The Texas Supreme Court has been more active in addressing insurance coverage issues than at any other time in the last 20 years.
With increasing concern, coverage lawyers are watching closely the areas it chooses to focus on as well as the approach to insurance the Court takes to glean its bent. One of the areas that the Court has dealt with on several recent occasions is the nexus of claims-made policies and the effectiveness of conditions precedent.
For instance, on Aug. 29, 2008 the Texas Supreme Court issued Ulico Casualty Co. v. Allied Pilots Association, 262 S.W.3d 773 (Tex. 2008), addressing whether there is a prejudice requirement as a prerequisite to applying estoppel concepts to a claims made policy. Texas courts had generally required such a prejudice in liability policies beginning with Farmers Texas County Mutual Ins. Co. v. Wilkinson, 601 S.W.2d 520 (Tex.Civ.App.—Austin 1980, writ ref’d n.r.e), so it was not surprising that the Court formally adopted the prejudice requirement.
Notice, Prejudice and Claims-Made Policies
Still, there was some surprise when in late March, the Texas Supreme Court addressed whether the requirement of notice-prejudice in late notice cases, such as in PAJ, Inc. v. The Hanover Insurance Company, 243 S.W.3d 630 (Tex. 2008) would be extended to a claims-made policy.
As has now become common, the Court never hesitates to surprise us all.
Just weeks ago, the Court issued Prodigy Communications Corp. v. Agric. Excess & Surplus Ins. Co., – S.W.3d -, 2009 WL 795530 (Tex.), where a claims-made policy included a notice provision requiring the insured, “as a condition precedent,” must give the carrier notice of a claim “as soon as practicable …, but in no event later than 90 days after expiration of the Policy Period or Discovery Period.”
In Prodigy, the parties disputed whether the notice of the claim was given “as soon as practicable” as the policy required, but they did agree that the insured did provide the notice within the 90 day period. The insurer did not argue that it suffered prejudice due to the delay.
Despite the clear requirement under the policy, the Court decided that receiving notice “as soon as practicable” was not an essential part of bargain under the claims-made policy, and therefore prejudice to the insurer was required to defeat coverage.
The question to the Court was whether an insurer can deny coverage under a claims-made policy “based on its insured’s alleged failure to comply with a policy provision requiring that notice of a claim be given ‘as soon as practicable,’ when (1) notice of the claim was provided before the reporting deadline specified in the policy; and (2) the insurer was not prejudiced by the delay.”
In analyzing this legal issue, the Court reiterated its holding in PAJ (dealing with an occurrence-based policy) that “an insured’s failure to timely notify its insurer of a claim or suit does not defeat coverage if the insurer was not prejudiced by the delay.” The conclusion in PAJ was based on a prior decision that an immaterial breach does not deprive the insurer of the benefit of the bargain or relieve the insurer of a coverage obligation.
The Court’s opinion in Prodigy primarily addressed the argument that PAJ involved an occurrence-based policy and the policy in Prodigy was a claims-made policy. The Texas Supreme Court in PAJ recognized the critical distinction between the role of notice in claims-made policies and that of occurrence policies, concluding that timely notice “was not an essential part of the bargained-for exchange in PAJ’s occurrence-based policy.”
To determine whether “notice as soon as practicable” was an essential part of the bargained-for exchange in a claims-made policy, the Court reviewed the basic distinctions between occurrence and claims-made policies and analyzed the different notice requirements typically associated with each, relying almost exclusively on insurance law treatises and non-Texas cases in determining this issue. (It appears that the Court is not joining in the secession movement.)
A claims-made policy covers only those claims first asserted against the insured during the policy period, while an occurrence-type policy covers only claims arising out of occurrences during in the policy period. The primary advantage of a claims-made policy is to limit liability to claims asserted during the policy period, which allows insurers to calculate risks and premiums with greater precision. By eliminating its exposure for claims filed after the policy period, the insurer is able to issue claims-made policies at reduced premiums.
Both occurrence policies and claims-made policies typically require that the insurer be notified of a claim promptly or “as soon as practicable.” But unlike occurrence policies, claims made-and-reported policies also require that the claim be reported to the insurer within the policy period or a specified number of days thereafter.
Because the requirement that a claim be reported to the insurer during the policy period or within a specific number of days is considered essential to coverage under a claims-made-and-reported policy, the Court noted that most courts have found that an insurer does not need to demonstrate prejudice to deny coverage based on an insured’s failure to comply with this reporting requirement.
The Court then discussed two out-of-state supreme court decisions holding that the statutory notice-prejudice requirements in those jurisdictions applied only to the “as soon as practicable” type of notice and not to the requirement that a claim be reported within the policy period or the extended reporting period.
The Texas Supreme Court agreed with these other courts’ analyses, holding that in a claims-made policy, “when an insured gives notice of a claim within the policy period or other specified reporting period, the insurer must show that the insured’s non-compliance with policy’s ‘as soon as practicable’ notice provision prejudiced the insurer before it may deny coverage.” In reaching this holding, the Court concluded that the insured’s obligation to provide the carrier with notice of a claim “as soon as practicable” was not material to the bargained-for exchange under a claims-made policy.
A Dissenting Opinion
Justice Johnson dissented in an opinion joined by Justices Hecht and Willett, remarking accurately that the court had rewritten an unambiguous insurance contract and changed the agreement of the parties. The dissenting justices noted that the insuring agreements and notice provisions are completely separate, which they believe should prevent classifying one notice provision as more important than the other. Because the policy language shows that the parties intended for the two notice provisions to have the same effect, that of a condition precedent, the court should respect the agreement.
Prejudice Must be Shown
After Prodigy Communications, an insurer must show prejudice because of an insured’s failure to give notice “as soon as practicable” before it can deny coverage under either an occurrence or claims-made policy.
Although it is not yet clear whether an insurer must also show prejudice to deny coverage for an insured’s failure to comply with other policy conditions, such as the voluntary payments clause, the Texas Supreme Court’s materiality-to-the-bargain analysis and its reluctance to give legal effect to “condition precedent” policy language seem to make the existence of a prejudice requirement in those situations much more likely.
Brian S. Martin is a partner in the Insurance and Coverage section of the Houston office of Thompson, Coe, Cousins & Irons L.L.P. He has extensive experience in insurance coverage and defense matters, specializing in environmental, toxic tort and products cases.
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