On January 7, 2009, the Sixth Circuit Federal Court of Appeals held in that, under Kentucky law, an excess liability insurer must show harm or prejudice as a result of late notice of a claim in order to deny coverage on that ground. Old Republic Insurance Co. v. Underwriters Safety & Claims Inc., Case No. 07-6443.
According to the decision, an employee of the City of Louisville sustained an injury in March 1987 and sought disability benefits. The City was self-insured up to $250,000 and the plaintiff insurer served as its excess insurer. The City paid the injured employee disability benefits from March 1987 to July 2004, thereby exhausting the limits of its self-insurance. Upon exhaustion, the City, through its third party administrator, put the insurer on notice for the first time of the employee’s claim. The insurer filed a declaratory judgment action seeking a declaration that it had no coverage obligation based upon its policy’s notice provision.
The trial court found that the insurer had been entitled to notice in 1988 based on the excess policy’s terms. However, it also determined that, pursuant to Kentucky law, an excess insurer must show that it has been prejudiced by the late notice in order to avoid coverage on that ground. The court found that the insurer was prejudiced because it was exposed to liability without the opportunity to exercise its contractual right to participate in or control the defense of the claim.
On appeal by the defendant, the Sixth Circuit followed the prejudice test applied by the district court and determined that, in order to deny coverage based upon late notice, an excess insurer must demonstrate a reasonable probability that it suffered substantial prejudice as a result of the late notice. In considering whether prejudice existed, the court also applied the four factor test set forth in Jones v. Bituminous Casualty Corp., 821 S.W. 2d 798 (Ky. 1991): (1) whether the contract was one of adhesion; (2) whether the insured had reasonable expectations with respect to implications of failure to give notice of claim; (3) whether lack of notice would violate public policy; and (4) whether an insurer’s refusal to pay due to late notice of claim, and such late notice not causing prejudice, would create a windfall to the insurer. After applying these standards, the appeals court overturned the trial court’s decision, finding that the insurer had not met its burden because it failed to demonstrate that its loss of the right to participate in the defense of the employee’s claim would have changed the outcome.
While the Sixth Circuit acknowledged that current Kentucky law regarding the prejudice requirement does not specifically address excess liability insurers, the court predicted that future development of the state law would find that excess insurers are required to show prejudice in order to deny coverage based upon late notice.