February 02, 2017 Articles

The Notice-Prejudice Rule Debate in Claims-Made Policies

Should prejudice be required when notice is reported during the policy term?

by Ellis I. Medoway

Insurance policies require timely notice of a loss or claim. In occurrence-based policies, that notice should be “prompt” or “as soon as possible” (or “practicable”). The purpose of such notice is to aid the insurer in investigating, defending, and settling against the loss or claim. When the insurer seeks to deny coverage based on “late notice,” however, the insurer must show that it was materially prejudiced.[1] Unless the insurer can demonstrate such prejudice, the overwhelming majority of courts will reject the insurer’s attempt to deny coverage in order to avoid the policyholder’s forfeiture of the occurrence policy’s benefits. Because the law abhors forfeiture, courts view as unfair a policyholder’s loss of coverage based on the technical defense of late notice.[2]

This “notice-prejudice” rule and its rationale, however, are not applied in the same manner to claims-made policies. Unlike occurrence policies, which are often used in first-party and third-party general liability insurance, claims-made policies are used more for directors’ and officers’ (D&O) and professional liability insurance risks. In most states, strict compliance with the claims-made policy’s notice provision is required. Because claims-made policies generally provide retroactive coverage for losses that occurred at any time prior to the policy’s effective date, coverage is limited to claims made against the insured and actually communicated to the insurer during the term of the policy. As a general proposition, courts uniformly reject the policyholder’s invocation of the notice-prejudice rule when the insured fails to notify the insurer of a claim during the policy term.[3]

What should the rule be, however, if the insured provides notice of the claim within the claims-made policy term but that notice is not provided promptly or “as soon as practicable”? With respect to this particular issue—which involves “claims-made and reported” policies—courts have split over whether the notice-prejudice rule can be invoked in such circumstances. Some courts have held the notice-prejudice rule should apply because the “as soon as practicable” notice language mirrors the purpose of similar language found in occurrence-based policy notice requirements where the prejudice rule is recognized. Other courts have rejected its application, ignoring that the essence of a claims-made policy only requires the insured to provide notice to the insurer within the policy term.

These two divergent approaches to this unique notice issue in claims-made and reported policies is best illustrated in the Texas Supreme Court decision in Prodigy Communications Corp. v. Agricultural Excess & Surplus Insurance Co.,[4] which applied the notice­prejudice rule, and the more recent New Jersey Supreme Court decision in Templo Fuente v. National Union Fire Insurance Co.,[5] which rejected it. This article discusses these two decisions, identifies other courts that have followed their respective approaches, and concludes with an examination of why the Prodigy approach may be the better-reasoned decision.

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