young businessman running in a city streetLate notice of claim in both direct insurance and reinsurance are important issues. There are both contract and public policy issues that arise when considering if late notice will allow an insurer or reinsurer to avoid its obligations. We have authored a number blog posts here and commentaries on late notice issues in insurance and in reinsurance.

In a number of jurisdictions an insurer or reinsurer claiming late notice cannot avoid its obligation under the insurance or reinsurance contract unless it can show actual prejudice. This post will focus on the issue of what constitutes actual and substantial prejudice.

In those states that allow a late notice defense in reinsurance based on a showing of prejudice do so only if the reinsurer can show actual and substantial prejudice. So what is actual and substantial prejudice? One court has held that prejudice means tangible economic injury. Proving tangible economic injury because of late notice of a loss is not an easy task for a reinsurer. Arguments range from the loss of the opportunity to associate in the defense of the underlying claim to loss of retrocessional recovery because of an intervening commutation agreement.

In a recent case, a New York state motion court addressed whether an intervening commutation was actual and substantial prejudice. The case has a twist, however, because the court held that California law applied, so it was California’s law on late notice that was construed in this case. Granite State Ins. Co. v. Clearwater Ins. Co., No. 653546/11, 2016 N.Y. Misc. LEXIS 2314 (N.Y. Sup. Ct. Jun. 16, 2016).

The case involved the cession of losses arising out of hundreds and thousands of bodily injury claims from exposure to asbestos and other products produced by the underlying insured. The cedent had issued dozens of policies over the years to the insured and had entered into a facultative certificate with the reinsurer on one of those policies. At some point the reinsurer entered into a retrocessional agreement that included this certificate.

The underlying claims and related coverage disputes resulted in a settlement between the cedent and the insured to be paid on an installment basis. The cedent paid the claims using a horizontal bathtub methodology. It wasn’t until some years later that the claims hit the insured’s policy under the cedent’s method of allocation and triggered a billing to the reinsurer. In the interim, the reinsurer had commuted with its retrocessionaire.

The reinsurer rejected the billing based on late notice, among other arguments, claiming it was substantially prejudiced. The reinsurer claimed that it would never would have entered into the commutation with its retrocessionaire if it had known of the pending losses.

After deciding that California law applied, the court applied the California law of late notice to the facts. The court noted that the reinsurer must make a showing of actual and substantial prejudice stemming from the late notice. The question was whether the “disadvantageous commutation” was actual and substantial prejudice. The court held that under California law it was not. Quoting from Ins. Co. of State of Pa. v. Assoc. Int’l Ins. Co., 922 F.2d 516, 524 (9th Cir. 1991), the court found that a commutation is a collateral matter and collateral matters cannot constitute prejudice.

What the Ninth Circuit stated was that actual and substantial prejudice is “found in those cases where the insurer actually demonstrated that there was a substantial likelihood that it could have either defeated the underlying claim against its insured, or settled the case for a smaller sum than that for which its insured ultimately settled the claim.” Apparently, under California law and as construed by the New York court in Granite State, a disadvantageous commutation is not actual and substantial prejudice because it is collateral and does not show a substantial likelihood that the claim could have been defeated or settled for less.