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How can prior acts coverage best be addressed when a two partner professional practice splits up. Basically, there are three choices: (1) buy a tail; (2) have both partners maintain prior acts coverage; or (3) have one maintain prior acts coverage as the successor to the dissolved firm.
The first option, which is the most expensive, would involve purchasing an extended reporting period endorsement (Tail coverage) from the existing carrier for the existing firm. Each partner would then purchase less expensive "no prior acts" policies for their new solo practices. Typically, a policy not covering prior acts runs about half the cost of a policy covering full prior acts. The cost of the policies for the new solo practices would normally increase over time because of the step rate increases applied at each renewal due to the increasing prior acts exposure. The increases normally cease sometime between the fifth and seventh year of coverage when the policy is deemed mature. All things being equal, a mature policy, whether it covers 5 years of prior acts or 25 years, would cost the same.
The advantages of purchasing a tail is that neither partner would have to depend upon the other to maintain prior acts coverage. Also, the coverage would definitely be in place for the term of the tail. There are several disadvantages to this approach as well. First, is the expense. Typically, a tail endorsement would cost approximately 100% of the expiring premium for a one year term, 150% for two years, 185% for three years and approaching 300% for an unlimited tail. The exact factors used differ from carrier to carrier.
Second, some carriers offer very limited tail options. For example, the maximum duration tail available from the existing carrier may be three years or less. The insureds may not be comfortable with a tail that is so short. Finally, once a tail is purchased, even if it were for an unlimited duration, normally the total available limits are the limits in force on the expiring policy to which the tail endorsement attaches. With tail coverage, you typically do not get fresh, replenished limits of liability at each policy anniversary as you would with a normal policy. A few carriers do, however, offer annually renewable tails which may provide a new limit of liability each year depending the carrier's preference.
The second approach would be to forego purchasing a tail and have each attorney obtain a policy which would cover predecessor firm prior acts exposure. This would normally be less expensive than buying a tail plus two no prior acts policies. The problem with this approach is that many carriers have very limited definitions of predecessor firms. Most carriers will only afford coverage for predecessor firms if the successor is the majority successor in interest. Obviously, with a two attorney firm you can't have two majority successors. Some carriers require the successor firm to have succeeded to two-thirds of the predecessor firm's business.
There are few carriers that provide what is called "career coverage" which skirts the predecessor firm issue entirely. Essentially, what career coverage does is provide prior acts coverage for the insured regardless of whether the act, error or omission giving rise to a claim was performed on behalf of the named insured firm or predecessor firm. This type of coverage would not apply to a prior partner. Even if such coverage is obtained, since such provisions are the exception rather than the rule, coverage can be lost through inadvertence at renewal time, if the attorney moves his policy from an insurer offering career coverage to one which does not.
The final approach would be to recognize one of the partners as majority successor in interest. That partner would then maintain prior acts coverage for the predecessor firm on his/her new solo policy. The other former partner would purchase coverage without prior acts. The primary advantage of this approach is the cost savings realized by purchasing just one policy with prior acts and one without. The disadvantages are that one of the partners will have to depend upon the other to maintain prior acts coverage for the predecessor firm. Also, the majority successor ends up paying perhaps double the premium the minority partner would pay for the first year's policy. Sometimes the minority partner will agree to contribute to the cost of the majority partner's policy during the first few years following the split up. However, once the minority partner's policy matures, the cost of insurance theoretically would be the same for both partners. This results from the fact that mature policies would normally cost the same regardless of whether the years of prior acts coverage is 5 or 25.
One disadvantage of this approach is that if a claim arises out of the minority partner's activities at the former firm the majority partner's policy would respond. Depending upon the severity of the claim this could cause a substantial increase in the majority partner's cost of insurance. Again, the parties can agree in advance that were this to happen the minority partner would compensate the majority partner for this extra expense.
In sum, there are pros and cons to each varying approach to the prior acts insurance needs of a dissolving professional practice. If you find yourself in such a situation, please feel free to contact a Dominion representative to further discuss your options.
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