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Calling attention to the late notice problem.

EVERY YEAR, HUNDREDS of millions of dollars of insurance coverage is forfeited because of policyholders' natural reluctance to give notice of claims and occurrences to t h .e i r i n s u r e r s. Understandably, risk managers often wait until the extent of a loss or potential liability becomes clear to give notice to their insurers. However, insurance claims are not like fine wine; they do not get better with age. Under the laws of many states, policyholders who fail to give immediate notice may find that all coverage has been forfeited, even if the insurer has suffered no detriment as a result of the delay. Forfeiture - the loss of all rights - is one of the most serious penalties a court can impose on a contracting party.

Over the years, courts have denied coverage due to late notice even when the delay was as little as seven days, and are sometimes unpersuaded by the most reasonable excuses of policyholders. For example, one policyholder waited approximately two years to give notice of a hazardous material spill, believing up until the time notice was given that the cleanup expenses would be minimal. When the problem compounded and notice was finally given, the insurer denied coverage on the basis of late notice without even attempting an investigation of the claim. A court held that coverage was forfeited by reason of late notice, and the policyholder was left with actual liability approaching $1 million.

No sound reason exists for automatically punishing policyholders who give late notice with a total forfeiture of insurance coverage. Under general principles of contract interpretation, the measure of damages caused by late notice would be limited to the loss to the insurance company, and the burden would be on the insurer to prove the extent of that loss. If the illogic of forfeiting insurance coverage merely because of late notice was applied in all contract cases, the homeowner whose final mortgage payment was late would forfeit all of the payments made and the house as well ! Until recently, there was an implied understanding between risk managers and underwriters that notice was not necessary if the matter did not seem to be serious. This was the "custom of the trade." Moreover, the usual legal rules of insurance policy construction require that policy provisions be interpreted to promote coverage. The heavy-handed late notice rule imposed in some states is an exception to the coverage promoting rule. Forfeiture of all rights hardly promotes coverage. Even outside the field of insurance the law frowns upon forfeitures - it is a penalty far out of proportion to the "crime."


Standard form liability insurance policies, as well as property insurance and other policies, contain provisions that require policyholders to give notice of occurrences, claims and suits against them. A standard notice of occurrence provision found in general liability policies states that "you must see to it that we [the insurer] are notified as soon as practicable of an occurrence or an offense that may result in a claim. To the extent possible, notice should include: how, when and where the occurrence or offense took place; the names and addresses of any injured persons and witnesses; and the nature and location of any injury or damage arising out of the occurrence or offense."

A standard notice of claim or suit provision bund in general liability policies states that "if a claim is made or suit is brought against any insured, you must: immediately record the specifics of the claim or suit and the date received and see to it that we [the insurer] receive written notice of the claim or suit as soon as practicable." Insurers maintain that these clauses are intended to enable them to investigate occurrences, claims and suits while the relevant facts are still available, so that informed decisions concerning coverage can be made.

The notice provisions and other standard form policy language were drafted by insurance industry trade associations in order to permit uniform interpretation of the basic policy terms. In spite of this fact, the courts are sharply divided over how the standard notice provisions should be construed. As a result, in different states a variety of distinct late notice rules are currently applied to identical insurance policy provisions. (See chart on pages 34-35.)

The old anti-policyholder, pro-insurance company rule, which is still followed in some states, requires strict compliance with the notice provisions as a prerequisite to coverage; under this rule, a policyholder who fails to do so automatically forfeits coverage for the particular loss or claim. A court will not even consider whether or not the delay caused any harm to the insurer. This rule was intended to effectuate the claimed purpose underlying the notice provision: providing the insurance company with notice before the trail of evidence grows cold. However, even if late notice has no effect upon the insurance company's investigation, coverage is forfeited.

This rule is so unfair that even insurance companies have criticized it. Hartford Insurance Group members have characterized the harsh forfeiture rule as a "triumph of form over substance" arrived at through a "17th century type of analysis." In attacking that rule, these insurance companies recognized "the need to protect an insured from the severe consequences of a forfeiture of a rightful payment, based upon technical grounds." Policyholders and the public need protection from what the Hartford Insurance Group aptly refers to as a primitive style of justice. Many states have modified the old anti-pollcyholder rule somewhat by allowing policyholders to avoid a forfeiture of coverage if they can demonstrate that they acted reasonably in failing to give timely notice and that late notice did not prejudice the insurance company. Even this less arbitrary, but still anti-policyholder, rule can result in the forfeiture of coverage where the insurer was not harmed, because it places upon the policyholder the considerable burden of proving a negative proposition: that the insurance company was not prejudiced by late notice.

In recent years, courts in a number of states have recognized the extraordinary severity and impracticability of the anti-policyholder rules. These courts have held that coverage is not forfeited unless the insurer can demonstrate that it was prejudiced by the delay. This rule gives weight to the overriding purpose of insurance - to insure. For convenience, this rule can be referred to as the pro-policyholder rule. However, even this rule allows the insurance company to bring about the forfeiture of coverage if it can prove it was prejudiced by late notice. Thus, the pro-policyholder rule can still result in disproportionate punishment of the policyholder - forfeiture of all coverage and premiums - even when the insurance company was damaged to a far lesser extent.


The courts' interpretations o[ the notice rules have led to two major problems. First and foremost, policyholders are unfairly losing the benefits of the insurance coverage they paid for and upon which they relied. Second, the courts' inconsistent interpretations of the standard form notice provisions result in wasteful litigation. Often it is impossible to know which notice rule will be applied in any given instance. That determination can be made only by a court applying a sometimes complex legal analysis. Factors typically considered by the courts include the site of the loss; the location of negotiation,

signing, delivery and performance of the insurance policy; and the residences of the policyholder and insurance company.

The ruling that a court might make on the issue of which late notice rule to apply is often unpredictable in situations where the policyholder and insurance company have strong ties to states with different late notice rules. Insurance companies may take advantage of these conflicting rules and deny coverage on grounds of late notice, requiring the policyholder to commence a lawsuit before the question can be resolved.

These conflicting state laws lead to "forum shopping," where each of the contesting parties attempts to get the case tried in court in a state with rules favoring its position, Insurance companies have not hesitated to sue their policyholders in order to have the late notice issue decided in a court unfavorable to the policyholder. The value of insurance is greatly diminished when the parties must endure the time and expense of litigation to determine the meaning of standard policy provisions. For example, it has been reported that Shell Oil Co. has been forced to spend in excess of $25 million in its environmental insurance coverage action. Very few policyholders could or would spend that much, so the mere threat of litigation by the insurance company against its policyholder can effectively nullify insurance.


If liability insurance coverage is to function as it was intended, a single interpretation of the notice provision should be adopted nationwide. Moreover, as a matter of contract interpretation and common sense, standard form notice provisions should always be given the same meaning. That was the intention of the insurance industry groups that drafted the notice provisions and the expectation of policyholders who purchased standard form policies. As a number of insurance industry organizations recently argued to the California Supreme Court, all standard form provisions must be uniformly interpreted for insurance to function properly.

To address these problems, the courts should uniformly apply a new late notice rule grounded in contract law, public policy and fundamental fairness. For several reasons, an insurer should be required to demonstrate it was prejudiced by late notice in order to defeat coverage and then have coverage reduced only by the amount the insurance company has been damaged. First, in construing insurance policy provisions, most courts recognize that they should seek to uphold the fundamental purpose of insurance - to give certainty and protection to the policyholder in the form of coverage. That primary goal will often be defeated under existing late notice rules, in some instances regardless of whether the insurance company was prejudiced by late notice. This proposed rule promotes coverage, while recognizing that insurance companies should not suffer to the extent of their actual prejudice from late notice.

Second, by promoting coverage and not forfeiture, the proposed rule advances the social goals of insurance. Courts have long recognized that the shifting and pooling of risk accomplished by insurance benefits not only the policyholder, but the larger society as well. Recognizing those goals, the attorney general of New York, a state that still follows the old anti-policyholder late notice rule, recently argued to a New York court that New York state should adopt a more policyholder-oriented rule. The social policy goals of insurance have also been acknowledged by Hartford Insurance Group companies, which argued that "the public, i.e., the ultimate beneficiary of ... insurance, will be deprived of any possibility of recovering damages if insurance is declared forfeit."

Third, under general rules of contract law, the party alleging a breach of contract must demonstrate that it suffered some damage as a result of the breach. The proposed rule is consistent with the principle that the burden of proving damage should rest with the party alleging a breach. An insurance company should be compensated for its actual damages flowing from late notice - it should not be entitled to declare the entire coverage forfeited.

Fourth, the standard form notice provisions in liability insurance policies are typically non-negotiable terms that must be accepted by the policyholder if it wants to purchase coverage. Such one-sided provisions should be interpreted in the light most favorable to the policyholder.

Unfortunately, no mechanism exists for persuading the courts to adopt a single, correct approach to the late notice problem. Although courts in several states have slowly abandoned the anti-policyholder rules, the adoption of a uniform, correct approach, if it is to happen at all, will probably take decades. A Maryland court, advocating the uniform interpretation of standard insurance policy provisions, stated that the structure of the state and federal court systems "make[s] the achievement of such uniformity an illusion."

Thus, for the foreseeable future, policyholders will continue to face the possible forfeiture of coverage when they give late notice. Risk managers must overcome their reluctance to give immediate notice in situations where they think a problem is not sufficiently serious. At a later date, when the full extent of the problem is known, insurance coverage may have been forfeited. For the same reason, notice should be given to umbrella and excess insurers even though it may seem likely that upper levels of coverage will never be reached. The fact that a policyholder's reluctance to give late notice is understandable does not impress aggressive insurance company lawyers who are more interested in winning lawsuits against policyholders than in promoting business relations and fulfilling the public policy goals of insurance.

Giving notice may seem like a bitter sip of medicine. Take it now because it is not wine. TABULAR DATA OMITTED
COPYRIGHT 1992 Risk Management Society Publishing, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Title Annotation:liability insurance claims
Author:Anderson, Eugene; Harckham, Finley; Lewis, Joan
Publication:Risk Management
Date:Nov 1, 1992
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