What Is Long-Tail Liability?

A long-tail liability is a type of liability that carries a long settlement period. Long-tail liabilities are likely to result in high incurred but not reported (IBNR) claims because it may take a long period of time for the claims to be settled.

Long-Tail Liability Explained

Whether a settlement period for an insurance claim is considered a long-tail liability or short term widely varies according to the type of risk being covered. Property insurance claims tend to be settled relatively quickly, while liability insurance claims are often classified as long-tail liabilities. 

Insurers that offer liability insurance may see claims come in a long time after a claim event occurs. For example, a patient may sue a doctor months after a surgery if they think that medical malpractice has been involved. The long settlement period is the result of a variety of factors. Liability insurance claims can be for larger sums of money than other insurance claims, and may result in settlement offers as well as court cases. The insurance company will also want to examine the claim thoroughly to ensure that it is being made in good faith and is not fraudulent.

Insurance companies that offer coverage for risks that are considered long-tail may have higher investment income ratios (net investment income / earned premiums) than companies that offer coverage for short-term liabilities. This is because the gap between when the insurer receives the premium and when a claim is potentially made is greater for policies relating to product liability, medical malpractice, and reinsurance.

Policies covering long-tail liabilities tend to have higher loss ratios (losses incurred divided by earned premiums) and higher combined ratios (losses and loss adjustment expenses divided by earned premium). Combined ratios below 100% indicate that the insurer is making a profit from its underwriting activities.

Some common examples of long-tail liability claims include occupational disease claims, such as asbestos and environmental claims that involve air pollution exposure over many years. Medical malpractice, employment discrimination, child abuse, and cyber liability are also considered long-tail liabilities. 

Long-Tail Liability and Business Records

Since it can be years, or even decades, before a claim is made and makes its way through courts, companies that face the potential of long-tail liability claims should be careful with old records and keep them until an effort has been made to determine if insurance policies, or evidence of insurance policies, is among them. This is so because if a company is unable to locate an old liability policy, it must rely instead on secondary evidence to show that a policy existed and that it was lost or destroyed without intent to defraud the insurer. Such evidence could include corporate minutes, accounting ledgers, annual reports, internal memoranda, transactional records, and even personal appointment calendars – but nothing is more important than locating the policy number itself.