Noticeable Confusion - "Claims Made" Policies, Late Notice, And When Your Insurer Must Prove Prejudice To Avoid Coverage

By John E. Heintz, John A. Gibbons, and Omid Safa

An adverse claim is an unwelcome surprise to any business, particularly those unaccustomed to being sued. A lawsuit is unsettling and brings with it a litany of pressing litigation concerns, which compound the already significant day-to-day burdens associated with running a successful business. Understandably, with such immediate concerns, insurance may not be your first thought when the suit comes in. Fortunately, however, you did have the foresight to purchase insurance coverage to protect your business from a host of potential liabilities, including this claim.

In fact, you have purchased insurance coverage from the same insurance company for over a decade, paid thousands of dollars in premiums, and incurred few prior claims.

So, when the insurance company initially denies coverage based on "late" notice, you chalk it up to a simple misunderstanding. You highlight that the claim is still in the early stages and that the insurer has not been prejudiced in the slightest by any perceived delay. To your surprise, however, the insurer insists on denying coverage and contends that prejudice is irrelevant to "late" notice under a "claims made" policy. Suddenly, your business faces the threat of having to confront the claim without the benefit of the insurance you purchased.

All too often, policyholders find themselves in just such a predicament when seeking coverage under "claims made" liability policies. Contrary to the misconception fostered by some insurers, however, the failure to strictly adhere to the notice provision in a "claims made" policy does not necessarily forfeit your right to the insurance coverage you purchased. Indeed, even under the most restrictive forms of "claims made" policies, a showing of prejudice may still be required before the insurer may disclaim coverage based on late notice. Nevertheless, insurers often succeed in discouraging policyholders from pursuing coverage by capitalizing on the confusion surrounding the late-notice rules applicable to different types of "claims made" policies.

There are two types of policies commonly referred to as "claims made" policies: (1) "general claims made" policies (also known as "discovery policies"), and (2) "claims made and reported policies" (also known as "reporting policies"). Such policies are anything but synonymous and accounting for their distinct features is critical to assessing when an insurer must prove actual prejudice to avoid its coverage obligations. Unfortunately for policyholders, the tendency to use the shorthand "claims made" when referring to both types of policies has led to substantial inconsistency and confusion. At times, courts interpreting one type of policy have mistakenly followed decisions involving the other, believing that both cases involved equivalent "claims made" policies.1 Thus, decisions involving "claims made" policies should never be taken at face value.

As discussed below, the availability of coverage turns on the interpretation of the relevant policy language, the factual circumstances of the case, and sometimes state statutory law. Thus, before you accept the representations of your longtime insurer and resign yourself to facing a claim alone, a thorough coverage analysis is a must.

I. The "Notice-Prejudice" Rule

The requirement that an insurer demonstrate actual prejudice before avoiding coverage based on late-notice is commonly known as the "notice-prejudice" rule. The notice-prejudice rule first rose to prominence in the context of occurrence policies, when the vast majority of jurisdictions began rejecting the old-style "strict compliance" approach, which relieved liability insurers of their coverage obligations in any instance where notice was even a moment late. Generally, courts identified three reasons for rejecting the old approach in favor of the notice-prejudice rule (which, as discussed in Parts II.A-B. below, apply with equal force to "general claims made" policies broadly, and to "claims made and reported" policies when notice is technically late but nonetheless reported within the policy period).

First and foremost, courts emphasized that the principal purpose of a notice provision was to provide the insurer with an opportunity to investigate, defend, and settle any third-party claim implicating or potentially implicating the policy. Thus, where such interests remained unprejudiced despite late notice, "it follow[ed] neither logic nor fairness to relieve the insurance company of its obligations under the policy . . . ."2 This rationale is consistent with the recognized principle that only material breaches may relieve a contracting party from performing its obligations under a contract.

Second, courts disfavored forfeitures that would result in windfalls to insurers that had suffered no actual detriment due to late notice and would deprive innocent tort victims of an important source of recovery. As one court explained:

[A]lthough the policy may speak of the notice provision in terms of "condition precedent," . . . nonetheless what is involved is a forfeiture, for the carrier seeks, on account of a breach of that provision, to deny the insured the very thing paid for. This is not to belittle the need for notice of an accident, but rather to put the subject in perspective. Thus viewed, it becomes unreasonable to read the provision unrealistically or to find that the carrier may forfeit the coverage, even though there is no likelihood that it was prejudiced by the breach. To do so would be unfair to insureds. It would also disserve the public interest, for insurance is an instrument of a social policy that the victims of negligence be compensated.3

Third, courts also recognized that the rationale underlying the old approach no longer applied in light of the realities of the modern insurance market.4 While the old approach was grounded in "the view that insurance policies [we]re private contracts in the traditional sense" and the judiciary should refrain from redrafting policy provisions contrary to the expressed intent of the parties, the courts acknowledged that insurance policies were, in reality, no longer fully negotiated agreements.5 Instead, modern insurance policies were increasingly based on standard forms with "conditions [that] [we]re by and large dictated by the insurance company to the insured."6 Moreover, the notice conditions imposed by insurers were generally uniform within the insurance market, depriving insureds of meaningful alternatives.7

II. "Claims Made" Policies

Over the past three decades, "claims made" policies have increasingly supplanted traditional occurrence policies as the insurance sold to policyholders, as insurers have sought to guard against substantial losses from asbestos, environmental, and other long-tail claims. In conjunction with this shift, courts have weighed the principles underpinning the notice-prejudice rule against the language of "claims made" policies to determine whether an insurer must show prejudice before denying coverage based on late-notice.

"The only true mark of a 'claims made' policy is that it provides coverage for any claim first asserted against the insured during the policy period, regardless of when the incident giving rise to the claim occurred. Whether reporting to the insurer is also a condition of coverage depends on the terms of the specific policy."8

A. "Claims Made And Reported" Policies

"Claims made and reported" policies expressly require notice within the policy period; or alternatively, within a short, predetermined "extended reporting period" immediately following the expiration of the policy (e.g., 60 days).9 This requirement is routinely an express part of the insuring agreement that triggers coverage under the policy.10 For example, the insuring agreement in a "claims made and reported" policy commonly provides:

[The insurer shall] pay on behalf of the insured all sums which the insured shall become legally obligated to pay as money damages because of any claim or claims first made against the insured and reported to the company during the policy period . . . .11

Thus, as their name suggests, there are two prerequisites to triggering coverage under such policies: (1) a claim made against the policyholder (2) reported to the insurer, during the policy period (or extended reporting period).12 Aside from these prerequisites, the policies also typically require a policyholder to provide notice "as soon as practicable" as a "condition precedent" to coverage.

Absent countervailing statutes, the courts in most jurisdictions have declined to extend the notice-prejudice rule to "claims made and reported" policies when notice is delayed beyond the policy period (or extended reporting period, if applicable). Instead, such courts have held that the language of "claims made and reported" policies mandate strict compliance with the requirement that notice be given during the policy period. In that context, courts have distinguished the purpose of notice under an occurrence policy-which allows the insurer to investigate, defend, and settle third-party claims-with the purpose of notice under a "claims made and reported" policy-which is necessary to trigger coverage in the first place:

The purpose of the notice provision in an occurrence policy is to allow the insurer to conduct a timely investigation of the incident giving rise to coverage. . . . Applying the notice-prejudice rule in such cases makes sense "because to do so merely preserves existing coverage and, absent a showing of prejudice, does not materially alter the insurer's risk." . . . With claims-made-and-reported policies, however, giving notice within the policy period is what actually creates coverage in the first instance. . . . Allowing the insured to invoke the notice-prejudice rule to claims made during the policy period but reported after the policy period ends would "provide coverage the insurer did not intend to provide and the insured did not contract to receive."13

Even so, in certain jurisdictions, the notice-prejudice rule has been applied to "claims made and reported" policies even when notice was given after the expiration of the policy period (or extended reporting period) based on state notice statutes.14 Thus, a policyholder should always consult the notice statutes in the relevant jurisdiction to determine whether the legislature has mandated the notice-prejudice rule as a matter of public policy.

Courts have also applied the notice-prejudice rule to "claims made and reported" policies when notice was late-i.e., not provided "as soon as practicable"-but was nonetheless provided within the policy period. For example, in Prodigy Communications Corp. v. Agricultural Excess & Surplus Insurance Co., the Supreme Court of Texas held that "when an insured notifies its insurer of a claim within the policy term or other reporting period that the policy specifies, the insured's failure to provide notice 'as soon as practicable' will not defeat coverage in the absence of prejudice to the insurer."15 In reaching this decision, the court distinguished the purpose of the reporting requirement that triggered coverage and the "as soon as practicable" condition, which (as in occurrence policies) merely served to facilitate the involvement of the insurer in handling a third-party claim:

In a claims-made [and reported16] policy, the requirement that notice be given to the insurer 'as soon as practicable' serves to 'maximize the insurer's opportunity to investigate, set reserves, and control or participate in negotiations with the third party asserting the claim against the insured.' . . . By contrast, the requirement that the claim be made during the policy period 'is directed to the temporal boundaries of the policy's basic coverage terms[.] This type of notice is not simply part of the insured's duty to cooperate, but defines the limits of the insurer's obligation, and if there is no timely notice, there is no coverage.'17

The court also highlighted that the failure to fulfill the "as soon as practicable" condition did not deny the insurer "the benefit of the claims-made nature of its policy."18 Indeed, late notice within the policy period still allowed the insurer to "close its books" at the end of the period and to calculate risks and premiums with greater certainly than possible under traditional occurrence policies.19 Other courts have reached similar conclusions, while noting that the traditional reasons for adopting the notice-prejudice rule apply with equal force to "claims made and reported policies" under such circumstances.20

B. "General Claims Made" Policies

"General claims made" policies and "claims made and reported" policies are "two different animals."21 A "general claims made" policy "requires only that a claim be made within the policy period . . . ."22 The event that triggers coverage is the assertion of a claim against the policyholder during the policy period, and the insuring agreement includes no special reporting requirement. For example, the insuring agreement in a "general claims made" policy often states:

The [insurer] shall pay on behalf of the Insured . . . on account of any claims first made against the Insured during the Policy Period.

Pursuant to the notice provisions in such policies, a policyholder need only report a claim "as soon as practicable" in order to preserve coverage.23 Such policies "'implicitly allow reporting of the claim to the insurer after the policy period, as long as it is within a reasonable time.'"24

Given these characteristics, most courts have extended the application of the notice-prejudice rule to such policies.25 In doing so, courts have likened the notice provisions in "general claims made" policies to the notice provisions in traditional occurrence policies, and distinguished them from the reporting requirements in "claims made and reported" policies:

[A] claims-made-and-reported policy differs from a general claims-made policy containing no requirement that the claim be reported within the policy period. . . . The reporting requirement serves two different purposes in the two policies. The notice provision in a general claims made policy, as in an occurrence policy, often requires notice "as soon as practicable." This serves to "facilitate the timely investigation of claims by bringing an event to the attention of the insurer and allows an inquiry 'before the scent of factual investigation grows cold.'" In contrast, in a claims-made-and-reported policy, notice is the event that actually triggers coverage. Because [the] policy did not contain a reporting requirement, the notice prejudice rule applies.26

Courts have also highlighted that failing to distinguish between "general claims made" policies and true reporting policies contravenes a fundamental rule of insurance policy interpretation, as it renders the reporting language in the latter policies superfluous.27

III. Conclusion

Given the confusion surrounding "claims made" policies and the notice-prejudice rule, policyholders should make every effort to provide notice to their insurers as soon as possible after receiving a claim. Policyholders should recognize, however, that a delay in providing notice does not necessarily forfeit coverage, notwithstanding the insurer's assertions. Coverage may still be available based on the relevant policy language, the factual circumstances of the case, the case law in the relevant jurisdiction, and state statutory law. Businesses should not be dissuaded from providing notice that an insurer (or broker) says may be late, or pursuing coverage after an insurer's initial denial based on alleged "late" notice. The insurer's assertion of such a defense is the beginning of the process of making a claim, not the end. It is critical that businesses advocate for their insurance rights, and bring in experienced coverage counsel to assess your particular situation and respond accordingly. Having coverage counsel involved early on will ensure that you are well positioned to counter any pushback from your insurer and to take the steps necessary to secure the coverage you deserve.

Endnotes

1. See, e.g., Prodigy Communs. Corp. v. Agric. Excess & Surplus Ins. Co., 288 S.W.3d 374, 380 n.7 (Tex. 2009) [enhanced version available to lexis.com subscribers], ("[M]any courts fail to distinguish between [general] claims-made and claims-made-and-reported policies, and simply speak in broad terms of 'claims-made' policies."

2. Brakeman, v. Potomac Ins. Co., 371 A.2d 193, 197 (Pa. 1977) [enhanced version available to lexis.com subscribers]; see also, e.g., St. Paul Fire & Marine Ins. Co. v. House, 315 Md. 328, 346-47 (1989) (same) [enhanced version available to lexis.com subscribers].

3. Cooper v. Gov't Employees Ins. Co., 51 N.J. 86, 93-94 (1968) [enhanced version available to lexis.com subscribers]; accord Brakeman, 371 A.2d at 197; see also, e.g., Friedland v. Travelers Indem. Co., 105 P.3d 639, 646 (Colo. 2005) [enhanced version available to lexis.com subscribers], ("In Colorado, there is a strong public policy in favor of protecting tort victims; this is a fundamental purpose of insurance coverage . . . . [T]he insured pays premiums for the protection provided by the liability policy, and the insurer should not reap a windfall through a technicality it invokes to deny coverage."); Weaver Bros. Inc. v. Chappel, 684 P.2d at 125 684 P.2d 123, 125 (Alaska 1984) [enhanced version available to lexis.com subscribers], ("In the absence of prejudice, regardless of the reasons for the delayed notice, there is no justification for excusing the insurer from its obligations under the policy. We recognize the strong societal interest in preserving insurance coverage for accident victims so long as the preservation is equitable for all parties involved.").

4. Brakeman v. Potomac Ins. Co., 371 A.2d at 196; see also, e.g., Nat'l Union v. FDIC, 264 Kan. 733, 749-50 (1998) [enhanced version available to lexis.com subscribers].

5. Brakeman, 371 A.2d at 196.

6. Id. at 196; see also, e.g., Friedland v. Travelers Indem. Co., 105 P.3d 639, 646 (Colo. 2005) (adopting the notice-prejudice rule because, among other things, "the insured is typically provided with form contracts promulgated by the insurer, and there is a disparity of bargaining power"); Weaver Bros., Inc. v. Chappel, 684 P.2d 123, 125 (Alaska 1984) (adopting notice-prejudice rule after recognizing that modern "[i]nsurance policies may be considered contracts of adhesion due to the inequality in bargaining power.").

7. Brakeman, 371 A.2d at 196.

8. Jones v. Lexington Manor Nursing Ctr., L.L.C., 480 F. Supp. 2d 865, 868 (S.D. Miss. 2006) [enhanced version available to lexis.com subscribers].

9. See Pension Trust Fund v. Fed. Ins. Co., 307 F.3d 944, 955 (9th Cir. Cal. 2002) [enhanced version available to lexis.com subscribers]; Jones v. Lexington Manor Nursing Ctr., L.L.C., 480 F .Supp. 2d 865, 868-69 (S.D. Miss. 2006) ("The 'claims made and reported' policy is a variation of the 'claims made' policy, which 'covers only claims first made during the policy period but also imposes the condition that, to be entitled to coverage, the insured must also report the claim to the insurer within the policy period, or within a specified time after learning of the claim (often prescribed to be 30, 60 or 90 days).'").

10. Alternatively, some insuring agreements incorporate the reporting requirement by reference. See, e.g., Atl. Health Sys., Inc. v. Nat'l Union Fire Ins. Co., No. 08-1661, 2011 U.S. Dist. LEXIS 39797, at *3 (D.N.J. Apr. 11, 2011) [enhanced version available to lexis.com subscribers], (insuring agreement required claim made during the policy period and reported to the insurer pursuant to the terms of the policy, which included a reporting provision mandating that "in all events a Claim must be reported no later than either: (1) anytime during the Policy Period or during the Discovery Period (if applicable); or (2) within 30 days after the end of the Policy Year or the Discovery Period (if applicable), as long as such Claim is reported no later than 30 days after the date such Claim was first made against an Insured.").

11. Zuckerman v. Nat'l Union Fire Ins. Co., 100 N.J. 304, 307, 495 A.2d 395, 396-97 (1985) [enhanced version available to lexis.com subscribers] (emphasis added).

12. These policies ought not to be confused with "occurrence first reported" Bermuda form policies sold in the 1980s and 1990s, which only require reporting during the policy period of an occurrence taking place at any time.

13. Or. Schs. Activities Ass'n v. Nat'l Union Fire Ins. Co., 279 F. App'x 494, 495 (9th Cir. 2008) [enhanced version available to lexis.com subscribers], (emphasis added, citations omitted); see also, e.g., Atl. Health Sys., Inc. v. Nat'l Union Fire Ins. Co., 463 F. App'x 162, 167 (3d Cir. 2012) [enhanced version available to lexis.com subscribers], ("Notice provisions in an occurrence policy are given a liberal and practical construction because they do not define coverage, but merely assist the insurer to investigate and resolve claims. By way of contrast, . . . the coverage trigger in a claims-made [and reported] policy is the submission of the claim. . . . 'Because notice of a claim or potential claim defines coverage under a claims-made [and reported] policy, we think that the notice provisions of such a policy should be strictly construed.'" (emphasis added, internal citations omitted)); Lexington Ins. Co. v. W. Pennsylvania Hosp., 423 F.3d 318, 325 (3d Cir. 2005) [enhanced version available to lexis.com subscribers], ("Notice provisions serve different purposes in occurrence and claims-made [and reported] policies. In an occurrence policy, notice provisions are included to help the insurer investigate, settle, and defend claims; they do not define coverage. . . . 'By contrast, the event that invokes coverage under a 'claims made' [and reported] policy is transmittal of notice of the claim to the insurance carrier. . . . Thus, an extension of the notice period in a 'claims made' [and reported] policy constitutes an unbargained-for expansion of coverage, gratis, resulting in the insurance company's exposure to a risk substantially broader than that expressly insured against in the policy.'" (citations omitted, ellipse in original)). Although the courts in Atlanta Health Systems and West Pennsylvania Hospital both referenced "claims made" policies throughout their decisions, a closer examination confirms that the policies at issue in those cases were "claims made and reported" policies. See W. Pennsylvania Hosp., 423 F.3d at 321 ("The . . . policy states that it will pay for damages 'caused by a medical incident which occurs on or after the Initial Effective Date . . . and for which claim is reported to Company during the policy period." (emphasis in original)); see also supra note 12.

14. Lexington Ins. Co. v. Rugg & Knopp, Inc., 165 F.3d 1087, 1093-94 (7th Cir. 1999) [enhanced version available to lexis.com subscribers], ("An insurer may choose to insure either the risk of the activity which causes the injury-here the negligent rendering of services-as with an occurrence policy, or to insure the risk of a claim being made based on the injury, as with a claims-made policy. What the insurer may not do under any sort of policy, whether claims-made [and reported] or occurrence, is to refuse liability for payment merely because of late notice. That is Wisconsin public policy as determined by the legislature."); Sherwood Brands, Inc. v. Great Am. Ins. Co., 418 Md. 300, 303, 326-327 nn. 21-22 (2011) [enhanced version available to lexis.com subscribers], (statute requiring "actual prejudice" to disclaim coverage "on the ground that the insured . . . breached the policy . . . by not giving the insurer required notice" applied, because "[n]otice provisions, even in claims-made-and-reporting policies, must be deemed covenants such that failure to abide by them constitutes a breach of the policy sufficient to make § 19-110 applicable to such policies"); accord McDowell Bldg., LLC v. Zurich Am. Ins. Co., No. 12-2876, 2013 U.S. Dist. LEXIS 132854, at *8 (D. Md. Sept. 17, 2013) [enhanced version available to lexis.com subscribers].

15. Prodigy Communications Corp. v. Agricultural Excess & Surplus Ins. Co., 288 S.W.3d 374, 382-83.

16. Id. at 380 ("Although Prodigy's policy [wa]s labeled a 'claims-made policy,' its requirement that notice of a claim be given 'as soon as practicable during the Policy Period, . . . but in no event later than ninety (90) days after the expiration of the Policy Period, or Discovery Period' [wa]s characteristic of a 'claims-made-and-reported policy'" (ellipse in original, citation omitted)).

17. Id. at 380 (original citations, brackets, and ellipse omitted).

18. Id. at 379, 382.

19. Id.

20. Fulton Bellows, LLC v. Fed. Ins. Co., 662 F. Supp. 2d 976, 991 (E.D. Tenn. 2009) [enhanced version available to lexis.com subscribers], (concluding that application of the notice-prejudice rule was consistent with the public policy reasons underlying the Tennessee Supreme Court's adoption of the notice-prejudice rule in the occurrence context - i.e., " 1) the adhesive nature of insurance contracts; 2) the public policy objective of compensating tort victims; and 3) the inequity of the insurer receiving a windfall due to a technicality").

21. Resolution Trust Corp. v. Moskowitz, 868 F. Supp. 634, 637 (D.N.J. 1994) [enhanced version available to lexis.com subscribers].

22. Prodigy, 288 S.W.3d at 380 n.7 ("Whereas the former requires only that a claim be made within the policy period, the latter also requires that the claim be reported to the insurance company within the policy period." (quoting Jones v. Lexington Manor Nursing Ctr., L.L.C., 480 F. Supp. 2d 865, 868 (S.D. Miss. 2006)).

23. See, e.g., Resolution Trust Corp., 868 F. Supp. at 637 ("There is no requirement that the policyholder report the loss to the insurance company during the policy period. Rather, the 'discovery' policy merely requires the policyholder to report this loss 'as soon as practicable.'").

24. See, e.g., Jones, 480 F. Supp. 2d at 869.

25. See, e.g., Pension Trust Fund, 307 F.3d 944, 955 (9th Cir. Cal. 2002); Evanston Ins. Co. v. Keeway Am., LLC, No. 3:09-cv-1115-M, 2010 U.S. Dist. LEXIS 66072, at *3 (N.D. Tex. Jun. 29, 2010) [enhanced version available to lexis.com subscribers]; Resolution Trust Corp., 868 F. Supp. at 639; Nat'l Union v. FDIC, 264 Kan. 733, 745, 751 (1998).

26. Pension Trust Fund, 307 F.3d at 956-57 (citations omitted).

27. Id. at 956 ("[A claims made] policy cannot be treated as a claims-made-and-reported policy."); see also Keeway Am., LLC, 2010 U.S. Dist. LEXIS 66072, at *3 (refusing to read a reporting requirement into a "general claims made" policy because [the insurer] could have expressly required notice before the expiration of the coverage period, but it did not do so.").

John E. Heintz is a Washington, DC-based partner and leader of the Dickstein Shapiro LLP's Insurance Coverage Group. He can be reached at (202) 420-5373 or heintzj@dicksteinshapiro.com. John A. Gibbons is also a Washington, DC-based partner and Mid-Atlantic regional leader for the firm's Insurance Coverage Group. He can be reached at (202) 420-3644 or gibbonsj@dicksteinshapiro.com. Omid Safa is a Washington, DC-based associate in the firm's Insurance Coverage Group. He can be reached at (202) 420-3472 or safao@dicksteinshapiro.com. Copyright (c) 2014 by John Heintz, John Gibbons, and Omid Safa. Responses are welcome.]

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