Prior Knowledge Provisions: What Your Insurer Wants to Know Pre-Policy (and Why)

At times, an insured will first learn that their client had a problem with their work via receipt of a lawsuit or formal demand letter. More often than not, though, an insured and its client will discuss the client’s concerns—and even potentially attempt resolution—well before the client takes the next step of asserting a claim. When these discussions occur, what should an insured disclose to its insurer - and when? And, what are the consequences if an insured fails to disclose a circumstance which it foresees, or reasonably should foresee, will later develop into a claim? 

Prior Knowledge Provisions

Liability insurance policies address these issues via various provisions considering the insured’s “prior knowledge” of a problem; that is, the insured’s awareness, prior to a policy’s inception, of an issue that could give rise to a claim. 

• Prior Knowledge provisions typically appear in one of two different places in an A&E policy:
  • In an insuring agreement: such provisions provide that coverage will only be available if, prior to the policy inception, no insured had knowledge of a circumstance (sometimes referred to as a “potential claim”) which it knew would develop into a claim and/or reasonably could have foreseen would develop into a claim.
  • In an exclusion: such exclusions eliminate coverage if, prior to policy inception, an insured had knowledge of a circumstance which it knew would develop into a claim and/or reasonably could have foreseen would develop into a claim.
• The purpose of these provisions is to ensure that an insured discloses all potential claims when it applies for coverage so that it does not obtain coverage for known errors or omissions which have, for whatever reason, not yet developed into a claim before policy inception.

Timely Reporting of Circumstances to Avoid Consequences of Prior Knowledge Provisions

• To ensure that matters which could—but have not yet—developed into a claim are covered, many A&E policies’ Conditions sections will contain a “Notice of Circumstance” or “Notice of Potential Claim” provision which provides that if an insured becomes aware of a circumstance which it knows or reasonably could foresee will develop into a claim, and reports the details of that circumstance during that policy year, then any later claim that develops will be considered “made” at the time the insured first reported the circumstance.
• If an insured reports a circumstance in policy year one, and the circumstance develops into a claim in policy year two, the claim is considered made—and therefore covered—during policy year one. By timely reporting the circumstance, the insured ensures that there is a “home” for the claim in year one, as that claim could otherwise be precluded from coverage via policy year two’s Prior Knowledge provision.

How Is a Prior Knowledge Issue Evaluated?

• Depending on the policy language, courts will apply one of the following approaches to determine whether the insured’s knowledge of a pre-policy circumstance eliminates coverage under the policy period during which the matter develops into a claim:
  • Subjective standard: a court reviews what the insured actually knew about the circumstance and evaluates whether, based on this knowledge, the insured knew the circumstance would develop into a claim.
  • Objective standard: a court reviews whether a reasonably objective insured would have expected the circumstance to develop into a claim, with no reference to the insured’s specific frame of mind.
  • Mixed subjective/objective standard (most common): a court evaluates whether, based on what the insured actually knows about the circumstance (subjective prong), a reasonably objective insured would have expected a claim (objective prong).
• Oftentimes, these provisions will require that the knowledge be held by a certain member of the insured’s “control group” (officers/executives, general counsel, and/or the risk manager), meaning knowledge of a circumstance from a lower-level employee may not trigger the Prior Knowledge provision or exclusion.

 

Bulletin provided by Phelps Dunbar, LLP. Disclaimer: the information contained in this bulletin is for general guidance and educational purposes only and does not constitute legal advice. Discussion of insurance policy language is descriptive only; every policy has different language and is subject to different terms and conditions. Please refer to your own policy for its specific language.