Professional indemnity insurance is a specialised form of insurance. The “claims made and notified” nature of professional indemnity insurance distinguishes it from the more common insurance situation where an entitlement to indemnity is “event” or “occurrence” based; that is, on the date on which the accident or relevant incident occurred. This distinction is explained in more detail below.  The word “claim” can have two different meanings in the context of professional indemnity insurance and this duality is also discussed in detail below.

Professional indemnity insurance is often compulsory. Even when it is not compulsory there are good reasons why it should be obtained. Professional indemnity insurance is only offered by a limited number of insurers.

Professional indemnity insurance is a specialised form of insurance

Professional indemnity is a specialised form of insurance designed to cover those who work in a professional capacity. Professional indemnity insurance insures professionals against damages they are held liable to pay as a result of an act or omission in the conduct of their professional business.

Professional indemnity insurance is often compulsory

In many professions insurance cover for the members of the profession is compulsory.

In those professions or businesses in which insurance cover is not compulsory it is commercially extremely unwise not to have such cover. One of the first things that many professionals say to us when they see us at the beginning of a matter is that this is their first claim after many years of practice; this is generally followed by a statement that there is no substance in the claim. Indeed it often does turn out that there is in fact no substance in the claim, with the action either being withdrawn some time later or judgment being entered in favour of our client. Naturally, there are also cases where the claim made against the professional is legitimate.

Even when it is not compulsory there are good reasons why it should be obtained

Even in cases where we are successful in defending claims against our clients, the major benefit in having professional indemnity insurance cover is that the insurer covers the legal costs incurred by the professional for whom we are acting. The exception to this is where the professional has chosen to have a costs-inclusive excess; in this case the insured organisation will be liable for some or all of the legal costs incurred in the defence of the claim. It is usually only large professional organisations which choose to have a costs-inclusive excess.

In most cases however the insurer pays all of the professional’s legal costs. These can be substantial, particularly as many professional indemnity clams involve complex commercial litigation-related issues. In view of the complexity of the issues it is not uncommon for legal costs to run to many thousands of dollars, even where the action does not proceed to trial – a sufficient reason by itself to obtain appropriate and adequate cover! Legal costs will certainly be very high where the action proceeds to a hearing and judgement, even if the claim against the professional fails.

Professional indemnity insurance is only offered by a limited number of insurers

In view of the specialist nature of the insurance being offered, professional indemnity insurance is only offered by a limited number of insurers (underwriters) in Australia. Cover is normally also obtained through one of the specialised brokers dealing with insurance of this type.

This general introduction brings us to some of the more technical issues that are likely to be relevant to professional indemnity insurance.

The first of these is fundamental. The issue of what amounts to a claim is particularly important in professional indemnity insurance – and often not at all straightforward.

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What is a claim?

This depends upon the context in which the term is used.

The answer to this question depends entirely upon the context in which the word “claim” is used. There are two common meanings of the term that we encounter on a daily basis:

• First, “claim” can be used to describe an insured’s assertion of an entitlement to a payment or indemnity under a policy of general insurance. For example, if a window is broken at home, you may “claim it on your insurance”.  In the circumstances of a professional indemnity policy, the insured professional may “claim” an entitlement to cover arising out of a breach of professional duty and the legal consequences of that breach.  The use of the word “claim” in this sense is rarely contentious.

• Secondly, in the case of liability policies (for example professional indemnity and public liability policies) the word “claim” is usually defined in the policy wording to mean a claim for compensation made by a third party against the insured. A common definition is:

“Claim” means any demand made by a third party upon the Insured for compensation, however conveyed, including a writ, statement of claim, application or other legal or arbitral process.

Upon receipt of such a “claim” the insured seeks an indemnity from its insurer for all amounts it is legally required to pay as a consequence of the third party’s claim against it.

Thus, in the world of professional indemnity insurance, the word “claim” can have one of two meanings, depending upon the context in which it is used.

What amounts to a “claim” by a third party against the insured?

In the context of a professional indemnity policy, it is sometimes difficult to tell whether a third party has made a “claim” against an insured or has merely intimated a possibility that it may hold the insured liable for some realised or yet to be realised damage.

Staying with our earlier example of the footing engineer; the owner of the house may simply write to the engineer in the first instance and advise that the house is subject to excessive movement and the condition of the building is being monitored. Depending on the circumstances, the engineer may consider that he or she has some liability in the event that the condition of the building continues to deteriorate; however the engineer may equally consider that it is unlikely that the matter will be pursued.  Does this correspondence from the house owner amount to a “claim” against the engineer?  In Antico v C E Heath Casualty & General Insurance Limited[1] a letter indicating an intention to pursue an investigation of a business venture and reserving the rights of investors against the insured, was held not to be an assertion of rights so as to amount to a claim.

Alternatively, our fictitious footing engineer may receive from the house owner or his solicitors, a letter advising that if the building continues to deteriorate to a point where loss is suffered, the engineer will be held responsible in contract and in tort. The authorities suggest that this does not constitute a claim because there is no assertion of a right to compensation from the insured engineer. It is a distinction which in practice is not always clear.

In Junemill Ltd (In Liq) v FAI General Insurance Co Ltd[2] a letter was sent to the insured alleging that a number of grounds for legal proceedings existed and that the action would be begun if loss was suffered.  It was held in first instance that the letter did not constitute a claim on the ground that it did not assert an entitlement vested in the claimant and that the loss had not been quantified. An assertion of a possible future claim was found to be insufficient. This finding was however reversed on appeal[3], partly because the word “claim” had been defined in the policy in terms of a demand for compensation, and partly on the ground that subsequent correspondence had made it clear that it intended to operate as a notification of a claim. It was found that the reference to legal proceedings in the original letter must have been legal proceedings for damages, that is, for compensation. In any event, the subsequent letter made it clear that it was to operate as a claim.  In the Court of Appeal, Fryberg J remarked that there was “… no formula which must be included in a claim by a third party” and cited authority to the effect that “… what was required, unless the policy expressly so stipulated, was a form of demand or assertion of liability, not a formal demand or assertion of liability”.[4]

In any determination of whether a third party has made a “claim” for the purposes of a professional indemnity insurance policy, the starting point must always be the definition of “claim” in the policy. The application of that definition is critical in the context of “claims made and notified policies” because the date upon which the claim is made by the third party and notified by the insured to its insurer, may determine which (if any) policy responds and perhaps which insurer (if any) is on risk in respect of the claim.

The “claims made and notified” nature of professional indemnity insurance

Occurrence v Claims Made Policies

Occurrence Policies

As the name implies, occurrence (or event) based policies focus upon the occurrence of the event insured. This is both simple and satisfactory in situations where the loss or damage is apparent soon after the mishap occurs.[5] For example, a motor vehicle insurance policy provides cover for damage occurring within the policy period. This works effectively because the damage almost always coincides with the incident.  A similar situation occurs in respect of most household claims and even public liability insurance claims, as most third parties are aware of their injuries at or soon after the incident and report them promptly.

This situation is not, however, satisfactory in the context of a professional indemnity insurance, product liability insurance, or directors and officers liability cover, because the loss and damage may come to light many years after the insured’s negligent act has been committed.[6] This created a difficulty for insurers who were potentially exposed to an unknown number of claims over an indeterminate period that result from a negligent act of the insured within the policy period.

Using once more the example of our hapless footing engineer, assume that he or she negligently designed the footing in the year 2000.  It took 12 months for building approval to be granted and a further 2 years before the house was constructed and occupied.  Several more years or so passed before the defects became apparent and before the owner of the house made a claim against the engineer. Hence, the insurer was exposed to a claim arising out of a policy which it underwrote 7 or 8 years earlier. This “long tail” risk produces uncertainty in respect of the financial reserves the insurer requires for particular policy periods and confusion as to which insurer may be on risk in respect of the claim. As a result the “claims made” policy was developed.

Claims made policies

A claims made policy of insurance provides cover in respect of claims first made against the insured during the policy period regardless of when the event (usually a negligent act) giving rise to that claim occurred.  The insuring clause of a typical claims made policy may read as follows:

The Insurer will indemnify the Insured against liability at law for compensation and claimant’s costs and expenses in respect of any Claim or Claims first made against the Insured and notified to the Insurer during the Period of Insurance for breach of professional duty in the conduct of the Professional Services but not in respect of any such Claim or Claims resulting from any act, error or omission occurring or committed prior to the Retroactive Date.

The claims made policy is therefore the opposite to an occurrence policy; the former provides cover for claims made during the policy period irrespective of when the incident giving rise to the loss occurred; the latter provides cover irrespective of when the claim is made for an incident occurring in the policy period.

In order to limit the insurer’s risk, claims made policies frequently contain a “retroactive date”.  A claim made in the policy period will be covered unless the event giving rise to the claim occurred before the retroactive date. The retroactive date is the subject of a negotiation between insurer and insured (or the insured’s broker) and it is not uncommon for the retroactive date to be unlimited, excluding, of course, known claims and circumstances.

Claims made and notified policies

A more restrictive type of “claims made” policy is known as a “claims made and notified policy”. This requires not only that the claim by the third party be first made upon the insured during the policy period but also that the claim must be notified to the insurer during the policy period. In the absence of notification, cover could be declined. The “claims made and notified policy” is now the most commonly used in the area of professional indemnity insurance.

Other variations have also evolved; for example it is common for a policy to include cover for “circumstances likely to give rise to a claim” which become known to the insured and notified to the insurer during the policy period. In that case, even if the claim is made by the third party against the insured several years after the expiration of the policy period, so long as the insured notified of circumstances giving rise to that claim during the policy period, then that policy will respond to the claim.

The effect of the Insurance Contracts Act upon claims made and notified policies

The effectiveness (from an insurer’s perspective) of “claims made and notified policies” has been diminished somewhat by a liberal interpretation of section 54(1) and section 40(3) of the Insurance Contracts Act.

The leading authorities on this area are East End Real Estate Pty Ltd v C E Heath Casualty & General Insurance Limited[7]; FAI General Insurance Co Limited v Perry[8]; Antico v C E Heath Casualty & General Insurance Limited[9]; and FAI General Insurance Co Limited v Australian Hospital Care Pty Ltd[10].

Briefly, in the East End Real Estate case a claim under a “claims made and notified policy” was made during the currency of the policy but no notification to the insurer was made until after the policy had expired. This omission on the part of the insured was excused by virtue of section 54(1).

Though this position was weakened somewhat by the New South Wales Court of Appeal’s decision in FAI v Perry, subsequent High Court decisions in Antico v CE Heath and FAI v Australian Hospital Care have, by and large, confirmed the view taken in the East End Real Estate case.  Hence, while most insureds comply with the requirements of their “claims made and notified policies”, those that do not may be wholly or partly excused by section 54(1).

“Claims made and notified policies” were also the target of section 40 of the Insurance Contracts Act; in particular, section 40(3). The effect of this section is to incorporate in all “claims made and notified policies” the abovementioned extension to “circumstances likely to give rise to a claim” which become known to the insured and notified to the insurer during the policy period.

As will therefore be apparent, the effectiveness of “claims made and notified policies” has been eroded to some extent by operation of the Insurance Contracts Act.

As will also be apparent from this Overview, professional indemnity insurance is a highly specialised class of insurance and many of the issues that arise and must be considered in professional indemnity insurance are can only be efficiently considered and dealt with by lawyers who have a specialisation in the area.

[Note: Many of the authorities and principles discussed elsewhere in our website[11] are equally relevant in professional indemnity claims. Likewise the procedural matters discussed in our website apply to professional indemnity claims.]

Revised October 2009

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[1] (1995) 8 ANZ Ins Cas 61-268 (SCNSW) 75,999-76,000.

[2] (1996) 9 ANZ Ins Cas 61-315 (Sup Ct Qld).

[3] (1997) 9 ANZ Ins Cas 61-377 (Ct Appeal Qld).

[4] Kenneth Sutton, Insurance Law in Australia (3rd Ed, 1999), 1074.

[5] Sutton, above n 4, 662.

[6] Ibid.

[7] (1991) 25 NSWLR 400 (Gleeson CJ, Mahoney, Clarke JJA)

[8] (1993) 30 NSWLR 89;

[9] (1995) 8 ANZ Ins Cas 61-268; AFFD (1996) 38 NSWLR 681; reversed by the High Court in (1997) 188 CLR 65.

[10] (2001) 11 ANZ Ins Cas ¶61-497; 75 ALJR 1236.

[11] For example, in the Introduction to General Insurance and in the Topical Issues and Decisions section (in General Insurance)