Key Insurance Coverage Trends and Decisions in the United States

By Scott M Seaman, Hinshaw & Culbertson

Scott Seaman explores the most significant trends and developments that the US insurance market has experienced over the past year, including landmark decisions and the growing prevalence of cyber claims and data privacy matters. 

WWL Insurance & Reinsurance 2017 - Scott Seaman

At least anecdotally, the volume of mega insurance coverage actions remains below the pre-2008 level in the US. Corporate policyholders continue to watch their discretionary litigation budgets and many insurers have refined their practices regarding the use and management of outside counsel. Overall, insurers have increased the size and expanded the role of in-house legal staff; upgraded the capabilities of claims staff (with more lawyers filling claims roles); increased reliance upon billing and litigation guidelines; and applied more sophisticated metrics. These changes are deeper and more structural than the cyclical ebbs and flows seen historically. Myriad factors, including prior litigation and releases, use of claims-made general liability policies, insurance industry consolidation, and the types of claims litigated have produced many significant coverage actions involving a smaller number of insurers.

Though the pace of asbestos and environmental coverage actions has slowed, these actions as well as other product and construction defect coverage actions dominate the complex third-party liability coverage arena along with a variety of Coverage “B” claims. There has been a marked increase in cyber and data breach claims and coverage actions under traditional property, general liability and “all-risk” policies. Policy language and exclusions under a variety of cyber-risk policies now are being subjected to court interpretation. Drones and self-driving vehicles appear poised to usher in their share of future coverage claims.

Securities, climate change and cyber matters remain key areas of interest in the directors and officers liability insurance domain. The growth in the transactional liability insurance market (eg, “reps and warranty” and contingent liability insurance) is expected to produce claims activity. 

There was no shortage of significant coverage decisions in 2016 with many more on the horizon in 2017. We highlight some of key decisions below.

Allocation of losses is still a dominant issue, with pro rata allocation remaining the majority rule. Louisiana remains squarely in the pro rata allocation camp with the Louisiana Supreme Court decision in Arceneaux v Amstar Corp, which held that defence costs must be prorated based upon time on the risk. New York has been a pro rata allocation jurisdiction since at least the 2002 Consolidated Edison decision. However, pro rata allocation took a hit in that state with the New York Court of Appeals decision in In Re Viking Pump, Inc. In answering questions certified by the Delaware Supreme Court, the New York high court emphasised that, absent policy language requiring a different result, New York continues to adhere to the pro rata approach. However, the court ruled that the “non-cumulation” clauses incorporated into the subject excess policies were inconsistent with a pro rata allocation, requiring an “all sums” allocation and permitting the policyholder to vertically exhaust coverage. A subsequent New York intermediate appellate court decision in Keyspan Gas East Corp v Munich Reinsurance America, Inc reaffirmed that New York is a presumptive pro rata allocation jurisdiction. It also rejected the so-called “unavailability of insurance” exception to the general rule followed by all but a couple of pro rata jurisdictions that the policyholder is responsible for periods of no insurance, regardless of whether or not coverage for such risks is available in the marketplace. In the wake of In Re Viking Pumps, Inc, the open question under New York law is what allocation method applies when some policies contain or follow form to “non-cumulation” clauses while others do not.

An interesting case to watch in 2017 is Continental v Honeywell. The New Jersey Supreme Court granted review on two issues in this asbestos coverage action. The first issue concerns choice of law. The more interesting issue concerns the circumstances under which the policyholder is responsible for uninsured periods. The trial court ruled and the Appellate Division affirmed that insurance coverage was “reasonably available for purchase” through 1986 for primary and 1987 with respect to excess coverage. The allocation period was ended at that point. The New Jersey Supreme Court is asked to consider whether the policyholder is responsible for periods beyond the period in which insurance coverage was “available” based on fundamental principles articulated by the New Jersey Supreme Court in Owens-Illinois v United Insurance Co and its progeny, including transfer and assumption of risk, incentivising responsible conduct, pricing products to cover their full costs, notions of simple justice, and exceptional circumstances. The main exceptional circumstance the insurers point to in Honeywell is the manufacturer of brake and clutch pads with asbestos until 2001 by the insured knowing that it faced asbestos lawsuits and lacked coverage for such claims after 1987.

There was a dearth of meaningful trigger of coverage decisions in 2016 largely because most states with appreciable coverage activity have adopted a trigger of coverage theory. The majority of cases apply either an injury-in-fact or continuous trigger, with occasional manifestation rulings on property damage claims. It is rare that a single coverage action results in decisions by two different state supreme courts. In Re Viking Pumps, Inc, however, was such a case. After the New York Court of Appeals answered the certified questions, the case returned to the Delaware Supreme Court where that court addressed trigger of coverage. Applying New York’s injury-in-fact trigger, the court held that asbestos-related bodily injury first occurs, for policy purposes, upon cellular and molecular damage caused by asbestos inhalation, and such cellular and molecular damage occurs during each and every period of asbestos claimant’s significant exposure to asbestos and continues thereafter. The court also addressed defence cost coverage under a variety of excess and umbrella contracts. Finally, the court followed the majority of decisions in holding that an assignment after the loss has occurred does not alter the risk originally undertaken by the insurer and does not violate the anti-assignment provisions in the policies. The New Jersey Supreme Court followed suit in its decision upholding assignment of insurance policy rights in Givaudan Fragrances Corp v Aetna Casualty & Surety Co.

There were several decisions rendered in the construction defect coverage setting. The New Jersey Supreme Court held, in Cypress Point Condominium Association v Adria Towers, that damages resulting from a subcontractor’s defective work on a condominium complex triggered an insurer’s duty to defend the general contractor. The court held that consequential damages to the common areas of a Hoboken condo complex and to unit owners’ property caused by subcontractors’ defective work constitute “property damage” under the CGL policy. Further, the water intrusion from rain flowing into the interior of the property due to the subcontractors’ faulty workmanship constitutes an “occurrence”. The court noted that the “subcontractor exception” in the subject 1986 ISO form narrowed the scope of the “your work” exclusion. Similarly, in National Surety Corp v Westlake Investments LLC, the Iowa Supreme Court held that defective workmanship by an insured’s subcontractor may constitute an “occurrence” under the 1986 ISO CGL policy form that contained the “subcontractor exception” to the “your work” exclusion. Finally, Navigators Specialty Insurance Co v Moorefield Construction Co, a California court of appeal decision, held there was no “occurrence” when the policyholder proceeded with construction knowing the preliminary work did not satisfy construction specifications. Further, the insurer could recoup the amount it paid as damages since it had no duty to indemnity, but could not recoup the payment attributed to attorney fees as it had a duty to defend. 

One of the more important first party insurance decisions of 2016 involved the concurrent cause doctrine. The Florida Supreme Court resolved a conflict among Florida intermediate appellate courts by ruling in Sebo v American Home Assurance Co that the concurrent cause doctrine applies where a policyholder suffers a loss from both covered and excluded risks. The ruling reinstated Sebo’s US$8 million jury award for the loss of his home, which was attributed to the excluded risk of construction defects, as well as the covered causes of rain and wind. The court left the door open for the efficient proximate cause doctrine (under which a loss is covered under a policy only if the primary cause of the loss is a covered peril) to apply where an insurer can point to a single excluded cause that set in motion the events causing a loss.

Courts across the US are divided on the issue of whether or not an insurer must demonstrate that it was prejudiced by a policyholder’s late note of a claim or occurrence under “occurrence-based” liability policies in order to vitiate coverage. Wyoming can now be counted among the notice-prejudice states in the wake of the Wyoming Supreme Court’s decision in Century Surety Co v Jim Hipner, LLC. In answering a question certified by the United States Court of Appeals for the Eighth Circuit, the Wyoming high court held that, apart from the notice being untimely, an insurer must show “prejudice ... before coverage may be denied based upon a violation of a notice provision contained in the policy.”

A Colorado Supreme Court decision illustrates that the notice-prejudice rule is less likely to apply to policyholders’ violations of the “no voluntary payments” policy provision. In Travelers Property Casualty Co v Stresscon Corp, the court ruled the notice-prejudice rule was inapplicable, noting that an insurer’s denial of coverage due to a policyholder’s failure to comply with a provision precluding voluntary payments is not just a technicality. Finally, the New Jersey Supreme Court ruled in Templo Fuente De Vida Corp v National Union Fire Insurance Co that an insurer does not have to show it was harmed by a policyholder’s late notice of a lawsuit under a claims-made policy in order to deny coverage for an ensuing settlement. The unanimous opinion is in accord with the vast majority of rulings across the country on claims-made policies. 

On the products liability front, the Wisconsin Supreme Court ruled in Wisconsin Pharmacal Co v Nebraska Cultures of California that the incorporation of a defective ingredient into women’s probiotic supplement tablets did not constitute “property damage” as defined in the policies. Further, coverage is barred by the exclusion for losses arising from “impaired property.”

Several decisions were rendered in the context of cyber, data breach and privacy claims. In State Bank of Bellingham v BancInsure, Inc, for example, the United States Court of Appeals for the Eighth Circuit affirmed a summary judgment ruling in favour of the insured bank, finding the “overriding cause” of the loss was the criminal activity of a third-party hacker. Thus, the employee-caused loss exclusions, a theft of confidential information exclusion, and exclusions for mechanical failure were inapplicable to bar coverage. The policyholder scored another win in Travelers Indemnity Co of America v Portal Healthcare Solutions. The case stemmed from a class action alleging that Portal allowed patients’ private medical records to be accessed on the internet for more than four months by a simple Google search of a patient’s name. The district court concluded under Virginia law that allowing confidential medical records to be found in an online search constituted “electronic publication of material” that gave “unreasonable publicity to” and “disclose[d] information about” the patients’ private lives”. The Fourth Circuit affirmed the ruling that the insurer had a duty to defend, rejecting the insurer’s argument that there was no publication or disclosure because no third party was alleged to have viewed the records.

Insurers secured a cyber win in PF Chang’s China Bistro v Federal Insurance Co. The Arizona district court rejected the restaurant chain’s attempt to recover $2 million it paid following a 2013 breach where hackers obtained 60,000 credit card numbers belonging to Chang’s customers and posted them on the internet. The insurer agreed to reimburse Chang’s $1.7 million under a “CyberSecurity” policy for claims brought by injured customers and issuers, but refused to reimburse an additional $2 million in fees and PCI-DSS assessments that were passed down to Chang’s by credit card service providers. The court held that coverage for such fees was subject to exclusions for liability the policyholder assumed under a contract. In Apache Corp v Grant American Insurance Company, the Fifth Circuit determined that cyber losses were not covered by commercial crime policies because the loss was not a “direct result” of “computer use” as required by the policy. The policyholder sought coverage after an employee inadvertently made authorised payments of legitimate vendor invoices to criminal bank accounts. The criminal scheme started with a fraudulent phone call and was confirmed by a fraudulent email that appeared to be on the vendor’s letterhead, which contained a fake vendor number that Apache Corporation used to confirm the payment. The court reasoned that “computer use” – ie, the fraudulent email – was only one part of a larger fraudulent scheme and, thus, incidental to the unauthorised transfer of money.

The United States Court of Appeals for the Ninth Circuit has been asked in Los Angeles Lakers v Federal Insurance Co to rule on the scope of an “invasion of privacy exclusion” in the context of claims of a Lakers fan that the team violated the Telephone Consumer Protection Act of 1991 by sending unsolicited text messages. This is one of many cyber cases to watch in 2017.

Even in jurisdictions that recognise insurance bad faith, being wrong or incorrect in a coverage determination, denying policy benefits, or making a mistake does not, without more, give rise to bad faith liability. Courts recognising first-party bad faith generally conclude that an insurance company breaches the implied covenant of good faith and fair dealing only if it acts “unreasonably” or worse. Many jurisdictions have adopted the “fairly debatable” standard, under which bad faith liability on an insurer cannot be imposed so long as the coverage is “fairly debatable.” Similarly, California courts apply the “genuine dispute” doctrine. According to the Tenth Circuit in Home Loan Investment Co v St Paul Mercury Insurance Co, however, “fair debatability” is not necessarily sufficient, standing alone, to defeat a bad faith claim” under Colorado law.

One interesting case pending before the Texas Supreme Court is Great American Insurance Company v Glen Hamel, where the court will review the lower court’s decision requiring the insurer to cover most of a judgment entered against its insured, Terry Mitchell Builder Inc, in underlying litigation over damage to a Dallas-area home. The insurer argues that the underlying judgment was the product of a collusory agreement between its insured and the homeowners designed to manufacture insurance coverage for the claim. Recently, in USAA Texas Lloyd’s Co v Menchaca, the Texas Supreme Court announced five rules addressing the relationship between insurance contract claims and tort claims under the Texas Insurance Code. In Rancosky v Washington National Insurance Co, the Pennsylvania Supreme Court may weigh in for the first time on the proper standard for statutory bad faith.

Considering that most reinsurance disputes are decided in confidential arbitration proceedings, the lack of interesting published reinsurance decisions in 2016 is not surprising. Global Reinsurance Corp v Century Indemnity Co is one case that bears following. The Second Circuit certified a question to the New York Court of Appeals in December in this case that may determine whether the Second Circuit adheres to its 1990 Bellefonte decision in which it ruled that fairly common language in facultative certificates serves to limit reinsurers’ liability to its ceding company for both expense and indemnity. Although widely followed, Bellefonte remains a controversial decision more than a quarter of a century after it was decided.

A number of notable coverage decisions will be rendered in 2017 and the regulatory environment impacting insurers and financial companies will be interesting as well under the Trump administration. 

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