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December 2017

Submitted by: Gordon K. Walton, Esq.

 

Insuring intangible assets:

Is the insurance industry keeping pace with its customers’ changing requirements?

Written by: Stephen Carter and Samantha Wilson

With developments in technology and the increasing value of intangible assets, does the insurance industry need to reassess the role it plays in protecting its customers against significant losses flowing from damage to these assets?

 

Tangible and Intangible Assets

A Harvard Business Review article from May 1981 described a more useful way of distinguishing goods and services as being to speak of tangible and intangible products.  This concept is therefore relatively new to the 300 year old insurance market. 

 

The tangible assets of a company are widely understood and easy to identify; they are the buildings, machinery and equipment – anything that you can touch and feel. The intangible assets are the parts of a company which are not physical in nature but are resources which are controlled by the company. These could include intellectual property, supply chain resilience, contacts database, business methodology, reputation and goodwill or the network through which the company conducts its business.

 

The significant development in technology over the past 40 years has seen the perceived value of intangible assets soar. From Amazon to Uber, the meteoric rise of technology driven companies, whose value is rooted predominantly in their intangible assets, has disrupted, and in some cases completely wiped out, longstanding businesses and business models. In less than a generation, technology has changed everything from the way we buy groceries to how we interact socially. Around the time of the Harvard article, intangible assets represented only a small percentage of a company’s value. As at 2016, Forbes estimated that figure to be around 80%.

 

Take Amazon as an example: most of its value is not in its warehouses or its stock (though these are, of course, significant). It is in its reliable reputation, that its efficient network provides customers instant access to its website, to search its extensive supply network, for almost any conceivable product, which will be sourced at a competitive price and delivered from one of its warehouses to the customer in as little as an hour. The customer’s belief that each step in this process will work reliably is what makes Amazon so successful.

 

These often incredibly valuable intangible assets cannot be destroyed in a fire or a hurricane. However, they can be damaged even in momentary carelessness.  A 15 minute outage in BA’s power supply, possibly caused by an engineer’s human error, lead to 75,000 customers being stranded and an estimated £150m damages bill. It is therefore increasingly important to a business that these assets are sufficiently protected in the event something does go wrong.

 

Insuring Intangible Assets

Insurance has developed by assessing the risk of a peril to a physical asset and underwriting that risk based on an analysis of data acquired from similar losses. Applying the same method to intangible assets, which are more difficult to quantify and in relation to which the effects of losses are less predictable, is more of a challenge. The industry already successfully covers some intangible assets, such as loss of supply chain, by means of business interruption insurance, though this is usually still linked to a physical loss. Such losses are easier to quantify to the extent that a comparison can be made against previous annual turnover and past performance.

 

One of the major concerns for risk managers is whether their businesses will be sufficiently covered in the event that significant damage is caused to one of their valuable intangible assets.

 

The area of cyber risks is a good illustration of this problem.

 

In the 1980s, when the internet was a closed-off community mostly used by academics, cyber threats were relatively unknown.  By the late 2000s, the internet was an important part of every day life. Most businesses now had some form of online presence and relied on the internet and internet-connected systems to run their company. However, the internet is vulnerable. If a virus breaks through your fire wall, or accesses your system through a less secure company in your supply chain, your entire network is exposed. The rise of smart phones over the past 10 years provides a further unprecedented level of accessibility to a company’s most valuable assets. Many employees now access their work email through their personal smart phone, which is unlikely to have the same level of security as their company’s main network. 

 

Any company of any size in any sector is at risk. A recent poll by Barclaycard showed that SMEs are more concerned about a cyber attack on their business than the effect of Brexit. 

 

Whatever the type of attack (commoditised attacks, affecting millions of victims; targeted attacks, which have the highest chance of a significant financial reward; and high end attacks, focussing on few victims for very high reward), the legal and financial ramifications can be astronomical and commercially catastrophic.

 

 

Cyber risks insurance is available, albeit that coverage is provided on a broadly similar basis to other forms of insurance. Thus, coverage is provided for the cost of reinstating a computer system and database and associated costs, such as notification, forensic investigations and dealing with regulatory authorities.

 

Lloyd’s of London has this week published a report, “Counting the cost: Cyber exposure decoded”, concluding that a major cyber attack could generate losses to the businesses affected of up to £40.7bn. The scenarios set out in the Lloyd’s report show that there is a substantial gap in the take up of coverage and in the event of a significant incident, as little as 7% of economic losses of the type insured by a Lloyd’s policy would actually be insured.

 

However, the real point is that insurance is rarely even offered to protect businesses for loss or damage to their intangible assets arising out of a cyber-related loss.

 

Companies are improving their ability to analyse and value their intangible assets. Such businesses want to be protected against the risk of damage to those assets. The insurance industry, even if it covered such risks, would be unlikely to have the capacity to deal with such catastrophic losses. Few insurers would want to provide cover up to the limits required. Equally, few customers would be willing to pay a premium high enough to cover it.

 

How can the insurance industry adapt?

There are a number of ways in which the insurance industry could respond to the challenge of protecting intangible assets.

 

Pooling – Similar to Pool Re (which, consequently, specifically excludes damage caused by virus, hacking and similar actions), the industry could collaborate with the government to create a scheme that would cover losses to intangible assets, but underpinned by an agreement that, if the losses became so big that they exhausted reserves, then it could draw funds from the UK government to meet its obligations. This is a realistic possibility and would provide the resources required to protect against the significant losses described. However, as with the terrorist atrocities in the 1990s which precipitated the establishment of Pool Re, it may require a catastrophic event to take place before the industry would consider it worthwhile to develop the product.

 

Captive Insurer – As insurers internal to a particular group of businesses, captives could provide coverage at a lower rate of premium than the open market.  One issue faced by an insured is that many insurance products contain a number of exclusions, so businesses are not confident their loss would be covered. A captive could provide that breadth of cover. However, even a captive backed by reinsurance is unlikely to be able to provide limits of cover for the type of exposure under discussion.

 

Incentives for increased security – A significant issue for businesses is finding the capital to invest in better security for their intangible assets. Insurers could provide incentives such as reduced premiums for businesses that can show they have improved their security and therefore decreased the likelihood of making a claim. This is a long-term solution that would only work if an insured could demonstrate the ability to meet premium and remain claim free for a number of years. It would not protect businesses that require the capital assistance now.

 

Insurance Linked Securities These are financial instruments whose values are driven by insurance loss events, usually providing substantial limits of cover. Investors underwrite the same type of risks that insurers and reinsurers do, collecting premiums and paying out losses as and when these materialise. As such, insurers are able to pass on unwanted accumulations of risk to the capital markets. As catastrophic losses are low-probability, they could be attractive to investors. However, investors will no doubt wish to take a cautious approach on premium, so this is likely to be a relatively expensive option.

 

Risk Management – Here the idea is that experts would be consulted before a crisis required them to become involved. Companies would have their risks assessed, systems updated and protections put in place before they suffered a loss. These systems would then be monitored and tested regularly, to ensure the greatest protection against suffering damage.

 

The one great opportunity for the insurance industry arising from the above is that insurers have the specialist knowledge and expertise to put these systems in place.  Rather than paying a significant premium, an insured could use those resources to pay for expert consultants to assess their security requirements and bring their systems up to the standard required to minimise the risk in the first place. This would provide comfort to insurers who could continue to monitor the risk and charge lower premiums as a result, for the risks that they do actually take on in the traditional manner.  The issue with this approach is that it would require a significant financial outlay at the start and negotiating who would be responsible for those costs could be problematic.

 

CPB Comment

Many of the discussed options have proved successful in providing the high levels of coverage required to cope with catastrophic losses to tangible assets.  All have their disadvantages; however we consider that the final option presents the best opportunity for insurers to use their expertise and resources to meet their customers’ needs. Rather than looking at how to deal with issues of capacity, the industry could assist its customers to properly assess their risk and secure against future losses. In a more advisory role, insurers would be assisting the insured to put a lock on the warehouse door rather than pay to replace the equipment stolen from inside it.  

 

 


 

November 2017

Submitted by: Richard D. Gable

 

 

Federal Judge finds post loss assignment of benefits proper under Pennsylvania law

 

In a recent opinion, Judge Schmehl of the Eastern District of Pennsylvania denied a forced placed insurer’s Motion to Dismiss a suit brought by the assignee of a homeowner for water damage to the home.  In Williams v. American Surety Insurance Company, the subject home was damaged by water while the mortgage company was in the process of foreclosing on the home.  The homeowner, who had been designated as “Borrower” under a forced placed insurance policy issued to the mortgage company, made a claim under the policy.  After the home was subsequently purchased at Sheriff’s Sale, the new buyer obtained an assignment of the claim.  The claim was denied and the purchaser brought suit.

 

In denying the insurer’s Motion to Dismiss, the court ruled that the policy’s anti-assignment clause only served to bar pre-loss assignments.  The claim, being a fixed and vested right at the time of the loss, is assignable under Pennsylvania law.   The court also rejected arguments relating to timing of the assignment, finding that it was irrelevant that the original claimant had already sold the home at the time the assignment was made.  The court found that the only issue that mattered was whether the assignor had an insurable interest at the time of the loss, which the court concluded she did.

 

Notably, the court cited with approval to the Florida decision of One Call Prop. Servs., Inc. v. Security First Ins. Co., 165 So .2d 749 (Fla. 4th DCA 2015) for the proposition that the assignable right accrues as of the date of loss even though payment may not be due.  Florida courts are awash in assignment of benefits (AOB) suits brought by restoration companies.  While the avalanche of AOB cases in Florida is likely the product of the state’s unique one-way, fee shifting statute (§ 627.428), it will be interesting to see whether decisions like Williams will encourage similar litigation in Pennsylvania. 

 

 

 

October 2017

Opinion Piece re Texas House Bill 1774 – “Hailstorm Litigation Reform Bill”

 

By:       W. Neil Rambin & Susan Egeland

            Drinker Biddle & Reath LLP

            Dallas, Texas 75201

 

Texas is known for its prolific weather events – wind, hail, tornadoes, and the most recent Hurricane Harvey – all of which can wreak havoc and cause significant damage to residential and commercial properties. As the locals say: “If you don’t like the weather in Texas, wait five minutes” and the next weather pattern will roll in. But 6-12 months after the storm rolls out, Texas is (or was) known for another prolific event: the filing of storm litigation cases across the state. While some of these claims were meritorious, many were not, resulting in clogged courthouses and escalating attorneys’ fees.  

 

Texas House Bill 1774, which became law on September 1, 2017 (codified as Texas Insurance Code §542A, “Certain Consumer Actions Related to Claims for Property Damage”), is Republican-backed legislation intended to address “insurance claims and certain prohibited acts and practices in the business of insurance.” It applies to all first-party property claims which pertain to “damages to or loss of covered property caused, wholly or partly, by forces of nature, including an earthquake or earth tremor, a wildfire, a flood, a tornado, lightning, a hurricane, hail, wind, a snowstorm, or a rainstorm.” Supporters argue the legislation will reduce unwarranted storm litigation by: (1) weeding out frivolous claims before they reach the courthouse; and (2) giving insurance companies a means to identify and settle meritorious claims before they become lawsuits. Opponents argue the legislation is draconian and unfairly swings the pendulum back too far in favor of the insurance companies.

 

To accomplish its goals, §542A introduces new pre-suit notice requirements; pre-suit inspection requirements; options for abatement; limitations on actions against individual agents; and restrictions on the award of attorneys’ fees. The key provisions of §542A include:

 

-       An insured must give specific pre-suit written notice specifying his damages and attorneys’ fees incurred to date at least 60 days before filing suit. (§542A.003). This provision allows the insurance company to evaluate the claim for potential early resolution. Failure to comply with the pre-suit notice requirement may prevent the insured’s recovery of attorneys’ fees should the claim become a lawsuit.

 

-       Upon receiving pre-suit written notice, an insurance company is entitled to request a pre-suit inspection. (§542A.004). This provision, too, allows an insurance company to evaluate the claim for potential early resolution.

 

-       If the insured does not comply with the pre-suit written notice or pre-suit inspection requirements, the insurer may seek abatement of the case. (§542A.005). This should stop the insured’s attorneys’ fees from accruing while the insurance evaluates the claim.

 

-       For actions brought against an insurer’s agents – including individual employees, representatives, and adjusters who perform acts on behalf of an insurer – the insurer “may elect to accept whatever liability an agent might have to the claimant for the agent’s acts or omissions related to the claim by providing written notice to the claimant” which then prevents the plaintiff from suing the agent individually. (§542A.006). Practically speaking, this allows an insurance company to streamline its defense without having to incur additional fees defending its agents. Further, this provision is intended to eliminate an insured’s ability to add a Texas-resident agent for the sole purpose of defeating diversity to prevent the insurance company from removing the case to federal court.

 

-       Should the case proceed to trial, an insured’s recovery of attorneys’ fees is tied to his original pre-suit written notice specifying his damages. The insured has an incentive to be accurate in his assessment of damages or else risk not receiving any attorneys’ fees (for example, if the judgment awarded to the insured for damage to covered property is less than 20% of the amount alleged to be owed for that damage in the original pre-suit notice, the court may not award attorneys’ fees). (§542A.007).

 

Creating particular consternation is House Bill 1774’s modification of existing Texas Insurance Code §542.060(c) which lowers the interest payment on claims not paid promptly to only 5% above the prejudgment interest rate as determined by §304.003 of the Texas Finance Code (which is currently 5%) resulting in a current interest rate of 10%. Compare this to the prior law’s 18% interest rate. As a result of this provision, which applies to all claims made on or after September 1, 2017, Texas saw a barrage of social media posts, lawyer advertisements, and media articles urging insureds to submit all Hurricane Harvey claims before September 1 in an attempt to lock in the 18% interest on any claims not paid promptly.

 

Emergency orders issued by the Supreme Court of Texas to extend procedural deadlines on account of Hurricane Harvey did not impact the effective date of the law, which applies to all claims and lawsuits filed on or after September 1, 2017. While the impact of House Bill 1774 remains to be seen, the basic premise is sound: any claimant, whether in the insurance context or not, should be able to clearly articulate his claim and damages before filing suit.

 


SEPTEMBER 2017

 

Lee Losciale v. State Farm Lloyds, 2017 WL 3008642 (S.D. Texas, Houston Division).
The Court granted State Farm’s motion for summary judgment following full and timely payment of the appraisal award. After receipt of the appraisal award, State Farm issued payment based on the actual cash value of the award. Replacement cost benefits were not released, as Plaintiff had not submitted any repair/replacement documentation. After issuing payment, State Farm sought summary judgment based on its timely payment of the award. Plaintiff argued that Menchaca overruled the vast legal authority regarding payment of an appraisal award, which eliminates both contractual and extra-contractual claims following payment of the award. The Court listed the five rules outlined in Menchaca and commented that Plaintiff did not identify which of the “rules” he relied on as support for his Insurance Code claims against State Farm. Nonetheless, the Court found that none of the rules apply given State Farm’s full and timely payment of the appraisal award. In line with Hurst, the Court reasoned that payment of the appraisal award satisfied Plaintiff’s right to receive benefits under the Policy; therefore, there was no “loss of benefits.” Additionally, Plaintiff presented no evidence of an independent loss that did not flow or stem from the original denial of policy benefits. Thus, summary judgment was granted in favor of State Farm.
 
Certain Underwriters at Lloyd’s of London v. Lowen Valley View, LLC and Panade II LTD, d/b/a Hilton Garden Inn, 2017 WL 3115142 (N.D. Texas, Dallas Division).
 
This is an insurance coverage dispute involving damage to a hotel. The policy period at issue was June 2, 2012 to June 2, 2013. In November 2014, the manager of the hotel, Ajay Desai, was evaluating the property for potential capital improvement projects when he noticed the shingles “looked bad.” The roofing contractor he hired to look at the roof found significant hail damage to various roofing systems at the Property. The weather report obtained by the Contractor noted nine events of hail “at location” between January 1, 2006 and December 21, 2014. Of the nine hail events, only one (June 13, 2012) was during the policy period. After learning of the hail damage, Desai reported the damage to his agent, who then reported a claim to Underwriters with a June 13, 2012 date of loss. Following inspection, the adjuster sent out by Underwriters determined the roof needed replacement. On March 2, 2015, Underwriters sent a Reservation of Right letter based on “potential coverage issues.” After a year of investigation, Underwriters denied the claim based on a failure of the insured to provide timely notice. On the same day, February 18, 2016, Underwriters filed its Original Complaint and Request for Declaratory Judgment. Underwriters then moved for summary judgment on Defendants’ breach of contract and Texas Insurance Code counterclaims because: 1) Defendants presented no evidence segregating damage attributable from the June 13, 2012 storm from the damage attributable to the other storms; and 2) Defendants failed to provide prompt notice of the loss. Under Texas law, the insured must prove that its claim falls within the insuring agreement. The Court agreed with Underwriters that Defendants failed to provide evidence that would allow the trier of fact to segregate covered losses from non-covered losses and granted summary judgment in favor of Underwriters. 

 

 

AUGUST 2017

 

BEWARE:  WOOD CONSTRUCTION AND LACK OF SECURITY CAN RESULT IN LARGE, UNSUBROGABLE LOSSES

Recent practices involving construction of multi-apartment units have moved to the area of all wood construction.  In recent months we have investigated two losses in excess of $50 million which were frighteningly similar in that they involve new construction that was approximatley 90% complete.  The construction is essentially entirely cured wood with no effective fire stopping or gypsum board included.  Likewise, in both cases the residential sprinkler system was not operational nor was there any effective fire or smoke detection, fire watch or security detail.  Both fires are suspicious in origin. 

 

In both cases the general contractor had responsibility for site safety and security.  In neither case was there any security program in place other than fencing the project.  Not surprisingly, subrogation was barred in both cases by the terms of the builder’s risk coverage, OCIP, CCIP and/or effective waivers of subrogation. 

 

Would it be sensible to reexamine these types of coverage programs with an eye towards encouraging general contractors and others to provide effective security and fire detection at ongoing construction projects before Certificates of Occupancy have been issued. 


Perhaps breach of the security obligation could be an exception to the waiver of subrogation.  We would suggest this be considered because of the magnitude of the losses that can and do result from the absence of effective security.  For example, the Protective Safeguards Endorsement includes as one of its items, security that must make hourly property reviews.  In both recent instances, the severity of the loss would likely have been substantially less if the fires were discovered in their incipient stages. 

 

 

JUNE 2017


The New Jersey Supreme Court recently decided its first property insurance case arising from Storm Sandy in
Oxford Realty Group v. Travelers Excess & Surplus Lines Co. The central issue was whether the debris removal coverage in the policy applied in addition to the policy’s endorsement sublimiting flood coverage for all losses “resulting from flood to buildings, structures or property in the open” in the policy’s flood zone.  In a 5 to 2 decision, the court held that the debris removal coverage did not apply in addition to the flood endorsement’s $1 million sublimit. If the Appellate Division’s decision had not been overturned, insureds may have used the same line of argument to assert that various other property coverages, including business interruption coverage arising from a flood, would not be limited to the flood sublimit. A similar line of argument also could have been made for other sublimits tied to a particular peril, such as earthquake. The decision also contains some significant holdings that contra proferentem and the reasonable expectations doctrine generally do not apply to benefit sophisticated commercial entities, and that both doctrines apply on if there are ambiguous or misleading policy terms. The court held that because the terms of the policy were not ambiguous, it did not need to address the insured’s arguments on contra proferetem or the reasonable expectations doctrine.

 

FDCC member Wystan Ackerman of Robinson & Cole LLP briefed and argued this case for the insurer. 



APRIL 2016


In Metsack v. Liberty Mutual Fire Ins. Co., 2017 U.S. Dist. LEXIS 24062 (D. Conn Feb. 21, 2017), a Connecticut federal judge held, in a case of first impression, that the gradual deterioration of a concrete foundation caused by a corrosive mineral in the concrete aggregate was not a “sudden and accidental” collapse under the terms of an Allstate Insurance Company homeowners insurance policy, and granted Allstate’s motion for summary judgment on all counts of the plaintiff’s complaint.  FDCC member firm Robinson + Cole LLP (of Hartford, CT) represented Allstate in the action. 


Metsack was one of many lawsuits now pending in Connecticut’s federal and state courts involving the failure of concrete foundations that were poured during the 1980s and 1990s.  The failures involve cracking and deformation due to long-term corrosion of the mineral pyrrhotite, found in a quarry from which a concrete supplier in northeastern Connecticut excavated aggregate used in the concrete mix.  Lawyers for the homeowner plaintiffs argue that the cracking of the concrete constitutes a “collapse” of the foundation. In Beach v. Middlesex Mutual Ins. Co., 205 Conn. 246, 532 A. 2d 1297 (1987), the Connecticut Supreme Court held that where an insurance policy provides coverage for “collapse,” and that term is not otherwise defined in the policy, “collapse” means a “substantial impairment of the structural integrity of the building.”  In Metsack the Court held that Allstate’s policy was different than the policy at issue in Beach because the Allstate policy, while providing limited coverage for “collapse,” required that a covered collapse be “a sudden and accidental direct physical loss.” Rejecting the plaintiff’s contention that the term “sudden” was ambiguous in the context of the Allstate policy, the District Court held: “Because the parties do not dispute that the Metsacks’ basement walls deteriorated over time, rather than ‘suddenly,’. . .the Allstate policy excludes coverage for their loss. . . .” 2017 U.S. Dist. LEXIS at *23.  

 

 

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