Policyholders must comply with policy notice provisions or risk facing arguments from insurers that they have forfeited coverage. Even though many states have case law that prohibits an insurer from denying a claim on the grounds of late notice unless it can demonstrate that the late notice has resulted in prejudice to the insurer, this is not always the case, as one Kentucky hospital recently found out.
In 2011, Ashland Hospital Corporation agreed to pay $40.9 million to resolve allegations by the United States Department of Justice that it billed federal healthcare programs for heart procedures that were not medically necessary.1. Ashland had a $15 million directors and officers policy (the “primary” policy), as well as a $10 million excess policy that covered the time period in question. Both polices were “claims-made” policies, which provide coverage when claims are brought against the insured during the life of the policy, as opposed to “occurrence-based” policies, which provide coverage as long as the covered event occurs during the policy period.
In Ashland’s case, it notified the primary policy carrier of the claim against it, but failed to notify the excess policy carrier until approximately six months later. The excess policy carrier denied coverage on the grounds that notice was untimely. When Ashland pointed out that the carrier had suffered no prejudice by the late notice, the carrier responded that it did not need to establish prejudice because timely notice was a “condition precedent” to coverage under the policy.
The dispute made its way to the United States District Court for the Eastern District of Kentucky. There, the court determined Ashland’s notice was untimely and it further agreed with the insurer that it was not required to demonstrate that Ashland’s late notice resulted in prejudice. Although the court recognized that in some instances an insurer must demonstrate that it suffered prejudice as a result of late notice, in looking at Kentucky state law for guidance, the court found that there was no state law that would require the application of a “notice-prejudice rule” to a claims-made policy.
The court further noted that a majority of jurisdictions do not require an insurer to show prejudice for late notice under a claims-made policy, and it determined that the Kentucky Supreme Court was unlikely to require a showing of prejudice under these facts and under the type of policy at issue. According to the district court, requiring a showing of prejudice would effectively result in a rewriting of the contract and eliminate the benefit to both parties that the reporting requirement served, i.e., to allow the insurer to predict risk and afford lower premiums for its ability to predict that risk.
The district court was affirmed on appeal by the Sixth Circuit Court of Appeals, which found that while the Kentucky Supreme Court had adopted the “notice-prejudice rule” under occurrence-based policies, it had never ruled as to whether such a rule would apply to claims-made policies.2. The appellate court agreed with the district court that the Kentucky Supreme Court was unlikely to extend such a rule to claims-made policies like the one at issue that contained what both courts deemed to be an “unambiguous” notice requirement that operated as conditions precedent to coverage.
The take-away from Ashland Hospital Corporation v. RLI Insurance Company is this: To avoid facing arguments that coverage has been forfeited, policyholders must understand the type of policy they have and understand their obligations under the policy. The failure of a policyholder to appreciate the language in the policy or understand the nuances in the law can result in unintended consequences, as Ashland Hospital Corporation found out when it was not permitted to obtain the $10 million in insurance coverage for which it paid.