Claims-made — Qualified

Key Claims-Made Terminology

Claims-made policies cover claims only if they are reported during the policy period. Key terms include:

Retroactive Date: A date specified in the policy. No claims arising from occurrences prior to this date will be covered, even if reported during the active policy term.
Nose Coverage (Prior Acts): Coverage provided by a new claims-made insurer for claims occurring after the retroactive date but reported during the current policy.
Tail Coverage (Extended Reporting Endorsement - ERP): Coverage for claims that occurred during the claims-made policy period but are reported after the policy expires.

Gaps in Coverage (Policy Transitions)

Switching between occurrence and claims-made forms can create coverage gaps:

Occurrence $\to$ Claims-Made:
- Gap Risk: No gap, provided the retroactive date of the new claims-made policy matches the expiration date of the previous occurrence policy.
Claims-Made $\to$ Occurrence:
- Gap Risk: High risk of a coverage gap. Claims that occur during the claims-made policy but are reported after its expiration will not be covered by the claims-made policy (expired) or the occurrence policy (only covers occurrences after its inception).
- Solution: Buy tail coverage (ERP) from the claims-made insurer or purchase nose coverage from the occurrence insurer.
Retirement / Cessation of Business:
- Gap Risk: Claims-made policies must be extended with tail coverage to cover claims reported post-retirement.

Report Year Organization

Claims-made claims are organized by Report Year (RY) rather than Accident Year (AY). Development triangles are constructed using Report Lag (time between occurrence and reporting):

Report Lag (RL): Number of years between occurrence and reporting.
$L(\text{RY}, \text{RL})$ : Losses reported in a given Report Year with a specific Report Lag.

Report Year Development Table

RY	RL 0	RL 1	RL 2	RL 3
2011	$L(2011,0)$	$L(2011,1)$	$L(2011, 2)$	$L(2011,3)$
2012		$L(2012,1)$
2013			$L(2013,2)$
2014				$L(2014,3)$

[!TIP] Simple Mental Model: A claim represented by $L(2012,1)$ occurred in $2012 - 1 = 2011$ , and was reported in $2012$ . The diagonal of this triangle represents occurrences covered by an occurrence policy for AY 2011.

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Principles of Claims-Made Pricing

Principle 1: Pricing vs. Occurrence Policies

The price of a claims-made policy is generally less than that of an occurrence policy, provided loss costs are increasing over time.

Reason: Occurrence policies cover claims reported far into the future, exposing the insurer to a longer period of trend and settlement lag. Claims-made policies only cover claims reported during the policy term, limiting report lag exposure.

Principle 2: Reduced Trend Uncertainty

Claims-made rates are more accurate and responsive than occurrence rates when underlying trends shift unpredictably.

Reason: Shorter forecast periods for trends reduce estimation uncertainty. Since trend selections are updated annually for the upcoming report year, rates respond more quickly to changes.

Principle 3: Shifts in Reporting Patterns

Sudden unexpected shifts in reporting patterns affect the cost of a mature claims-made policy far less than an occurrence policy.

Mathematical Reporting Shift Example

Consider a reporting shift where $8\%$ of claims are delayed from their normal reporting year and reported gradually over subsequent years ( $+2\%$ per year for 4 years):

Year 1: Reporting drops by $8\%$ (immediate underreporting).
Year 2: Reporting is $-8\%$ (from Year 2 occurrences) $+ 2\%$ (delayed from Year 1) = Net $-6\%$ .
Year 3: Reporting is $-8\% + 2\% + 2\%$ = Net $-4\%$ .
Year 5: Reporting is $-8\% + 2\% \times 4$ = Net $0\%$ .
Conclusion: For a mature claims-made policy, the net reporting rate stabilizes back to $100\%$ over time, whereas occurrence policies remain exposed to the cumulative development shift.

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Principle 4: Elimination of Pure IBNR

Claims-made insurers do not carry liability for “pure” Incurred But Not Reported (IBNR) claims (claims that occurred but have not been reported), since the policy only covers reported claims.

Benefit: Greatly reduces the risk of reserve inadequacy.

Principle 5: Reduced Investment Income

Claims-made policies generate substantially less investment income than occurrence policies.

Reason: Because there is no report lag beyond the policy term, the time between premium collection and claim payment is shorter, reducing the period over which premiums can be invested.