Ticking Coverage Bomb: The Cost of Delayed Notice in Claims-Made Policies

Claims-made policies often require that policyholders notify their insurer promptly or as soon as practicably possible after an incident that may give rise to a claim.

This requirement exists primarily to allow insurers to investigate potential claims while evidence is still fresh. Prompt notice helps ensure that key details and documentation are secured, which is crucial for an accurate evaluation of the claim. It also minimises the risk of delays that could compromise the insurer’s ability to defend the claim, ultimately protecting both the insurer’s and the policyholder’s interests.

A question recently arose in Massachusetts, USA, in the matter of Stormo v. State Nat’l Ins. Co., whether an insurer must prove that it was prejudiced by the policyholder’s untimely notice in order to deny coverage under a claims-made policy.

The insured, a legal practitioner, assisted his clients with a property transaction. However, the transaction fell through after he allegedly informed the buyer that his clients had withdrawn from the sale upon receiving a superior offer. Unhappy with his actions, the insured’s former clients instituted a professional negligence claim against him. Notably, the legal practitioner failed to notify his insurer of the claim until more than a year after proceedings had commenced. As a result, the insurer refused to provide indemnity under its claims-made professional indemnity policy, invoking the prior knowledge exclusion. It also denied coverage under the policy’s notice clause, which required prompt written notification of any claim.

The insured’s former clients were successful in the malpractice suit and subsequently obtained an assignment of rights to pursue legal action against the insurer for breach of contract and statutory bad faith. The insurer argued that the policy did not afford coverage based on the insured’s breach of his reporting obligations. The trial court ultimately agreed and granted judgment in favour of the insurer.

The case was taken on appeal, which upheld the trial court’s decision that the insurer was not obligated to indemnify the insured because of the delayed notification. The appellate court dismissed the contention that the insurer needed to show it was prejudiced by the late notice to deny coverage under the notice clause.

In conclusion, the Stormo decision underscores the strict nature of notice provisions in claims-made policies, with significant implications for both policyholders and insurers. For policyholders, the decision serves as a stern reminder that prompt notification is a critical contractual obligation. Failure to report a claim in a timely manner can result in coverage denial, regardless of whether the insurer can demonstrate actual prejudice.

For insurers, the decision confirms that the contractual language governing notice requirements need not be supported by a showing of demonstrable prejudice. In other words, insurers are entitled to rely solely on the insured’s failure to comply with the prompt notice provision to deny coverage. This outcome reinforces the importance for insurers to draft clear and unequivocal policy terms that protect their interests by limiting their exposure to stale or inadequately investigated claims.