be available to provide for the net future costs associated with future DDR benefits. For MPL insurance coverage specifically, the established DDR reserve must be disclosed in the Schedule P Interrogatories of the Statutory Annual Statement. This DDR benefit reserve is typically carried on the balance sheet as part of the unearned premium reserve, but in special cases has been carried as part of a company’s claim reserves with authorization from the company’s domiciliary insurance regulator. The associated claims may not occur until many years in the future, or may never occur. In estimating the DDR liability, the actuary must make assumptions regarding loss costs, rate levels, interest rates, trends and nonrenewal rates, as well taking into consideration any age and tenure requirements in the contracts. The expected loss costs are affected by the age and tenure demographics of the insured population, mortality considerations, morbidity considerations, and pricing differentials (if any) related to the insureds. Various methodologies for estimating the DDR liability currently exist, relying on some or all of these parameters. These parameters, which are more typical of life insurance reserves, are rather unique among property/casualty reserve projections. It is important that an insurer engage an actuary to perform the estimation of the indicated liability for DDR, since an extremely loose qualification standard coupled with an insured population that is weighted toward older ages could result on “a run on the bank”, resulting in a need to provide a large number of ERE’s in a relatively short period of time. This could result in a significant drain on the insurer’s surplus, since once an extended reporting endorsement is issued, the insurer should book the expected value of losses based on the equivalent premium (whether purchased or “free”) as an incurred but not reported (IBNR) or “bulk” reserve.