Beware of Prior Act Exclusions and Retroactive Dates When Procuring or Renewing CoverageAn 11th Circuit decision issued earlier this year serves as a reminder of the importance of carefully evaluating time-based exclusions and retroactive dates when procuring or renewing coverage. Liability policies such as directors’ and officers’, private entity, and professional liability policies provide coverage for claims made and reported during the policy period (or an extended reporting period) regardless of the date of the underlying alleged wrongful act. This coverage is not unlimited, however, and an insurer selling a policy with a Prior Acts Exclusion may well deny coverage for alleged wrongful acts that purportedly “arise out of” even tangentially connected conduct that first happens before the policy’s retroactive date. Insurers will do so even though a reasonable insured would not make any connection between the otherwise covered wrongful acts and prior conduct. In Zucker v. U.S. Specialty Insurance Co., the 11th Circuit endorsed this very approach. The court relied on a broad “Prior Acts Exclusion” combined with a retroactive date to eliminate coverage for actions that occurred after the retroactive date and that led to a claim first brought during the policy period.

Zucker (the bankruptcy plan administrator) alleged that corporate officers fraudulently transferred monies from BankUnited because they transferred the money while the bank was insolvent. The insolvency and the alleged fraudulent transfers occurred during the policy period, and the officers timely submitted their claims for coverage after Zucker sued them for the fraudulent transfers. The insurer denied coverage for the lawsuit on the grounds that the fraudulent transfer claims required the insolvency, and the insolvency resulted from the officers’ mismanagement of the bank before the retroactive date. Using a broad “Related Claims” exclusion, the insurer connected the insolvency with the mismanagement and denied coverage. The 11th Circuit agreed. Broadly construing the phrase “arising out of” in the Prior Acts Exclusion under Florida law, the court described the insolvency as an “essential element” of Zucker’s claim that “has a connection to some wrongful acts” of the officers and directors that “occurred before the policy’s effective date.” The court concluded that the Prior Acts Exclusion barred coverage:  “Given that, Zucker’s fraudulent transfer claims do share ‘a connection with’ wrongful acts covered by the Prior Acts Exclusion.” The court noted that the governing Florida law broadly construed “arising out of” to encompass virtually any connection and imposes a standard that “is not difficult to meet.”

Tellingly, the 11th Circuit recounted the bank’s decisions regarding placement of the coverage. When offering the coverage to the bank, the insurer offered a choice between two policies:  “one with a Prior Acts Exclusion (barring coverage for losses attributable to conduct of the officers before November 10, 2008) and one without the exclusion.” The premium with the exclusion was $350,000; the premium without the exclusion was $650,000. Although the bank purchased other coverage enhancements and doubled the policy limits, resulting in a final premium at $700,000, the bank’s decision to accept the exclusion proved fatal to coverage.

This case should serve as a stark reminder to policyholders to carefully examine their policies and insurers’ coverage proposals. Policyholders should resist or limit as much as possible any terms designed to restrict the time period relevant to coverage, including Prior Acts Exclusions and retroactive dates. Certain seemingly innocuous terms can result in an unexpected and painful outcome that far overshadows any upfront premium savings.

The Perils of Late NoticeAs every policyholder should know, purportedly “late” notice under claims-made insurance policies can eradicate coverage – even if the policyholder purchases successive policies from the same insurer. Alaska Interstate Construction, LLC (AIC) faced this very situation, and lost coverage in a recent unpublished Ninth Circuit decision (Alaska Interstate Construction, LLC. V. Crum & Forster Specialty Insurance Company, Inc.). AIC purchased successive professional errors and omissions liability policies from Crum & Forster Specialty Insurance Company, Inc. (C&F). C&F issued an initial policy for the policy period of December 1, 2011, to May 1, 2013, and then a renewal policy with a policy period of May 1, 2013, to May 1, 2014. Thus, for the period from December 1, 2011, until May 1, 2014, C&F insured AIC. On January 10, 2013, during the initial policy period, a third party made a claim against AIC. AIC did not report the claim during the initial policy period but instead reported the claim on June 19, 2013, during the renewal policy period. The court found no coverage because AIC received the claim in one policy period but reported the claim in the subsequent policy period.

In a creative attempt to avoid this outcome, AIC argued that the policies’ vague definition of “policy period” as “the period shown in the Declarations” did not limit the “Declarations” to one specific policy period, and that the policy period could reasonably be interpreted as encompassing both the initial and renewal policy periods. The Ninth Circuit unequivocally rejected this argument and instead treated the policies as two separate contracts without a continuous policy period.

Ironically, AIC’s renewal of the policy placed it in a worse position than had it walked away. The initial policy, which expired on May 1, 2013, included a 90-day automatic extended reporting period (ERP) when the policy “is canceled or not renewed by [C&F] for any reason except non-payment of premium.” AIC argued that if the policies are viewed separately for purposes of determining the policy period, then the initial policy was effectively cancelled when its policy period ended, thus invoking the automatic ERP, which was in effect when AIC reported the claim to C&F. The Ninth Circuit rejected this reasoning: “the plain language of the policy states that cancellation and non-renewal are the events that trigger the ERP. Thus, because AIC renewed its policy, the ERP did not apply.”

This case is just one of many decisions depriving policyholders of coverage under claims-made policies due to the timing of notice. To avoid this outcome, commercial policyholders should ensure that they report all claims asserted against them during the operative policy period. They should also carefully evaluate potential liabilities to determine whether to give notice of circumstance under a policy before the end of the policy period. This due diligence is essential – for with claims-made policies, late is not better than never.

House Bill 1774 Requires Urgent Action by Texas Policyholders to Preserve Coverage for Hurricane Harvey Flood ClaimsEven as Hurricane Harvey’s effects continue to unfold, Texas policyholders face another imminent threat. On September 1, 2017, a new Texas law becomes effective that dramatically limits insurance recoveries for Texan individuals and businesses. House Bill 1774 requires policyholders to provide more details when disputing insurance company coverage determinations and substantially reduces the penalties imposed on insurers who unfairly deny, slow pay, or underpay insurance claims filed after August 31, 2017. This anti-policyholder law also imposes additional (and potentially onerous) pre-suit notice and inspection requirements on policyholders; these requirements are all designed to minimize policyholder insurance recoveries. While policyholders may file claims after August 31, 2017, the penalty for insurers who fail to fully honor their obligations will be reduced. This law applies to homeowners and commercial policyholders on all commercial insurance programs (only government insurance programs fall outside the scope of this onerous law).

In light of this upcoming restriction on insurance recoveries, Texas policyholders should immediately ask their brokers or insurance agents to submit their insurance claims on all potentially responsive insurance policies no later than Thursday, August 31, 2017. If your broker or agent’s office is closed due to Hurricane Harvey, ask any affiliated office to immediately submit your claim. If your broker or agent does not have another office or you do not have a broker or agent, immediately submit your claim directly to your insurance company. Use any means available to document your notice submission in writing – whether by email, text, or letter – but undertake all efforts to comply with your policies’ notice requirements as your insurers may use any purported failure to follow the requirements against you.

Submitting notice of a claim will help you preserve your rights in the event of a covered claim.  It is better to risk a denial of a potentially uncovered claim than it is to lose coverage rights for an otherwise covered claim, so err on the side of notifying your insurers now.

Once you have dealt with the immediate notice issues created by the impending change of Texas law, you should take these additional steps to obtain any available insurance coverage for the damage caused by Hurricane Harvey:

  1. Gather all potentially applicable insurance policies.

Without copies of your insurance policies, it is very difficult to identify potentially responsive coverage. If you do not have copies of your insurance policies available, or your copies have been destroyed, obtain a copy from your broker or your insurance companies. Coverage may be available under a number of different policies and coverages, including property, named windstorm, flood, business interruption, contingent business interruption, loss of utilities, civil authority, automobile (commercial and personal lines), and homeowners’ policies.

  1. Identify potential coverage triggers.

Once you have obtained the potentially applicable policies, determine whether coverage is potentially triggered for the losses sustained as a result of the storm. Potential coverage triggers include:

  • Property damage or loss (to real or personal property) caused by:
    • Flood, if your policy includes flood coverage
    • Wind
    • Burst pipes
    • Sewer backup
  • Extra expenses for mitigation of damages
  • Business interruption due to shutdown of your facilities
  • Contingent business interruption due to shutdown of your supplier or customer facilities
  • Damage or theft by looters
  • Loss of power
  • Restricted access due to government shutdowns and restrictions
  • Damage to automobiles or other equipment

The particular losses incurred may trigger coverage under different policies depending on the structure of your insurance portfolio.

  1. Provide notice of claims if you have not already done so.

Once you have identified potentially responsive polices, provide notice of your claims if you have not already done so. Certain policies have strict notice requirements that require the policyholder to provide “prompt” notice as a condition precedent to coverage. Texas requires insurers show prejudice to deny coverage for late notice under a property policy and has historically allowed significant leniency for policyholders providing late notice under property policies. Last year, however, a federal appeals court upheld an insurer’s late notice defense under a property policy where the insured’s failure to provide notice until 19 months after incurring damage caused by a hail storm caused prejudice because the insurer was prevented from investigating the loss. Coupled with similar cases holding that delays of six weeks, three months, and six months are unreasonable as a matter of law, policyholders should be wary of delaying notice of loss, notwithstanding Texas’s historically favorable notice-prejudice case law.

  1. Document and mitigate losses.

Depending on the type of coverage, you may be required to provide proof of loss to demonstrate the extent of the insurance recovery. This process can be demanding, so you should be aware of necessary proof of loss documentation when you begin the mitigation and recovery process.

Take necessary, reasonable steps to protect property from further damage. Document the extent and nature of the damage suffered, making extensive use of photographs and video where appropriate. Make back-up copies of documents and photographs. Retain subject matter experts and forensic accountants when appropriate to calculate the cost of repairs and replacements, document extra expenses, and determine lost profits. Where possible, identify and preserve documentation supporting valuation of personal and real property, and avoid costly appraisal disputes with insurers.

Additionally, be aware of your insurer’s right to investigate your property to make its own determinations regarding coverage and the extent of the damage. Often insurers will have a right to physically inspect the property upon request “as often as reasonably required.” Insurers may also have limited rights to sample damaged and undamaged property and a general right to “cooperation” in the investigation and settlement of any claim. Your insurers may also have the right to take your testimony under oath; this process is known as an examination under oath or an EUO. While some amount of cooperation is required, your policy should not grant an insurer carte blanche to review records, interview your employees or experts, or enter your property.  Policyholders need to strike a balance between unfettered access and cooperation.

  1. Prepare for potential exclusions.

While many insurance policies could provide coverage for losses arising out of Hurricane Harvey, policyholders must be prepared for potential coverage disputes as insurers deny coverage based on restrictive policy language. For example, the special cause of loss form (sometimes called “all-risks insurance”) includes a broad form “water” exclusion that removes coverage for loss or damage “caused directly or indirectly by…flood, surface water, waves (including tidal waves and tsunami), tides, tidal water, overflow of any body of water, or spray from any of these, all whether or not drive by wind (including storm surge).”  See ISO Form CP 10 30 09 17. This exclusion applies regardless of “any other cause or event that contributes concurrently or in any sequence of the loss.”  Policyholders can mitigate the impact of similar exclusions by carefully documenting losses and limiting claims submissions to exclude losses potentially implicated by broad exclusionary language.

  1. Lobby your legislators.

Texas commercial and personal policyholders should urge their lawmakers to repeal this upcoming onerous law, which is particularly ill-timed in light of Hurricane Harvey. Texas law should protect Texans – not penalize them when faced with a disaster. In addition, insurers may argue that the new law’s pre-suit requirements apply even to claims submitted before the law’s effective date – thus further impairing policyholders’ rights.

Have Questions?

These are particularly difficult times for all of Texas, particularly Houstonians and other Texans impacted by Hurricane Harvey. Bradley’s experienced team of policyholder attorneys is available to answer your questions as you grapple with this historic weather event.

Mobile App Terms and Conditions Decision Clarifies Best Practices in App Designs to Support Enforcement of Contract ProvisionsThe Second Circuit issued a decision of interest to every company that utilizes a mobile app to interact with its customers. In Meyer v. Kalanick, the court enforced the mandatory arbitration provision in the Uber app. The court considered the app from the perspective of a “reasonably prudent smartphone user” and discussed parameters supporting enforceability of contract terms for mobile apps. The Second Circuit enforced the arbitration provision because the Uber app gave the user reasonably conspicuous notice of the Terms of Service (which included the arbitration provision), and the user gave unambiguous (albeit not express) consent to arbitration in light of the objectively reasonable notice of the terms.

Due to the ubiquity of smartphones and smartphone apps, the Second Circuit analyzed the Uber app from the standpoint of a reasonably prudent smartphone user who would understand the use of hyperlinks. Uber’s “uncluttered” payment screen contained the warning that “By creating an Uber account, you agree to the TERMS OF SERVICE & PRIVACY POLICY.” The court explained that the “capitalized phrase is bright blue and underlined and contains a hyperlink to a third screen containing a button that, when clicked displays the current version of Uber’s Terms of Service and Privacy Policy. The text, including the hyperlinks to the Terms and Conditions and Privacy Policy, appears directly below the buttons for registration.” The entire screen, including the notice of the Terms of Service, was visible without scrolling. The court noted that the sentence is in small font, but “the dark print contrasts with the bright white background, and the hyperlinks are in blue and underlined.” The court appreciated the simplicity of the payment screen, which included only credit card fields, buttons to register for a user account or to connect pre-existing accounts to the Uber account, and the warning with the hyperlink.

The court explained that a reasonably prudent smartphone user would understand that text that is highlighted in blue and underlined is hyperlinked to another webpage with additional information, and found the screen design and text reasonably conspicuous, thus giving the user constructive notice of its terms. The court also described the payment screen and Terms of Service as “temporally coupled” because Uber provides the Terms of Service during enrollment. The court concluded that “a reasonably prudent smartphone user would understand that the terms were connected to the creation of a user account.”

The court distinguished the Uber screen from the Amazon screen in Nicosia v. Amazon.com, Inc., because the Nicosia screen contained much more information and several buttons, and the notice of terms and conditions was not adjacent to the consent button: “This presentation differs sharply from the screen we considered in Nicosia, which contained, among other things, summaries of the user’s purchase and delivery information, ‘between fifteen and twenty-five links,’ ‘text . . . in at least four font sizes and six colors,’ and several buttons and advertisements.  Nicosia, 834 F.3d at 236-37. Furthermore, the notice of the terms and conditions in Nicosia was ‘not directly adjacent’ to the button intended to manifest assent to the terms, unlike the text and button at issue here.  Id. at 236.”

The Uber app decision provides useful guideposts for designing user interfaces for smartphone apps that include contractual terms, such as arbitration clauses: (1) implement a simple design with minimal text and few buttons; (2) ensure the visibility of the entire screen, including the hyperlink to the contract terms, without scrolling; (3) expressly warn that by creating an account, the user is agreeing to be bound by the linked terms; and (4) require agreement to the contract terms during enrollment (ideally before completing enrollment, but not later than simultaneously with enrollment).  Although the Uber app did not do so, smartphone apps can also require the user to scroll through the governing terms and conditions before accepting them to further support enforceability of those terms and conditions.

webinarBradley’s Policyholder Insurance Group is pleased to present “Is the Cyber Liability Exclusion the New Pollution Exclusion? Analyzing Commercial and Product Liability Coverage Issues in Today’s Connected World” as part of our ongoing Policyholder Insurance Webinar Series.

This webinar will feature detailed information about the potential risks and coverage gaps facing policyholders presented by Bradley attorney Katherine J. Henry.

When: Thursday, September 28, 2017, 11:30AM – 12:30PM CST

Where: Webinar Registration

What: Decades ago, insurance companies added a total pollution exclusion to commercial general liability policies in response to rulings allowing coverage for the costs of pollution cleanup. In the years after insurance companies first included this exclusion, insurers used the broad wording of the pollution exclusion to deny coverage for an increasingly larger amount of alleged contaminants. Today, commercial policyholders may face the same risks with the cyber liability exclusion. Intended to exclude coverage for data-breach-related claims under CGL policies, the broad wording of the cyber liability exclusion creates the potential for similar expansion  and resulting coverage gaps in today’s interconnected world. Join us for a detailed discussion of the potential risks and coverage gaps facing policyholders, as well as strategies for preserving coverage
and eliminating potential gaps.

We look forward to seeing you there!

Upcoming webinars in the Policyholder Insurance Webinar Series:

  • Thursday, October 19: What Blockchain Means for Your Insurance
  • Thursday, November 9: Is That Drone Insured?

Recent Case Highlights Insurance Recovery Strategies and Pitfalls for Commercial PolicyholdersA recent Minnesota coverage decision provides guideposts for a commercial policyholder’s proper handling of an insurance claim as well as a cautionary tale regarding an excess insurer’s attempt to readjudicate liability in a subsequent coverage action.

In RSUI Indemnity Company v. New Horizon Kids Quest, Inc., the commercial policyholder (1) promptly and properly notified its primary insurer and its excess insurer (RSUI)  of a potentially covered claim; (2) involved those insurers in the underlying defense strategy; and (3) stipulated to liability in a manner that avoided a potentially applicable exclusion (and with the insurers’ consent). Nevertheless, after the verdict, the excess insurer attempted to readjudicate liability in a coverage action by arguing that an exclusion applied. The court, in a thoughtful decision, rejected the excess insurer’s arguments and granted summary judgment to the policyholder.

The Underlying Case

In the underlying case, a child’s parents sued the policyholder alleging that their 3-year-old son was physically and sexually assaulted by a 9-year-old child while both were under the policyholder’s care, custody, and control. In consultation with both the primary insurance insurer and the excess insurer, the policyholder did not contest liability, conceded that an “assault” occurred, but disputed the “nature, type, and extent of” the injuries sustained by the minor child.  The jury awarded $13 million in damages against the policyholder (later reduced to $6 million after a second trial), but did not determine whether a “sexual assault” occurred because it was not asked to do so. After the jury award in the underlying case, the excess insurer filed a coverage action seeking to avoid paying the excess verdict by invoking a sexual abuse exclusion.

The Coverage Litigation

In the coverage litigation, the court determined that although the jury was presented with evidence of sexual assault in the underlying case, the presentation of evidence alone was insufficient to support the excess insurer’s exclusion defense because the jury was not asked to determine whether a sexual assault occurred. The court explained, “With no insights into the jury’s method of awarding damages, and no effort by anyone—including RSUI—to ask the jury to parcel out its award, any conclusion at this stage that same or all of the damages arose from sexual abuse—whether by the undersigned or a new jury—would constitute pure and unfettered speculation.”  Additionally, the court noted that the excess insurer participated in both trials in the underlying litigation (more substantially in the second trial) and consented to the policyholder’s admission of liability.

Guideposts and Warnings for Commercial Policyholders

Promptly and Properly Notify All Insurers Potentially on the Risk

Providing prompt notice to all insurers on the risk, including excess insurers that may be impacted by a judgment or settlement, can avert unnecessary coverage litigation or at least place the policyholder in a better position if coverage litigation later ensues. In this case, the policyholder promptly and properly notified both its primary insurer and its excess insurer, thus avoiding a preemptive challenge to coverage based on late notice or failure to comply with applicable notice provisions. Although not apparent from the court’s decision, providing prompt notice better positioned the policyholder in the later coverage litigation as well by focusing the insured on its insurance coverage as it formulated its defense to the lawsuit. In addition, an insurer’s failure to assert certain defenses or, conversely, its participation and endorsement of particular defense strategies, may estop the insurer from raising particular defenses in a subsequent coverage litigation, as occurred in this case.

Mitigate Risks Arising from Different Defenses Asserted by Excess Insurers

As this case demonstrates, primary and excess insurers may take different coverage positions, even when the excess policy follows form or incorporates language similar to the primary policy. This decision does not reveal whether the excess policy followed form or included a different exclusion.  If the former, the excess insurer adopted a coverage position different than the primary insurer based on similar policy language. A primary insurer with the duty to defend must support defense strategies that are in the policyholder’s best interest even if those defenses are detrimental to the insurer’s potential coverage defenses. This conflict – which must be resolved in favor of the policyholder where the duty to defend is concerned ­– may preclude the primary insurer from asserting certain exclusions that require a liability determination. In contrast, an excess insurer with no defense obligation may not face the same conflict of interest and therefore may be better positioned to assert certain coverage defenses not available to the primary insurer bearing the defense obligation.

A savvy policyholder can mitigate certain excess insurer coverage defenses by involving the excess carrier in the defense of the underlying claim (or providing an opportunity for the excess carrier to decline to be involved). In this case, the policyholder promptly notified the excess insurer, consulted the excess insurer during the underlying litigation, and obtained the excess insurer’s approval of the admission of liability – critical facts that the court relied on when ruling in favor of coverage. By involving the excess insurer, the policyholder preserved coverage under both policies. Policyholders should be aware that different insurers may take different coverage positions – even on the same policy language – and take steps to mitigate that risk, as did the policyholder in this case.

Coordinate Defense and Insurance Recovery Strategies

Commercial policyholders can minimize uninsured losses by coordinating defense and insurance recovery strategies. While an insurance recovery strategy should not drive the defense of an underlying claim, coordination of the best available defenses to the underlying case with available insurance recovery strategies can minimize a commercial policyholder’s ultimate exposure. In this case, the policyholder coordinated its defense and insurance recovery strategies by admitting liability but disputing damages. This approach is an important strategic option available for policyholders seeking to maximize insurance recovery in litigation that involves both covered and uncovered claims. Admitting liability to avoid an unfavorable jury finding on an uncovered claim can help preserve insurance coverage for the entire liability. While asserting a strong liability defense for the uncovered claim or settling the entire matter may be a preferable option when available, an admission of liability can be an effective risk mitigation strategy. In a minority of cases, policyholders may adopt defense strategies that maximize insurance recovery at the expense of the underlying defense. To minimize liability and maximize insurance recovery, policyholders should carefully consider the risks and rewards of available insurance recovery strategies early in the defense of the underlying litigation (if not before).

Follow Form Coverage Does Not Always Follow Form

This case also highlights the discrepancies that can sometimes arise between different layers of insurance. Although the primary insurer defended under a reservation of rights and subsequently paid its share of the judgment, the excess insurer disputed coverage based on the sexual assault exclusion. The court’s decision does not specify whether the primary insurance policy included a sexual assault exclusion, but does note that the primary insurer defended under a reservation of rights. Assuming that the primary policy did not incorporate a sexual assault exclusion, the policyholder could have avoided the coverage with its excess insurer by ensuring that its excess policy followed the primary policy form without any additional exclusions. Although there are exceptions to every rule, policyholders rarely benefit from excess coverage that is more restrictive than their primary coverage. Commercial policyholders should carefully review their coverage towers to ensure that their insurance protection is coordinated across the primary and excess layers.

Past Insurer Cooperation Does Not Guarantee an Insurance Recovery

Finally, an insurer’s cooperation in the defense of an underlying claim does not preclude that insurer from later disputing coverage, especially when the insurer issues a reservation of rights letter. Disputes can arise despite an ongoing business relationship between the policyholder and the insurer. In this case, the excess insurer received prompt and proper notice of the claim, monitored the litigation through the first trial, consented to a defense strategy, actively participated in the defense of the second trial, and then denied coverage only after the second trial. These events underscore the need to proceed carefully when seeking insurance coverage. The outcome in this case may not have been the same if the policyholder had not complied with its notice obligations and involved the excess insurer in the underlying case.

Blockchain: The Policyholder Plan for Smart Insurance PoliciesInsurers’ exploration of distributed ledger technology (DLT), commonly referred to as blockchain, continues to expand. Last month, AIG announced a partnership with IBM and Standard Chartered Bank P.L.C. to test a “smart contract” insurance policy. The Blockchain Insurance Industry Initiative, B3I, formed last year, recently expanded to 16 members, including Munich Reinsurance Co. and Swiss Re Ltd., as well as Aegon N.V., Allianz S.E., Assicurazioni Generali S.p.A., Hannover Re S.E., Liberty Mutual Insurance Co., XL Catlin, and Zurich Insurance Group Ltd.

Industry analysts suggest that insurers can use DLT in reinsurance contracts, wholesale insurance products, claims management, reserve calculation, automated notice of claims and losses, evolving underwriting models, and fraud detection. DLT could increase administrative efficiency and reduce administrative overhead, improve underwriting accuracy and claims management efficiency, and provide access to new insurance markets.

These benefits, if realized, could substantially increase insurance company profitability. DLT could profoundly impact the bottom line of early-adopter insurance companies, even if those companies only touch the surface of DLT’s potential uses.

DLT’s emergence poses both opportunity and risk for policyholders. Savvy policyholders should:

  • Plan for potential claims automation.
  • Assess the future value of source-level data for risk assessment.
  • Develop strategies for controlling access to risk assessment data to maximize coverage benefits.

How Does DLT Benefit the Insurance Industry?

At its most fundamental, DLT is a customizable peer-to-peer digital ledger. DLT allows users to efficiently share information at a previously agreed upon level of automation. Before implementation, users agree on DLT’s key features, such as information sources, transfer methods, triggering events for information or payment transfer, and rules for recordkeeping on the ledger.

DLT allows users to add or remove functionality based on their needs. Insurers may not require immutability (a key characteristic of the bitcoin blockchain) in which past entries, once added to the ledger, cannot be changed. Ever. Period.

Bitcoin requires immutability to operate as a currency. Without it, users could spend the same bitcoin more than once, much like forwarding an email. In contrast, a permissioned blockchain privately operated between a group of insurers and reinsurers may not require immutability.

Insurers may customize DLT to use an “oracle” to trigger a blockchain event. An oracle is a mutually agreed on source of data (usually from a trusted third party). For example, a “smart” property policy could use National Earthquake Information Center (NEIC) data as an automated trigger to invoke or ignore an earthquake exclusion in a property loss claim. Similarly, a property policy could use a fire alarm as an automated trigger for notice of a fire-related insurance claim.

While DLT’s insurance applications are still in their infancy, insurers will likely customize their DLT applications to accomplish four goals:

  1. Efficiently gather and store information from policyholders (for both applications and claims).
  2. Automate portions of claims management.
  3. Automate and improve recordkeeping and data access.
  4. Share necessary information with reinsurers.

By customizing DLT, insurers hope to improve risk assessment, reduce overhead, and improve reinsurance outcomes by laying off appropriate levels of risk. The primary benefits to insurers are improved data gathering, data utilization, and operational efficiency, each of which should translate into better earnings or lower expenses.

How Does DLT Impact Policyholders?

DLT will likely impact policyholders through claim automation and data commodification. Policyholders should properly plan and negotiate placement of “smart” insurance policies to minimize the adverse impacts of both automation and commodification.

Policyholders Should Carefully Consider the Impact of Claims Automation

Implementation of claims automation without proper policyholder controls in place could wrest critical decisions from policyholders:

  • Should we submit this claim given current business conditions?
  • How should we describe the underlying event?
  • When did the operative event actually occur?
  • Does an exclusion potentially bar coverage?

Under the existing claims paradigm, policyholders can assess an event, determine the best strategy to manage and report the claim (in strict compliance with the policy’s notice requirements), and present the claim in a manner that maximizes the potential coverage available while accurately depicting the triggering event. This reporting process can range from simple and formulaic for some types of more routine claims to complex and customized for unique or substantial claims.

Negotiating automated triggers for reporting certain claim information and processing claim information necessarily removes an element of policyholder control from claims reporting. While automated processing could provide benefits (for example, automated claims notice mitigates the potential of a claim being denied for late notice), presenting certain information without context could increase the risk of a claim denial for other reasons.

For example, consider a cyberinsurance claims oracle that uses a mutually agreed upon set of network events to detect a distributed denial of service attack (DDoS) (a flood of requests to a particular network impacting the policyholder’s consumer web portal causing loss of sales and potentially leading to a business interruption claim).  While automated reporting may benefit insureds, both philosophical risk management questions and technical questions about the oracle framework could impact claims management using automated DDoS reporting.

From a philosophical perspective, should the policyholder report every DDoS event, even if the ultimate business interruption may not cause a covered loss (either because the DDoS event did not actually impact aggregate sales or the lost sales did not exceed the deductible)?  If this reporting is done, what information should be sent as part of the automated process? Should the notice be limited to the fact of the DDoS event or should it include additional network information that may be relevant to the insurance company’s investigation of the potential claim? Should the notification trigger a delayed sales impact report at a specific time following the DDoS event? May the insurer rely on notification of a DDoS event in subsequent renewal and premium decisions even if the event did not result in a claim? And perhaps most importantly, what benefit do policyholders obtain in exchange for this automated reporting system that they could not obtain at a less institutional cost than automated reporting?

From a technical perspective, the traffic monitoring protocol that detects a DDoS event and automatically reports the claim should report the event when the network speed is sufficiently impacted to cause the loss of sales while minimizing false positives due to higher than normal usage rates.  Policyholders should negotiate these technical details ahead of time to limit their adverse impact on the subsequent administration of a claim.

Policyholders Should Control Data Commodification

Adopting DLT applications could allow insurers to gather, store, and analyze policyholder data to a far greater degree than they currently do. Insurers already obtain a significant amount of data from their policyholders over the course of what is often a multiyear, collaborative business relationship. The development of DLT applications combined with the proliferation of always-on, always-connected devices (the Internet of Things or IoT) could substantially increase the depth and scope of the data that insurance companies obtain from their policyholders.

Insurance is and always has been a data-driven enterprise, but even modern insurance frameworks require substantial manual data entry and duplication of effort across departments. Despite the substantial information that insurance companies obtain from their policyholders, much of the analytic value of this data is currently lost to this administrative inefficiency.

With proper data management protocols and access to new and better sources of data from the IoT, insurers will have access to unparalleled databases to refine and improve their underwriting and risk assessment models. While improving risk assessment could benefit some policyholders in the form of reduced premiums, policyholders should carefully consider the type of data shared with insurers, the format of the shared data, and when that data is shared. Policyholders who negotiate restricted access to source data and instead present analytical results during renewal may obtain lower premiums than those companies that simply allow insurers continuous access to source-level data from key sources.

For example, consider commercial auto insurance. Insurers calculate premium rates based on several factors, including the type and amount of automobiles in the fleet, the number of authorized users, the location of automobiles, the usage of those automobiles, and the level of desired coverage.

With the advent of DLT, insurers could supplement this basic underwriting information with automatically reported driving monitoring data and offer dynamic premium pricing based on daily fleet usage. A sophisticated commercial policyholder might obtain lower premiums by using the same devices, gathering and analyzing the data itself, and reporting previously agreed-upon outputs to its insurer, rather than allowing the insurer access to the source-level driving data.

Even if the policyholder permits its insurer to access the source data, the policyholder should consider restrictions on the storage and use of that data. For example, may the underwriter use some or all of that driving data during renewal?

Driving is simply one example of DLT in action (and perhaps not even a long-lived example given the advent of autonomous vehicles). The IoT could make similar data reporting and analysis available for large portions of commercial and industrial systems. The commercial value of this data cannot be understated.

DLT applications allow insurers to more efficiently gather and store data for later use, but policyholders should control the type and form of data shared with the insurer before trading terabytes of data for the promise of reduced premiums.

 

Keep Viking Pump in Your Long-Tail Claim Toolbox “Long-tail” claims involve personal injury or property damage from alleged exposure to injury-causing products, such as asbestos or PFCs, over a number of years and multiple policy periods. Courts in various jurisdictions use different methods to identify the insurance policies applicable to these long-tail claims. One of the most important coverage cases of 2016 demonstrates that policyholders engaged in allocation disputes with insurers may succeed in securing “all sums” allocation even in so-called pro rata states.

The “all sums” method of allocation permits recovery of up to the limits of liability under any policy in effect during the periods when personal injury or property damage occurred. (The all sums method derives its name from the standard insuring clause promising to pay all sums above the self-insured retention “the insured shall become legally obligated to pay …”)

The “pro rata” method of allocation, on the other hand, limits each insurer’s liability to its pro rata share of the total loss incurred. Jurisdictions differ as to allocation for years with missing policies or policies issued by insolvent insurers. Certain jurisdictions allocate these years to the policyholder; others do not.

In the Matter of Viking Pump, Inc., 52 N.E. 3d 1144 (N.Y. 2016), New York’s highest court held that the policy language rather than a blanket rule determines whether the all sums or pro rata method of allocation is appropriate. This ruling sent shockwaves through the insurance industry because in 2002 the court had applied (and appeared to have adopted) the pro rata method.

The court held that the all sums method applied to allocate the excess insurers’ liability for asbestos-related losses in Viking Pump because the “non-cumulation” clause and “continuing coverage” clause in the followed primary policy was inconsistent with the pro rata method.

The non-cumulation clause in the policy (also known as a “prior insurance” clause) was substantially identical to the clause that first appeared in the London Market in 1960 to prevent policyholders from recovering under both a then-standard “accident-based” liability policy, as well as a subsequent now-standard “occurrence-based” policy. (Ironically, according to law professor Christopher French in an article cited by the court, some insurers have over the years attempted to expand non-cumulation clauses to eliminate their liability for long-tail claims altogether.) The continuing coverage clause extends coverage for continuing injuries after the policy period ends.

The Viking Pump court observed that pro rata allocation is based on policy language limiting liability to only those losses occurring during a particular policy period. In other words, “no two insurance policies, unless containing overlapping or concurrent policy periods, would indemnify the same loss or occurrence.” The presence of the non-cumulation and continuing coverage provisions, the court said, does not square with that principle. Those provisions “plainly contemplate that multiple successive insurance policies can indemnify insureds for the same loss or occurrence by acknowledging that a covered loss or occurrence may also be covered in whole or in part under any other excess policy.”

The court also held that “vertical exhaustion” is appropriate when an all sums allocation is applicable. This permits the policyholder to exhaust the layers of coverage in a specific policy year. (“Horizontal exhaustion” requires all applicable primary and umbrella excess layers to be exhausted before triggering any additional excess insurance.)

This week in Olin Corporation v. OneBeacon American Insurance Co., the Second Circuit extended Viking Pump, holding that once a layer is exhausted, the presence of a prior insurance clause reduces the limits of any applicable prior policies, whether or not the same insurers issued the prior policies.

The likely influence of Viking Pump cannot be overstated. This seminal case will be considered by courts around the country when called upon to decide allocation issues and should be included in the policyholder’s long-tail claim toolbox.

webinarBradley’s Policyholder Insurance Group is pleased to present “Flood Insurance for Lenders: ABCs of Flood Insurance Compliance” as part of our ongoing Policyholder Insurance Webinar Series.

This webinar will feature detailed information about flood insurance compliance presented by Bradley attorneys Katherine J. Henry and Heather Howell Wright.

When: Thursday, June 22, 2017, 11:30AM – 12:30PM CST

Where: Webinar Registration

What: Before a federally regulated lender makes a loan secured by real property, the lender must determine whether any structures on the real property are located in a special flood hazard area (SFHA) where flood insurance is available under the National Flood Insurance Program. Flood insurance is required if a lender takes a security interest in improved real estate that is located in an SFHA.This webinar will discuss the basic flood insurance compliance requirements applicable to lenders and servicers of residential and commercial loans. Topics discussed will include identifying the right amount of coverage, determining insurable value, force-placing flood insurance, escrow of flood insurance premiums under recent final rule making, and potential enforcement actions for failure to comply with these requirements.

We look forward to seeing you there!

Upcoming webinars in the Policyholder Insurance Webinar Series:

  • Thursday, September 28: Securing and Insuring the Internet of Things
  • Thursday, October 19: What Blockchain Means for Your Insurance
  • Thursday, November 9: Is That Drone Insured?

erosionA recent Fifth Circuit case highlights the potential risks of purchasing a defense-within-limits policy: If an insurer is obligated to hire independent counsel due to a conflict of interest, that counsel’s fees may erode your policy limits.

When an insurer accepts coverage of a liability claim, the insurer typically has the right to choose counsel to defend the policyholder as well as to control the defense. When an insurer defends under a reservation of rights, however, a conflict of interest arises between insurer and policyholder. Many states obligate the insurer in this situation to pay for independent defense counsel selected by the policyholder to obviate the conflict. For example, in Mississippi, a policyholder’s right to independent counsel paid by the insurer is known as the “Moeller” rule.

The Fifth Circuit recently decided just how far the rule extends. In Federal Insurance Co. v. Singing River Health Systems, the insurer agreed to defend a public hospital system, Singing River Health System (SRHS), and various officers, under a reservation of rights in multiple lawsuits stemming from alleged underfunding of a pension plan. The policy and policy application clearly stated that defense costs would erode the limits of liability. SRHS nevertheless argued that defense costs paid under Moeller should not erode the policy limits.

The policy defined covered “loss” to include defense costs that SRHS was “legally obligated to pay.” Because the insurer, not SHRS, is “legally obligated to pay” for Moeller counsel, SRHS reasoned that such costs should fall outside the limits. The federal district court agreed, holding that at a minimum, the phrase “legally obligated to pay” was ambiguous and should be construed in favor of SRHS.

During oral argument before the Fifth Circuit, the insurer reported that it had expended over $3 million in defense costs on a policy with $1 million limits.

The panel held that the district court’s ruling pushed the Moeller rule too far. The court cited a more recent Mississippi Supreme Court decision holding that the policyholder must meet the policy’s deductible requirement before the insurer’s Moeller obligation is triggered. The Fifth Circuit held that the insurer’s duty to pay for independent defense counsel is similarly subject to the terms of the policy, including the policy limits. The court also rejected SRHS’s public policy arguments against enforcement of the defense‑within-limits provision.

At oral argument, one of the judges quipped that perhaps SRHS underfunded its insurance coverage. While not apropos from a legal perspective, as a practical matter it is a valid point. SRHS had the option to purchase a separate limit of liability for defense costs and chose not to do so. However, even if there had been a separate limit, defense costs were triple the policy limit with the underlying litigation still ongoing. Failure to realistically assess risks and secure sufficient insurance coverage for those risks can be the ultimate peril.