Insurance News, Summer 2015

September 8, 2015 Advisory

Michael Menapace Testifies as Expert Before U.S. Senate on Cyber Insurance Issues

The U.S. Senate Commerce Committee asked Michael Menapace to testify as an expert witness at a hearing called by the Subcommittee on Consumer Protection, Product Safety, Insurance and Data Security entitled, "Examining the Evolving Cyber Insurance Marketplace." The hearing took place on Thursday, March 19, 2015, at 10 a.m. A video recording of the hearing and Mr. Menapace's written testimony can be found on the Senate Commerce Committee's website.

The hearing explored the growing cybersecurity risk insurance market. As one of the four witnesses invited to the hearing, Mr. Menapace testified about the evolution of cyber insurance offered, as well as the challenges and opportunities in the insurance and non-insurance industries, and the impact insurance can have on data breach avoidance, mitigation and response.

During his testimony, Mr. Menapace advocated for a single federal standard for notifying victims of cybersecurity breaches rather than the current patchwork of state laws, noting that a single standard would "eliminate the time, expense and inconsistencies involved in the 47-state analysis for each breach and would provide uniform treatment of consumers." Mr. Menapace also testified that a nationwide database or clearinghouse for data breach information, including how each breach occurred and who was responsible for the breach, would be beneficial to both the insurance industry and non-insurance businesses.

Attorney Notes

Michael Thompson's article, An Exhausting Question for Insurers, was published in the Connecticut Law Tribune in February 2015.

Joe Grasso and Robyn Gallagher wrote "Two Small Words: One Great Divide", which was published in the September 2015 issue of The Insurance Coverage Law Bulletin.

Joe Grasso will be attending the annual conference of the International Union of Marine Insurance (IUMI) in Berlin, as a member of Salvage Forum.

Michael Menapace will present a session at the 2015 Fall Conference for ARIAS-U.S. titled, "Engaging Technology to Further Arbitration Efficiency & Security."

Joe Grasso will be delivering a presentation on "Utmost Good Faith: Legislative Developments under UK Law and a US Perspective," at the Houston Marine Insurance Seminar on September 22, 2015.

Joe Grasso will be leading a panel on "Machinery Damage Claims" at the International Marine Claims Conference in Dublin on September 24, 2015. He will also be moderating a Panel on the "State of the Marine Insurance Industry in the U.S. and UK" during the fall meeting of the U.S. Maritime Law Association in Bermuda on October 23, 2015.

David Hall will present "Cyber Risks: Is the Marine Industry Prepared?" during the American Institute of Marine Underwriters' Marine Insurance Day Seminar on October 2, 2015.

Joe Grasso will be participating in a panel on "Cyber Liability Insurance – an Evolving Market" at the 28th Annual Conference of the Association of Insurance Compliance Professionals in New Orleans on October 12, 2015.

Michael Thompson will be attending the International Association of Claims Professionals' Fall Conference in Austin, Texas.

From the Courts

Third Circuit Holds that Punitive Damages Are Not Recoverable from Insurer

The U.S. Court of Appeals for the Third Circuit recently took up the issue of whether punitive damages awarded against an insured are recoverable in a coverage action against the insurer. The Court answered this question in the negative in Wolfe v. Allstate (June 12, 2015). We previously wrote about this case when the Pennsylvania Supreme Court decided a different question certified to it by the Third Circuit in 2014: whether a claim for bad faith by an insured against an insurer was assignable to a third party claimant. The Supreme Court answered that question in the affirmative.

In this case, the insured had been sued for personal injuries suffered by a claimant in an auto accident with the insured. When the claimant learned that the insured driver was intoxicated, the claimant sought, and recovered, punitive damages against the insured driver. The insurer had previously declined to settle the claim for the amount demanded by the claimant, $25,000, instead offering only $1,200. When the case failed to settle, it went to trial, with a jury awarding the claimant $15,000 in compensatory damages and $50,000 in punitive damages. The insurer paid the $15,000 but refused to pay the $50,000. The claimant, standing in the insured's shoes after assignment of the insured's claim against the insurer, obtained a trial court judgment against the insurer for $50,000. The Third Circuit vacated that judgment and remanded, with instructions to exclude evidence of the punitive damage award against the insured, because such damages are uninsurable under Pennsylvania law.

Fourth Circuit Overturns Victory for Underwriters on Coverage for Contractor Under Policy Issued to Subcontractor – A 9-Corner Rule?

The U.S. Court of Appeals for the Fourth Circuit recently found a duty to defend a contractor under a policy issued to a subcontractor, even though the subcontractor was not named as a party in the lawsuit against the contractor. In so holding, the Fourth Circuit overturned a Maryland federal court's decision in favor of underwriters. The Fourth Circuit held that underwriters were required to defend the contractor in a suit seeking damages for defective construction work and, in so holding, the Court looked beyond not only the four corners of the policy, but also beyond the four corners of the complaint against the contractor, to information indicating that the claim was potentially based on faulty work by the subcontractor. That was enough for the Court to find a duty to defend the contractor, based on the fact that the contractor was an additional insured, and the subcontract required the subcontractor to indemnify the contractor for all claims arising from the subcontractor's work and required the subcontractor to arrange insurance with the contractor as an additional insured. The case is another example of the importance of clear policy wording as to the coverage afforded to an additional insured. Capital City Real Estate LLC v. Certain Underwriters at Lloyds, No. 14-1239 (4th Cir. June 10, 2015).

Fifth Circuit, citing In re Deepwater Horizon, Limits the Amount of Available Insurance to Less Than Stated Policy Limits

In Ironshore Specialty Insurance Company v. Aspen Underwriting, the Fifth Circuit held that, under Texas Law, an extrinsic contract could be incorporated into an insurance policy for the purpose of setting limits on the policy amount payable on behalf of additional insureds, even where there is no language within the policy itself containing the limitation. This case arises from an oil drilling accident in which two employees of Basic Energy Services ("Basic") were killed while working at an oil field owned by Endeavor Energy Resources ("Endeavor"). Basic and Endeavor were parties to a master services agreement ("MSA") in which they agreed to indemnify each other and to procure insurance with limits of at least $5 million naming the other party as an additional insured. Endeavor procured a $1 million primary policy and $4 million in excess coverage; Ironshore was the excess carrier. Basic procured a $1 million primary policy, a $10 million first-layer excess policy from Aspen and other subscribing underwriters, and a $40 million second-layer excess policy from Dornoch, Ltd. and other subscribing underwriters.

Basic's excess carrier, Ironshore, brought this action against Endeavor's excess carriers asserting that they must pay up to their full policy limits in the underlying wrongful death actions. In response, Endeavor's excess carriers argued that the MSA was incorporated by reference into the insurance policies and, therefore, additional insured coverage for Basic was capped at the $5 million required in the MSA. The Court was skeptical of the defendants' position that express policy limits can in essence be trumped by another contract, but it determined that the recent Texas Supreme Court decision in In Re Deepwater Horizon was controlling law because the policy language at issue in that case was nearly identical to the language of the MSA and the excess policies issued to Endeavor. Because the excess policies specifically referenced the MSA, the court ruled, the $5 million contemplated in the MSA limited the available limits of the excess policies issued to Endeavor. As a result, Aspen would only have to provide coverage up to $5 million.

Sixth Circuit Declines to Allow Cause of Action for "Reverse Bad Faith"

The U.S. Court of Appeals for the Sixth Circuit interpreted Kentucky law as not permitting an insurer to maintain a claim for "reverse bad faith" against its insured, noting that all other states that have addressed the issue have also declined to allow such a cause of action. The facts of the case were fairly egregious, with evidence that the insured homeowner had paid for her house to be burned in order to collect the insurance proceeds. However, the Court found that Kentucky courts would distinguish between the duty owed by underwriters to their insureds on the one hand (with underwriters being in a superior bargaining position), and the more limited duty of good faith and fair dealing imposed on insureds. The case has spawned considerable debate among practitioners over whether a cause of action for reverse bad faith can be maintained by underwriters in any U.S. jurisdiction. The practical effect of the decision, however, may be limited, given the ability of underwriters to obtain all damages flowing from fraudulent insurance practices, including consequential damages such as investigation and defense costs. State Auto Prop. & Cas. Ins. Co. v. Hargis, No. 13-5020 (6th Cir. May 6, 2015).

Ninth Circuit Affirms Ruling That Insureds Failed to Adequately Plead Breach of Contract and Bad Faith Because their Claim Sought Coverage for Excluded Damages

In Daryl Gregory, et al. v. Nationwide Mutual Insurance Co., the U.S Court of Appeals for the Ninth Circuit (No. 13-15161) recently found that plaintiffs' bad faith claim against their insurer failed where the damages sought were specifically excluded under the policy at issue. In affirming the lower court's granting of Nationwide's summary judgment motion, the Ninth Circuit held that because plaintiffs cannot show that "benefits were due under the policy", their claims against Nationwide for breach of the implied covenant of good faith and fair dealing under California law could not stand.

The plaintiffs were homeowners who had purchased a homeowners' policy from Nationwide. The policy excluded coverage for loss from "[n]esting or infestation, or discharge or release of waste products or secretions by birds, vermin, rodents, insects or domestic animals." The homeowners filed a claim for damages caused by the infestation of mites. The Court concluded, however, based on the express policy language and standard dictionary definitions including mites as "vermin," that the plaintiffs could not have reasonably "construed the policy to insure against mite damage."

In response to the plaintiffs' contention that the term vermin is "legally ambiguous," the Court found it was not ambiguous "in the context of this policy and the circumstances of this case." The plaintiffs' breach of contract claim failed as a result because the only damages sought by plaintiffs were expressly excluded under their policy. For the same reason, the Court also rejected plaintiffs' assertion that Nationwide breached its implied duty of good faith by denying coverage for its mite infestation claim.

This is an "unpublished opinion", meaning that the precedential value of the decision is limited initially to courts within the Ninth Circuit. However, the reasoning underlying the court's decision may have broader applicability to any claim for bad faith against underwriters.

Delaware Trial Court Rules Construction Defect is Not an Occurrence

This past March, a trial court in Delaware became the latest court to weigh in on the debate over whether a claim for defective workmanship constitutes an occurrence triggering coverage for purposes of a commercial general liability ("CGL") policy. In this action, the insured, Miranda & Hardt Contracting and Buildings Services, L.L.C. ("Miranda") constructed a home pursuant to a contract with Fenwick Ventures, LLC ("Fenwick"), which then sold the home to the Pfautz family. Six years after purchasing the home, the Pfautzs sued Miranda and Fenwick complaining of defects in the home's construction. Miranda sought coverage for the Pfautzs' suit under a CGL policy issued to it by Westfield Insurance Company, Inc. ("Westfield").

Westfield argued, and the Court agreed, that under Delaware law defective workmanship does not constitute an occurrence because such action is within the control of the insured and is not the result of a fortuitous or accidental circumstance. In coming to this conclusion, the Court emphasized that a CGL policy was "not intended to serve as a performance bond or guaranty of goods or services." Although the Court ruled that a construction defect was not an occurrence under Delaware law, it relied on federal court precedent in coming to that conclusion, and the debate is therefore far from settled in Delaware, in the absence of a decision from the Delaware Supreme Court definitively deciding the issue. As a consequence, Delaware will likely continue to be a battleground state for construction defect coverage cases. Westfield Ins. Co., Inc. v. Miranda & Hardt Contracting & Bldg. Servs., L.L.C., No. CV N14C-06-214 ALR, 2015 WL 1477970 (Del. Super. Mar. 30, 2015).

Notice of a Construction Defect Claim Doesn't Qualify as a Suit

In a matter of first impression, a federal court in the Southern District of Florida considered whether a Florida statutory procedure for providing pre-suit notice of a claim for construction defects constituted a "suit" within the meaning of an insurer's policy. The insured, Altman Contactors, Inc. ("ACI"), was the general contractor for a high-rise residential condominium in Florida. ACI was served with a Notice of Claim and Supplemental Notices of Claim by the condominium pursuant to Chapter 558 of the Florida Statutes. Fla. Stat. Ann. § 558.004(13). After receiving the Chapter 558 notice, ACI sent a demand letter to its insurer, Crum & Forster Specialty Insurance Co. ("Crum & Forster"), which had issued a CGL policy covering ACI. Crum & Forster denied that it had a duty to defend ACI on the basis that the Chapter 558 notice did not constitute a "suit" under the terms of its policy.

Chapter 558 is commonly referred to as a notice and repair law and is intended to encourage non-legal resolutions to construction disputes. Once a notice of claim is filed under the statutory scheme, a contractor is given various options to respond, including a written offer to remedy the alleged defect, a written offer to compromise and settle by monetary payment and/or repairs, a written statement of dispute, or a written statement that a monetary payment, including insurance proceeds, if any, will be determined by the contractor's insurers after receipt of claim by the insurer. Unlike other similar notice and repair laws, Florida's statute expressly provides that a Chapter 558 notice shall not constitute a claim for insurance purposes and further that the statutory scheme does not impair technical notice provisions or requirements of a liability policy. Fla. Stat. Ann. § 558.004(13).

To determine whether a Chapter 558 notice constituted a "suit" within the meaning of Crum & Forster's policy, the court examined the policy's definition of "suit," the relevant terms of Chapter 558, and Black's Law Dictionary. The court reasoned that such pre-suit notice did not trigger coverage because there was no forum or decision maker involved in the pre-suit process and the purpose of Chapter 558 was to avoid the commencement of a formal civil action. Crum & Forster, therefore, had no duty to defend or indemnify ACI during the pre-suit process. Altman Contractors, Inc. v. Crum & Forster Specialty Ins. Co., No. 13-80831-CIV, 2015 WL 3539755 (S.D. Fla. June 4, 2015)

Practice Note: Although the federal district court persuasively found that Crum & Forster had no duty to defend under Florida's notice and repair law, the Court's analysis hinged on the unique structure and language of Chapter 558. As a consequence, the Court's rationale may not be applicable to a different jurisdiction's notice and repair law. When assessing whether a duty to defend has been triggered by a pre-suit claim under a notice and repair law, it will be important to carefully scrutinize both the language of the policy and the relevant statutory scheme as well as any precedent interpreting that jurisdiction's law.

Intentional Conduct Did Not Fall Within Cyber Policy

In Travelers Property Casualty Company of America v. Federal Recovery Services, Inc., No. 2:14-CV-170 TS, Slip Op. (D. Utah May 11, 2015), the United States District Court for the District of Utah held that there was no duty to defend under a cyber liability policy. The policy provided coverage for "errors and omissions wrongful acts," defined within the policy as any error, omission, or negligent act. The insureds had been sued by their client, Global Fitness Holdings, LLC ("Global Fitness"), for wrongfully withholding account information belonging to Global Fitness. The defendant's insureds tendered the claim to Travelers.

Travelers filed a declaratory judgment action, arguing that the allegations did not trigger its duty to defend. The defendants argued that the amended complaint did not say why the information was withheld and therefore, conceivably, it could have been withheld based on an error, omission, or negligent act. The Court, noting its obligation to limit its review to the "eight corners" of the complaint and policy, examined whether the allegations, if shown to be true, would trigger coverage. Because the claims brought by Global Fitness were premised upon allegations of malicious, intentional behavior as opposed to the sorts of errors, omissions, or negligent acts covered pursuant to the policy, the duty to defend was not triggered.

Coverage for Liquidated Construction Delay Damages Excluded by Contractual Liability Exclusion

In O&G Industries, Inc. v. Litchfield Ins. Grp. Inc., a Connecticut State Court held that a commercial general liability insurer did not have a duty to indemnify an insured whose liability was based on a liquidated damages provision in an extrinsic contract. The case arose out of an explosion occurring during the construction of a gas-fired power plant. O&G Industries, Inc. had entered into an engineering and construction agreement with Kleen Energy Systems, Inc., the owner of the soon-to-be power plant. After the explosion, O&G Industries paid liquidated damages to Kleen Energy based on a liquidated damages provision in the engineering and construction agreement. It then tendered the claim to Litchfield Insurance Group, Inc., its insurer. Litchfield argued that the claim was excluded under the policy's contractual liability exclusion. The Court agreed.

O&G Industries argued that the engineering and construction agreement constituted an "Insured Contract" and thus fell within an exception to the exclusion on the basis that the payment of damages bore a greater relationship to an action in tort because the precipitating event was an explosion, rather than an action in contract. The Court rejected this argument on public policy grounds because it would prevent an insurer from having certainty over whether specific contract provisions between the insured and a third party will result in coverage and because it would allow an insured to fix the amount of damages without any input from the insurer."

From the Regulators

Connecticut Continues Expansion of Captive Marketplace

The Connecticut Insurance Department recently announced the eighth captive insurer and first so-called "sponsored captive" company since the 2011 legislation cleared the way for the State to begin licensing captive insurers. For more information click here.

New Publication by Connecticut Insurance Department

The Connecticut Insurance Department recently launched its "Insurance Matters Newsletter." It is a free online newsletter from the Connecticut Insurance Department. For more information click here.

Florida bans "price optimization"

Florida recently became the fourth state to ban the controversial insurance practice called price optimization to determine the premium to be charged to policyholders. It instructed that "Insurers that have used price optimization in the determination of the rates filed and currently in effect should submit a filing to eliminate that use" in a memo from the Florida insurance commissioner. The other states that ban the practice are Maryland, Ohio and California. For more information click here.

About Wiggin and Dana's Insurance Practice Group

The Wiggin and Dana Insurance Practice Group provides international, national and regional insurers, reinsurers, brokers, other professionals and industry trade groups with effective and efficient representation. Our group members regularly advise clients in connection with coverage issues, defense and monitoring of complex claims, regulatory proceedings, policy wordings, internal business practices, and state and federal investigations. We also represent clients in insurance and reinsurance arbitrations. We have broad experience in many substantive areas, including property, commercial general liability, inland and ocean marine, reinsurance, E&O, D&O and other professional liability, environmental, energy and aviation. A more detailed description of the Insurance Practice Group, and biographies of our attorneys, appear at www.wiggin.com.

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