Insurance Services Organization Revises Policy Forms to Address CannabisThe Insurance Services Office, Inc. (ISO), which develops standard insurance policy forms for use by insurers, recently released its first cannabis-related endorsements (Cannabis Endorsements) to the businessowner policy form. This new release provides five cannabis exclusion endorsements; two of the endorsements change property coverage for cannabis, and the other three endorsements change liability coverage for cannabis. As with any insurance policy or endorsement, understanding the specific language of these new cannabis endorsements is critical to any insured engaging in cannabis-related activity.

The ISO businessowner policy is a package policy that provides a number of property and liability coverages for businessowners. Historically, property loss of cannabis-related businesses was not “covered property” under the Property Not Covered provision of the form, which provides that covered property does not include “contraband, or property in the course of illegal transportation or trade.” For decades under federal law, cannabis was effectively “contraband” for insurance purposes by statutes such as the 1937 Marihuana Tax Act and the 1970 Controlled Substances Act. The 2018 Farm Bill, however, changed the legal status of hemp, cannabis with a concentration of no more than .3 percent Tetrahydrocannabinol (THC). Specifically, the Farm Bill amended the Controlled Substances Act and the Agricultural Marketing Act to remove hemp from regulation as a controlled substance.

With an increasing number of states legalizing marijuana for medical or adult use and the 2018 Farm Bill legalizing hemp (in certain circumstances), ISO recognized that cannabis-related property may no longer constitute “contraband” under the businessowners policy. Thus, ISO released five Cannabis Endorsements, which were approved for use in a majority of states in September 2019.

  • BP 15 30-Cannabis Property Exclusion
  • BP 15 31- Cannabis Property Exclusion with Hemp Exception
  • BP 15 32-Cannabis Liability Endorsement
  • BP 15 33-Cannabis Liability Exclusion with Hemp Exception
  • BP 15 34-Cannabis Liability Exclusion with Hemp Exception and Lessors Risk

The Property Exclusion Endorsements (BP 15 30 and BP 15 31) clearly exclude coverage for cannabis by adding the term “cannabis” to the Property Not Covered provision of the businessowner property form. The Liability Exclusion Endorsements (BP 15 32, BP 15 33, and BP 15 34) add a specific exclusion to the liability portion of the businessowner policy form that broadly excludes from coverage any bodily injury, property damage or personal and advertising injury arising out of a laundry list of cannabis-related activities.

The most important part of these endorsements is the broad definition of the term cannabis. Each of the Cannabis Endorsements defines “cannabis” as “any good or product that consists of or contains any amount of Tetrahydrocannabinol (THC) or any other cannabinoid, regardless of whether or not any such THC or cannabinoid is natural or synthetic.” The Cannabis Endorsements each specify that the term “cannabis” includes “[a]ny plant of the genus Cannabis L. or any part thereof, such as seeds, stems, flowers, stalks, and roots, or [a]ny compound, by-product, extract, derivative mixture or combination, such as (1) resin, oil, or wax; (2) hash or hemp; or (3) infused liquid or edible cannabis.” For purposes of the Cannabis Endorsements, hemp, including CBD derived from hemp, is cannabis and is excluded from coverage – unless there is an exception to that exclusion.

As noted by their titles, three of the five Cannabis Endorsements contain a Hemp Exception. Form BP15 31- Cannabis Property Exclusion with Hemp Exception adds “cannabis” to the Property Not Covered provision of the businessowner form, but then provides that this exclusion does not apply to goods or products containing or derived from hemp, including (but not limited to) the following:  seeds, food, clothing, lotions, oils or extracts, building materials, or paper. Similarly, the hemp-exception liability endorsements provide that the cannabis exclusion will not apply to liability for bodily injury, property damage, or personal and advertising injury arising out of goods or products containing, or derived from, hemp.

Businessowners operating hemp-related businesses should be cautious in reviewing their insurance policies to ensure that if their policies have been endorsed with any of these new ISO Cannabis Endorsements, each endorsement includes the Hemp Exception. Otherwise, under the broad definition of “cannabis,” an ISO cannabis endorsement without a hemp exception would exclude coverage for any hemp-related products.

Private Flood Insurance Rules Now in Effect for Lenders and ServicersThe Board of Governors of the Federal Reserve System, the Farm Credit Administration, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Office of the Comptroller of the Currency (the interagency regulators) issued a final rule in February 2019 implementing the portion of the Biggert-Waters Flood Insurance Reform Act mandating acceptance of private flood insurance. The rule went into effect on July 1, 2019.  Recently, the Federal Reserve, the FDIC, and the OCC updated their examination manuals to ensure regulated institutions are in compliance with the private flood insurance rules.

The Biggert-Waters Flood Insurance Reform Act of 2012 (the Biggert-Waters Act) obligated the interagency regulators to issue a final rule requiring financial institutions to accept private flood insurance. On February 13, 2019, the interagency regulators announced the issuance of this joint final rule.  The final rule requires regulated institutions to accept flood insurance policies that meet the Biggert-Waters Act statutory definition of “private flood insurance” through four primary components: (1) mandatory acceptance of private flood insurance; (2) mandatory acceptance compliance aid; (3) discretionary acceptance of private flood insurance; and (4) flood coverage provided by mutual aid societies.

1. Mandatory Acceptance

The final rule mandates that regulated institutions must accept private flood insurance policies that satisfy the statutory definition of “private flood insurance.” Generally, a “private flood insurance” policy: (1) is issued by a duly licensed or approved insurance company; (2) provides coverage that is “at least as broad as” the coverage provided under a standard flood insurance policy (SFIP) issued under the National Flood Insurance Program (NFIP); (3) includes a requirement that the insurer must give 45-days notice to the borrower and lender (or servicer) prior to cancellation or non-renewal; (4) includes information about the availability of coverage under the NFIP; (5) includes a mortgagee clause similar to the clause in an SFIP; (6) includes a limitation provision that the insured must file suit not later than one year after the date of a written denial of a claim under the policy; and (7) contains cancellation provisions that are as restrictive as an SFIP.

To determine whether a private policy is “at least as broad as” an SFIP, the final rule requires institutions to conduct a substantive review of specific provisions in a private flood policy, including but not limited to, the coverage grant, deductible amounts, conditions, and exclusions. In a June 18, 2019, webinar, the interagency regulators articulated their expectation that regulated institutions will conduct such substantive reviews. If a private policy satisfies all these requirements, the institution must accept the policy for purposes of complying with its flood insurance obligations.

2. Compliance Aid

The joint regulator rule includes a “compliance aid” provision to assist institutions with evaluating policies. As set forth in the final rule, the compliance aid language is as follows:

“This policy meets the definition of private flood insurance contained in 42 U.S.C. 4012a(b)(7) and the corresponding regulation.” 

If a private policy contains this exact compliance aid language, then the institution need not conduct any further review of the policy.  In the June 18 webinar, the interagency regulators explained that only this specific language would relieve the lender of any obligation to conduct a substantive review of the private policy. While the compliance aid language is sufficient to satisfy the private flood rule, it is not necessary. Thus, a lender or servicer may not reject a private flood policy because this compliance aid language is not included.

3. Discretionary Acceptance 

The final rule allows institutions to accept private flood insurance policies that do not meet the statutory definition of “private flood insurance” so long as the private policy:

  • Provides coverage in the amount required by the flood insurance purchase requirement;
  • Is issued by an insurer that is licensed, admitted, or not disapproved by a state insurance regulator (including recognized surplus lines insurers);
  • Provides coverage for both the mortgagor and the mortgagee, with exceptions for a condominium association, cooperative, homeowners association, or other group; and
  • Provides sufficient protection of the designated loan, consistent with general safety and soundness principles and the institution must document this conclusion in writing.

In the June 18 webinar, the interagency regulators explained that regulated institutions could approve a private policy on the basis of this discretionary acceptance analysis without determining that the private policy would constitute a “private flood policy” as defined by the Biggert-Watters Act. Thus, an institution may conduct the discretionary acceptance analysis as an alternative to conducting the mandatory acceptance analysis.

4. Coverage by Mutual Aid Societies 

Finally, the final rule allows institutions to accept certain flood plans provided by mutual aid societies, such as an Amish Aid Plan, when certain conditions are met. The analysis for mutual made society plans is substantially similar to the discretionary acceptance analysis described above with one important exception. In order to accept a plan provided by a mutual aid society, the institution’s federal regulator must have issued a determination that mutual aid society plans will qualify as flood insurance. At this point, the OCC has approved the acceptance of Amish and Mennonite mutual aid plans, and the Farm Credit Bureau has approved the acceptance of Amish mutual aid plans. Institutions regulated by the Federal Reserve and NCUA should seek permission to accept a flood plan provided by a mutual aid society, and such requests will be reviewed on a case-by-case basis. The FDIC is also approving mutual aid society plans on a case-by-case basis and is considering whether the particular society is licensed or approved as an insurer by the state in which the property is located or whether the plan itself is treated as insurance by the state.

Conclusion

The statement by the interagency regulators in the June 18 webinar that they expect regulated institutions to conduct substantive reviews to determine if a private flood insurance policy is “at least as broad as” an SFIP policy, as well as the updated examination manuals of the FDIC, OCC, and Federal Reserve, demonstrate that compliance with the private flood rule will be considered during institutional examinations. As noted, the agencies expect substantive review of private insurance policies, which is a time intensive and resource heavy process.  Regulated institutions will benefit greatly by implementing policies and procedures aimed at creating the most efficient private flood insurance policy review process while still ensuring compliance with the private flood insurance rule.

Equitable Subrogation: A Useful Tool for Your Excess Insurer When Your Primary Insurer Refuses to Settle Within its LimitsEvery policyholder will likely face a scenario where its primary insurer refuses a settlement offer within limits. The primary insurer is potentially liable for that excess verdict if it acted in bad faith by refusing to settle within limits. Sometimes, a primary insurer will roll the dice because the policyholder procured excess liability coverage that should pay any verdict above the primary limits.

But the primary insurer cannot gamble with the settlement simply because the policyholder was conscientious enough to purchase excess insurance and cannot use the policyholder’s excess coverage as a shield against a claim for bad faith refusal to settle within limits.

Allowing the primary insurer to gamble with the excess coverage impairs both the policyholder and the excess insurer. The failure to settle within limits could impact the policyholder’s future premium and availability of coverage if the excess insurer pays and could immediately impact the policyholder if the excess insurer balks, forcing the policyholder itself to pay the verdict while pursuing a claim against the excess insurer.  And, of course, the excess verdict directly hits the excess insurer’s bottom line.

Assuming that the excess insurer steps up, the legal principle of equitable subrogation allows it to recoup its payments from the primary insurer if the primary insurer acted in bad faith by refusing to settle within the primary limits.  The excess insurer stands in the shoes of its insured to seek indemnification against the third parties legally responsible for the loss  (see, e.g.,  Allstate Ins. Co. v. Mazzola, 175 F.3d 255, 258 (2d Cir. 1999); ACE Am. Ins. Co. v. Fireman’s Fund Ins. Co., 2 Cal.App.5th 159, 167 (2016) (citation omitted)). The excess insurer must demonstrate that the primary insurer refused to settle within the policy limits when it could have done so, and instead gambled with the excess insurer’s limits.

Several courts have considered an excess insurer’s ability to seek equitable subrogation against a primary insurer, but have reached different conclusions.

A Nevada district court, for example, required a primary insurer that acted in bad faith to reimburse the excess insurer in the amount above the primary limit, even though the amount was reached by settlement rather than an excess judgment (see Colony Ins. Co. v. Colo. Cas. Ins. Co., 2018 WL 3312965 (D. Nev. July 5, 2018)). The primary insurer refused a policy-limits demand,  did not provide a counter-offer, did not properly and diligently investigate, and rejected the excess insurer’s demand that it settle within the primary $1 million limit. Only after new counsel evaluated the case did the primary insurer settle with the claimant for $1.95 million – placing the excess insurer on the hook for $950,000. The excess insurer demanded that the primary insurer pay the full settlement amount in light of its alleged bad-faith conduct. When the primary insurer refused, the excess insurer paid the remaining $950,000. Noting that the excess insurer did not voluntarily pay the excess amount and that the primary insurer had acted in bad faith by unreasonably refusing to settle the case within policy limits, the court held that the primary insurer was required to reimburse the excess insurer for the $950,000.

In contrast, a Florida district court rejected an excess insurer’s equitable subrogation claim because the excess insurer “voluntarily” paid the excess amount and never reserved its rights on priority of coverage (see Privilege Underwriters Reciprocal Exch. (“PURE”) v. Hanover Ins. Group, 304 F. Supp. 3d 1300 (S.D. Fla. 2018)). In this case involving defamation claims against attorney Alan Dershowitz, three policies – a homeowners’ policy, a business owners’ policy issued by PURE, and a professional liability policy — jointly provided a defense. Ultimately, the insurers each contributed to a settlement. At no time did the insurers enter into a subrogation agreement. The court denied PURE’s equitable subrogation claim against the homeowner’s policy because PURE had “volunteered its settlement funds and waived the right to seek subrogation” against the homeowners’ policy.

Likewise, a Colorado appellate court dismissed an excess insurer’s equitable subrogation claim because it was not brought as derivative of the insured’s right and did not plead bad faith (see Preferred Professional Insurance Co. v. Doctors Co., 419 P.3d 1020 (Colo. 2018)). When the primary insurer refused to pay the settlement demand within the primary limits, based on its contractual right, the excess insurer stepped up and settled within the primary limits on the insured’s behalf. The excess insurer later sought reimbursement from the primary insurer. The court noted that the excess insurer’s equitable subrogation claim is derivative of the insured’s rights and looked to what, if any, claim the insured could have asserted against the primary insurer. In this case, the claim would be for bad faith failure to settle. But without an excess award, because the excess insurer had paid the primary limit settlement demand, the excess insurer could not recoup its settlement payment from the primary insurer.  The primary insurer had a contractual right to control settlement that the excess insurer could not override. Allowing the excess insurer to recoup from the primary insurer would nullify the primary insurer’s right simply because the excess insurer disagreed with the risk of exposure, which the court would not do. So here the excess insurer’s willingness to protect its policyholder boomeranged and could lead other excess insurers to hesitate to step in when the primary insurer fails to honor its coverage obligations.

Although more jurisdictions are permitting excess insurers to bring equitable subrogation claims against primary insurers, even in the absence of an excess award, the claim can only be sustained if it is derivative in nature – the insurer must be “stand[ing] in the shoes of the insured” and assert bad faith against the primary insurer. In addition, it is incumbent on excess insurers to act to preserve their subrogation rights, including raising a priority of coverage defense and signing a subrogation agreement. As always, policyholders too must be vigilant to protect their rights under their primary and excess insurance policies to avoid facing financial exposure of their own.