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Wind, Flood or Storm Surge: Pick Your Peril CarefullyA catastrophic loss, such as a hurricane strike, can force any company out of business, even if it is insured. Although a business does not suffer any direct physical damage to its facilities, fickle natural disaster events can disrupt a company’s entire supply chain, with ripple effects for vendors, suppliers, customers and second-tier providers of services or goods.

With scorching August temperatures and the Atlantic hurricane season ramping up to full speed, the next months could, unfortunately, once again visit doom on vulnerable coastal areas, disrupting water or power services, causing evacuation and curfew orders, limiting travel, or halting operations either partially or fully. Securing insurance proceeds and FEMA assistance is crucial to business disaster recovery implementation.

1. What caused my loss?

A ubiquitous issue that arises with respect to natural disasters is how the peril is characterized – is it a hurricane, a “named storm,” a windstorm, a flood, or something else under your insurance policy? And what occasioned the particular damage at issue in the insurance claim – wind, wind-driven rain, storm surge, or flood?

How the mechanism of loss is characterized has critical implications for insurance recovery. Policies commonly provide different amounts of available limits (and sub-limits) for different types of losses (e.g., State Farm Florida Ins. Co. v. Moody, considering policy that limited coverage for damage caused by “hurricane” but that did not limit coverage for damage caused by “tornado”). And in some cases, policies may not provide coverage at all for losses that occurred as a result of certain causes (e.g., In re Katrina Canal Breaches Litig., considering whether damage to property was caused by flood or by the negligent design and construction of levees; flood being an excluded peril under the policy, while negligent construction was covered). For example, a commercial property insurance policy may provide coverage for damage caused by wind or a named storm but exclude coverage for damage caused by flood (e.g., Bradley v. Allstate Ins. Co.).  Complicating this analysis, policies often contain overlapping ill-defined concepts of “flood” vs. “named storm.” One may question whether a storm surge resulting from a named storm is treated as part of the named storm or as a flood.

The net effect is that the scope and amount of coverage can vary dramatically depending on how the cause of loss is characterized up front to the carrier at the proof of loss stage – a critical juncture that is rarely straightforward and that usually benefits from thoughtful legal analysis. To hold carriers to their promises of disaster recovery, policyholders need to have a thorough understanding of the coverage provided under their policies, the relevant case law, and the mechanism or mechanisms that caused their loss. Properly determining the peril at the time of claim submission can allow a policyholder to achieve the benefit of its bargain with its carrier.

2. What if there is no physical damage to my property?

Assuming no physical damage to your insured premises, how does a business function without electricity, telephone, email or water service? Utility service interruption coverage (if purchased) indemnifies, for example, against loss due to lack of incoming electricity affected by damage from a covered cause (fire or named storm) to property away from the insured’s premises — usually the utility generating station. This type of insurance is commonly referred to as “off-premises power coverage.” Service interruption coverage is not standard, or even common but a policy could be endorsed to cover any of the following:

  • Water services – pumping stations and water mains.
  • Communications services – property used to supply telephone, radio, microwave or television services. Includes communication transmission lines, coaxial cables and microwave relays.
  • Power services – electricity, gas and steam, utility generating plants, switching stations, substations, transformers, and transmission lines. Typically the policyholder must elect either to include or exclude overhead transmission lines.

The value of goods, including raw goods under refrigeration, is often challenged by the carrier when presented for coverage. The issue is further complicated in large scale operations by several commonly found exclusions that limit the inherent risks associated with perishables, including mechanical defect, failure to maintain systems and consequential losses.

3. What if my loss resulted from both covered and non-covered events?

Given that property policies may provide coverage only for certain causes of loss, or may provide different amounts of coverage depending on the cause of loss (e.g., named storm vs. flood), a debatable issue often involves the extent to which a loss is covered when it is caused concurrently or sequentially by both covered and non-covered perils.

Some courts apply an “efficient proximate cause” test, under which a dominant cause is determined and coverage hinges upon whether that cause is covered, or alternatively whether the covered cause set the chain of events in motion. Other courts apply one of two “concurrent cause” analyses: (1) Some courts have ruled that when two causes combine to produce an indivisible loss, there is coverage as long as one of the causes was a covered peril under the policy, and (2) other courts have ruled that the policyholder bears the burden of differentiating damage attributable to covered and non-covered causes, and if the policyholder cannot meet that burden there is no coverage.

This analysis turns on the policy language as well. Insurers have sought to eliminate coverage in instances involving concurrent causes by incorporating “anti-concurrent causation” language in their policies that purports to bar coverage when an uncovered cause is involved in any way, whether directly or indirectly. For example, the policy may state: “We will not pay for loss or damage caused directly or indirectly by any of the following. Such loss or damage is excluded regardless of any other cause or event that contributes concurrently or in any sequence to the loss.” Some courts have enforced these anti-concurrent cause provisions while others have held that they are unenforceable, predominantly on public policy grounds. Where and how this language appears in the policy is also important and factors into how a court will view it. If the language is buried deep in a definition or an exclusion, for example, the situation might be distinguishable from existing case law.

For this reason it is important to review your endorsements at the time coverage is bound as well as analyze the policy exclusions that may be applicable to any loss to determine whether they are subject to anti-concurrent causation language.

4. How is storm surge different than wind?

After a catastrophic weather event in coastal areas, insurers and insureds frequently litigate whether property damage was caused by wind, on the one hand, or storm surge, on the other. Such litigation arises because property policies often cover damage caused by wind, while excluding coverage for damage caused by flood.

Courts considering such claims tend to characterize the peril of wind and the peril of storm surge separately. Courts have noted that storm surge is “little more than a synonym for a ‘tidal wave’ or wind-driven flood” and have held that damage from storm surge falls squarely within the bounds of flood exclusions, even where the flood exclusions do not expressly include the term “storm surge.” See, e.g., Leonard v. Nationwide Mut. Ins. Co.; Tuepker v. State Farm Fire & Cas. Co.; or Bilbe v. Belsom (“We have repeatedly held that the term ‘flood’ includes storm surges.”). By contrast, property policies generally cover damage caused solely by wind (i.e., wind that doesn’t interact with water). See e.g., Leonard; Tuepker v. State Farm Fire & Cas. Co.; or State Farm Florida Ins. Co. v. Moody (determining that insureds were not entitled to recover because hurricane spawned the tornado that caused the damage and hurricane sublimit applied).

Recovery may rise or fall based on whether the property damage at issue resulted from wind alone (for example, a structure was blown over by wind) or whether the damage resulted from storm surge (i.e., flooding caused by wind). Insureds who buy a master property policy are wise to keep the distinction between wind and storm surge—and the impact of such distinction—top of mind when considering coverage issues post-hurricane. Legal analysis of the wording of any coverage grants or exclusions and choosing a peril wisely must become part of the recovery planning implementation strategy businesses rely on to maximize the insurance claim.

Trigger for Hurricane and Named Storm DeductiblesRecent damage from Hurricanes Harvey, Irma, and Maria have focused attention on special “named storm” and “hurricane” deductible endorsements found in most property insurance policies issued for coastal areas. Such endorsements typically convert the insured’s deductible from a fixed amount to a percentage of the property value, such as 1, 2, 5, or 10 percent, for damage caused by certain categories of storms. These percentages are usually taken from the insured value of the property, not merely the amount of damage, so when triggered the endorsement can result in a substantial increase in the out-of-pocket cost for the policyholder.

Several names are used for these endorsements. “Hurricane” deductibles generally apply when a storm has been designated a hurricane by the National Weather Service. “Named Storm” deductibles are broader and include declared tropical storms. “Windstorm” deductibles are the broadest of all and may apply to damage caused by almost any high wind weather event.

Circumstances triggering the deductible can vary significantly depending on the policy and state in which the insured property is located, so the individual policy language and state regulation must be reviewed to determine when the deductible applies. ISO Commercial Property Endorsement CP 03 25 (“Named Storm Percentage Deductible”), for example, provides that a “Named Storm” begins at the time the National Weather Service issues a watch or warning for the area in which the insured premises is located, and ends 72 hours after the termination of the last watch or warning issued for that area.

In some states, regulations have altered the circumstances for triggering the deductible by mandating the scope and duration of a “hurricane.” For example, Florida defines a “hurricane” for residential property insurance purposes as beginning at the time the National Weather Service issues a hurricane watch or warning for any part of Florida and ending 72 hours after the termination of the last hurricane watch or hurricane warning anywhere in the state. Because of the broad scope of this definition, policyholders in some areas may pay a “hurricane deductible” even though the insured property was never subjected to hurricane-force winds.

Where the insurer contends that a percentage deductible applies on account of a hurricane or tropical storm, policyholders should carefully review the policy language and insurance regulations in their state, as well as the actual conditions that caused property damage, to determine if there is an argument against the increased deductible.

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.

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.

Three Things You Need to Know about Blockchain and Insurance PoliciesDistributed Ledger Technology – commonly referred to as “blockchain” — has recently emerged as a buzz word in the insurance industry. The insurance industry is quickly deciding that this new technology will fundamentally reshape the insurance industry. For example, Aegon, Allianz, Munich Re, Swiss Re, and Zurich recently launched the “Blockchain Insurance Industry Initiative” to explore the potential of distributed ledger technologies to “better serve clients through faster, more convenient and secure services.” The insurers hope to use the blockchain to replace existing information systems, leading to streamlined paperwork and reconciliations for insurance contracts, improve auditability, accelerated information sharing, and faster claims payments.

While these insurers are actively testing and applying blockchain technologies, many insurers are behind the curve in the adoption of blockchain technologies. PwC recently estimated that almost one-third of insurance company executives are not at all familiar with blockchain, and widespread adoption is still likely several years away. Businesses can use this window to their advantage by building systems now to leverage the increased flow of information to better quantify risks, understand the impact of smart contracts and rapid information sharing, and demonstrate a case for reduced premiums.

Well-informed businesses can gain a potential competitive advantage by understanding the applications of blockchain technology in the insurance industry. Here are three things you need to know to understand the impact of blockchain technology on your insurance coverage:

1. Blockchain is an encrypted, easily-accessible, permanent digital ledger.

For all of its potential applications, the underlying concept for blockchain is simple.  Blockchain is a digitally‑stored public ledger. What makes blockchain exciting is the combination of ease of access, privacy, and security. Unlike existing digital ledgers, which use central administrators or clearinghouses to ensure accuracy and security, blockchain relies on a public network of individual computers solving incredibly complex cryptographic puzzles in exchange for verification of the legitimacy of each entry – each block – in the ledger. Each individual block is linked to the previous blocks, forming a chain. This process ensures the security and accuracy of individual entries.

Because each transaction stored on the blockchain is encrypted and publicly verified, it is secure despite being publicly accessible. Because the transactions themselves are pseudonymous and encrypted (like email), they are private despite being publicly accessible.

2. Blockchain encourages more sophisticated underwriting.

Because the blockchain allows for more information to be parsed and appended to so‑called smart contracts, substantial amounts of information can be shared easily between parties.  The applications of increased data availability are only now beginning to be parsed, but more nuanced and sophisticated underwriting is one promising application.

Consider a commercial auto policy for a large company with hundreds of potential drivers and a massive fleet of vehicles. The insurance company now underwrites these risks based on amalgamations of fleet size and location, number of drivers, and claims histories.  With a blockchain‑based insurance policy and proper data capture, insurers can base underwriting on real time use of individual vehicles by individual drivers in individual areas. Today insureds pay the same insurance premium rate regardless of whether an individual vehicle is in use, the user’s identity, the geographic location, and the period of time that the vehicle is in use. If this use data is captured in real‑time, insurance premiums can instead change dynamically based on the number of vehicles in use, the identity of the users, and the vehicle’s particular use. After all, the risk of a motor vehicle accident is drastically reduced when the car is parked in a garage on your company’s property.

This type of dynamic underwriting already exists in the drone insurance market, where companies can buy insurance by the hour, but the blockchain allows this technology to scale beyond a single hobbyist flying a drone in a park to a real world commercial application.

3. Blockchain allows for faster claims payments and more efficient claims management.

Increasing the efficiency of information sharing between insurers, brokers, and policyholders through the use of blockchain technology should lead to faster claims submissions and faster claims processing. It will also allow certain types of information to be automatically gathered and reported. The potential benefits of this increased efficiency are immediately apparent to insurers in the form of decreased overhead and greater control over claims adjustment. The potential benefits to policyholders are obvious too; undisputed claims may be paid more quickly and, hopefully, with less time spent gathering claim-related information.

On the other hand, a move towards efficiency and automation in claims adjustment, especially in the information-gathering phase, necessarily comes with a loss of at least some control over the flow of information between the parties. If blockchain technology impacts the claims submission and adjustment, commercial insureds should understand what portions of the claims process have become automated, what information will automatically be shared as part of this automation, and the avenues to engage in a more nuanced dialogue about more complex claims.

The Bottomline on Blockchain

Blockchain is really about sharing very large quantities of information quickly, reliably, and efficiently. Automation of information sharing in underwriting and claims adjustment may initially benefit insurance companies.  Savvy insureds, however, should be able to leverage this information sharing to their benefit by negotiating the automated information sharing in so-called “smart” contracts; gathering, controlling, and presenting shared data in a consistent and thoughtful manner to place the company in a favorable position when a claim arises; and negotiating clauses that allow for de-automation of the claims process in more complex claims.