10th Circuit Upholds Insurer’s Application of Insured-Versus-Insured Exclusion to FDIC Receiver Claims

August 28th, 2015

By Kimberly Jackanich, Sedgwick San Francisco

Recently the Tenth Circuit Court of Appeals in BancInsure, Inc. v. F.D.I.C., Case No. 14-3063, 2015 WL 4647980, held that an insured-versus-insured exclusion unambiguously barred claims brought by the FDIC as a receiver against an insured bank’s former directors. The decision universally upheld the reasoning and holdings reached by the United States District Court for the District of Kansas in finding that the plain language of the insured-versus-insured exclusion provided for its extension to claims brought by receivers of the insured, including the FDIC. In reaching its holding, the court rejected the insured’s arguments that a shareholder derivative action exception, and a regulatory exclusion endorsement, in the insured’s policy superseded the insured-versus-insured exclusion or otherwise rendered it ambiguous with respect to claims brought by the FDIC.

The case arises out of a lawsuit filed by the FDIC in its capacity as receiver of the insured bank against the bank’s former directors and officers (D&O) alleging negligence, gross negligence, and breach of fiduciary duty. In response to the lawsuit, the insurer brought suit against the bank seeking a declaratory judgment that it owed no duty of coverage under the insured’s D&O policy pursuant to the insured-versus-insured exclusion in the bank’s policy, which provided:

The Insurer shall not be liable to make any payment for Loss in connection with any Claim made against the Insured Persons based upon, arising out of, relating to, in consequence of, or in any way involving…a Claim by, or on behalf of, or at the behest of, any other Insured Person, the Company, or any successor, trustee, assignee or receiver of the Company…

Neither party disputed that the FDIC brought the lawsuit in its capacity as receiver of the bank. Instead, the Insured argued that, when the insured-versus-insured exclusion was read in light of other policy provisions, in particular the shareholder derivative exception and the regulatory exclusion endorsement, the exclusion was ambiguous as to whether it barred claims asserted by the FDIC.

The Policy included a shareholder derivative action exception which removed from the scope of the insured-versus-insured exclusion “a shareholder’s derivative action brought on behalf of the Company by one or more shareholders who are not Insured Persons and make a Claim without the cooperation or solicitation of any Insured Person or the Company.” Because the FDIC succeeds to all rights of a failed bank, including those of any stockholder, the Insured argued that actions by the FDIC share common characteristics with a shareholder derivative action such that the insured-versus-insured exclusion was inapplicable or at least ambiguous. The court rejected the Insured’s argument, emphasizing the explicit inclusion of “receiver” in the insured-versus-insured exclusion and concluding that the shareholder derivative action exception “cannot overcome the plain language of the policy.”

The Policy also included a regulatory exclusion endorsement, which eliminated a policy exclusion for “any action or proceeding brought by or on behalf of any federal or state regulatory or supervisory agency or deposit insurance organization,” and set forth an aggregate liability cap of $5 million for claims brought by such agencies. The Insured argued that the maximum aggregate liability cap provided coverage over claims previously excluded under the regulatory exclusion such that the endorsement should prevail over the original printed provisions of the Policy, including the insured-versus-insured exclusion. The Insured further argued that the endorsement evidenced “a clear intent to provide coverage” for actions previously excluded under the regulatory exclusion. Rejecting the Insured’s arguments, the court reasoned that, “removing an exclusion is not the same thing as affirmatively providing coverage.” The court further emphasized that an inference of coverage cannot be created from the deletion of an exclusion, especially where the endorsement clearly states the parties’ intent not to vary or waive other limitations of the policy. The court also rejected the Insured’s assertions that the regulatory action endorsement would be rendered meaningless by application of the insured-versus-insured exclusion, stating that “the mere overlap between the two exclusions does not introduce ambiguity into the plain language of the insured-versus-insured exclusion barring coverage of claims by ‘any…receiver of the Company.’”

The court’s holding reaffirms that an endorsement providing additional coverage is still subject to other policy exclusions and limitations, particularly when the endorsement explicitly provides that it does not alter, vary, or waive other policy provisions. Further, the court’s refusal to allow the regulatory exclusion endorsement to supersede the insured-versus-insured exclusion reinforces that courts will interpret policies as a whole. Thus, when endorsements are clear that they only affect designated parts of the policy, insureds may face an uphill battle in their efforts to broadly create affirmative coverage that was not intended by the insurers.

Insurer May Seek Recovery of Excessive, Unreasonable and Unnecessary Fees Directly From Cumis Counsel

August 11th, 2015

By Jason Chorley, Sedgwick San Francisco

On August 10, 2015, the California Supreme Court held that where an insurer (1) declines to defend its insured, (2) is compelled by court order to permit the insured to be represented by Cumis counsel, (3) is ordered to pay reasonable and necessary defense expenses while reserving the right to recover payments for unreasonable and unnecessary expenses, and (4) alleges that Cumis counsel charged fees that were excessive, unreasonable, and unnecessary, the insurer may seek reimbursement directly from Cumis counsel:

If Cumis counsel, operating under a court order that expressly provided that the insurer would be able to recover payments of excessive fees, sought and received from the insurer payment for time and costs that were fraudulent, or were otherwise manifestly and objectively useless and wasteful when incurred, Cumis counsel have been unjustly enriched at the insurer’s expense. Cumis counsel provide no convincing reason why they should be absolutely immune from liability for enriching themselves in this fashion. Alternatively, Cumis counsel fail to persuade that any financial responsibility for their excessive billing should fall first on their own clients — insureds who paid to receive a defense of potentially covered claims, not to face additional rounds of litigation and possible monetary exposure for the acts of their lawyers.

Background

Hartford Casualty Insurance Company issued one commercial general liability insurance policy to Noble Locks Enterprises, Inc. and a second policy to J.R. Marketing, LLC. In September 2005, a lawsuit was filed against Noble Locks and J.R. Marketing and several of their employees in Marin County, California. Later actions were filed against the same parties in Nevada and Virginia.

The Marin County action was tendered to Hartford, which disclaimed a duty to defend. The insureds, represented by Squire Sanders, immediately commenced a coverage action against Hartford. Hartford subsequently agreed to defend its insureds subject to a reservation of rights, but declined to provide independent counsel. The court in the coverage action ordered on summary judgment that Hartford had a duty to defend the Marin County action as of the date of tender and must pay for Cumis counsel for its insureds. The insureds retained Squire Sanders as their Cumis counsel as well. The court in the coverage action also entered an enforcement order, prepared by Squire Sanders, ordering Hartford to pay all past and future defense invoices, declaring that Squire Sanders’ invoices still needed to be reasonable and necessary, and that if Hartford wanted to challenge fees, it may do so through a reimbursement action after the Marin County action concluded, and that, as a breaching insurer, Hartford forfeited the benefit of Civil Code section 2860’s limitations on rates.

After the Marin County action concluded, Hartford filed a cross-complaint against Squire Sanders and various persons for whom it paid defense expenses in the Marin County action. Hartford sought to recover a significant portion of the $15 million in defense fees, including some $13.5 million paid to Squire Sanders, for services rendered to non-insureds, rendered prior to the tender of the Marin County action, for any services in the Nevada or Virginia actions, and for “abusive, excessive, unreasonable, or unnecessary” fees. The trial court in the coverage action sustained the cross-defendants’ demurrer to the reimbursement and rescission causes of action in Hartford’s first amended cross-complaint. The trial court held that Hartford’s right of reimbursement was from its insureds, not directly from Cumis counsel. Hartford appealed.

The Court of Appeal affirmed the trial court decision concluding that allowing Hartford to seek reimbursement directly from Cumis counsel would frustrate the policies underlying Civil Code section 2860. The Court of Appeal further held that, where an insurer breaches its duty to defend and loses all right to control the defense, it is likewise barred from maintaining a reimbursement action against independent counsel where it considers those fees unreasonable or unnecessary. Hartford appealed.

California Supreme Court Discussion

In a majority opinion of Chief Justice Cantil-Sakauye, and Justices Werdegar, Chin, Corrigan, and Kruger, the California Supreme Court reversed the Court of Appeal decision insofar as the dismissal of Squire Sanders was upheld.

The Supreme Court noted the distinction between its finding of a right of restitution against the insured in Buss with its finding in the present case. In Buss, the Supreme Court held that, where an insurer defends a mixed action, it is entitled to reimbursement for those fees and costs attributable solely to defending claims not covered by the policy because the insured would be unjustly enriched at the insurer’s expense – the assumption being that those non-covered fees and expenses were still reasonable and necessary to the insured’s defense against those non-covered claims. Here, however, the question presented is whether independent counsel is unjustly enriched if its fees were excessive, unreasonable and unnecessary for the insureds’ defense to any claim, and not incurred for the benefit of the insured. The Supreme Court found in the affirmative, but limited to the facts of this case.

The Supreme Court rejected the argument that Squire Sanders was merely an incidental beneficiary of Hartford’s promise to pay the costs of defending potentially covered third party claims against its insureds. The Supreme Court reasoned that Hartford’s defense obligation was not unlimited, but rather restricted to reasonable and necessary defense expenses, not Squire Sanders’ alleged overcharges: “Hartford did not accept a bargain binding it to absorb whatever defense fees and expenses the insureds’ independent counsel might choose to bill, no matter how excessive.”

The Supreme Court also rejected Squire Sanders’ argument that Cumis counsel’s independence, zeal, and undivided loyalty to its client would be compromised if it had to defend an insurer’s lawsuit challenging the reasonableness of its efforts in hindsight. The Supreme Court reasoned that attorneys in numerous settings know they will later have to justify their fees to a third party, and in fact, Civil Code section 2860 addresses the possibility of Cumis fee disputes potentially involving Cumis counsel itself, not just the insured. There is no threat to Cumis counsel’s independence by allowing reimbursement under principles of restitution, rather than only permitting the procedures of Civil Code section 2860. The Supreme Court also rejected Squire Sanders’ argument that 2860 provides for a contemporaneous resolution of fee disputes, reasoning that while 2860 does not foreclose contemporaneous resolution, it also does not require it. Further, the trial court’s order specifically provided that Hartford could seek reimbursement after the Marin County case concluded.

Squire Sanders’ argument that the insureds have the sole responsibility and authority to monitor counsel’s expenditure was rejected by the Supreme Court as creating a circuitous, complex, and expensive procedure. The Supreme Court refused to hold that “any direct liability to Hartford for bill padding by Squire Sanders must fall solely on the insureds.” The Supreme Court also rejected Squire Sanders’ due process argument based on attorney-client privilege, finding that an objective review of the underlying case is unlikely to involve an examination of attorney-client communications, which could be redacted in any event.

The Supreme Court’s decision was guided by the trial court’s order, drafted by Squire Sanders, requiring Hartford to pay for independent counsel and permitting a reimbursement action after the Marin County action concluded. The Supreme Court did not decide whether Hartford as a breaching insurer can pursue anyone for reimbursement of fees because that issue was addressed in the trial court’s order and not before the Supreme Court. The Supreme Court noted that Squire Sanders’ own conduct supports the ruling, as it drafted the initial order. The Supreme Court concluded that allowing Hartford to pursue a narrow claim for reimbursement against Squire Sanders under the terms of the 2006 enforcement order neither rewards an undeserving insurer nor penalizes unsuspecting Cumis counsel.

Concurring Opinion

In a concurring opinion, Justice Liu observed that none of the parties appeared blameless, including Hartford’s insured, J.R. Marketing, which was not “a helpless bystander.” Because the majority opinion relies on dual assumptions that (1) Squire Sanders’ billings were objectively unreasonable and unnecessary and (2) were not incurred for the benefit of the insured, Justice Liu reasoned that the majority opinion leaves open the possibility that some portion of the Squire Sanders fees were incurred for the benefit of J.R. Marketing. On remand, Justice Liu posited that Hartford bears the burden to show that Squire Sanders’ fees were objectively unreasonable and were not for the benefit of J.R. Marketing. To the extent the fees were unreasonable, but incurred for the benefit of J.R. Marketing, Hartford’s reimbursement action should lie against J.R. Marketing. Justice Lui concluded that Hartford should have to overcome a presumption that the fees were incurred for the benefit of J.R. Marketing because J.R. Marketing controlled the defense.

Insurer’s Reasonable Handling of Competing Claims on Policy Limits Sinks Bad Faith Claim

June 29th, 2015

By Timothy Kevane, Sedgwick New York

In Purscell v. TICO Insurance Co., the U.S. Court of Appeals for the Eighth Circuit held that an insurer’s unsuccessful attempt to resolve multiple personal injury claims exceeding the policy limits did not constitute bad faith.  2015 WL 3855253 (8th Cir. June 22, 2015).

The case arises out of an automobile collision.  The insured’s passenger – distraught, inebriated and suicidal due to a recent drunk driving incident that killed a friend of hers – commandeered the insured’s vehicle by slamming her foot on the accelerator.  The car entered an intersection at 75 m.p.h when it collided into another vehicle, injuring its two occupants.  The insured’s passenger died as a result of the crash.  The insured’s liability policy afforded limits of $25,000 per person and $50,000 per accident for bodily injury.  The insurer, Infinity, immediately put the full $50,000 per accident policy limits on reserve, designating $25,000 for the fatality and $25,000 for the other vehicle’s occupants (the Carrs).

Shortly after the accident, Infinity received a policy limits demand from the Carrs.  Although aware that Mr. Carr’s medical expenses were substantial, Infinity advised it needed to complete its investigation of the claim, including with respect to coverage issues, and kept its insured apprised of the investigation.  In response, the Carrs withdrew their offer.  Infinity responded by assuring that liability was not being denied, but in view of the potential fatality claim, the policy limits would have to be allocated.  After the fatality claim became certain, the Carrs filed their own lawsuit.

Infinity requested updates from the attorneys for the Carrs and the fatality claimants about how to split the policy proceeds.  The insured demanded that Infinity settle the Carrs’ claim within limits, but made no mention of the fatality claimants, who later made their own policy-limits settlement demand.  Infinity later clarified to the insured that the parents of the deceased passenger were also making a claim, and that all claimants were negotiating how to divide the policy limits.  The insured did not respond.  Infinity eventually filed an interpleader action, after having tried unsuccessfully to obtain input from the insured as to a viable settlement approach.  A jury subsequently awarded Mr. Carr $830,000 and Mrs. Carr $75,000 in damages.  The fatality claim was settled for about $7,000.

The insured sued Infinity for bad faith, claiming that it failed to focus on the one claim (by one of the Carrs) with the highest exposure.  To prove that claim, he had to show that Infinity: (1) reserved the exclusive right to contest or settle any claims; (2) prohibited him from settling claims without its consent; and (3) refused in bad faith to settle a claim within policy limits.  The evidence had to show the insurer intentionally disregarded the insured’s best interests when it had a reasonable opportunity to settle within policy limits.

The Court found no bad faith by Infinity in trying to settle all three claims globally, given that it never denied responsibility to pay the full limits.  When a global settlement became unattainable, the insurer appropriately filed the interpleader action.  Furthermore, the insurer never had a reasonable opportunity to settle the Carrs’ claim because it was unexpectedly withdrawn shortly after being made.  The Court also took note of the insured’s disregard of the insurer’s inquiry about the fatality claim, when he asked it to settle the Carrs’ claim only.  The Court concluded that “no reasonable jury” could find that Infinity acted in bad faith in seeking a global settlement of all three claims.

Significant Structural Decision — Washington Supreme Court Adopts a Broad Interpretation of “Collapse”

June 23rd, 2015

By Joel Morgan, Sedgwick San Francisco

In an En Banc decision published yesterday, the Washington Supreme Court in Queen Anne Park Homeowners Ass’n v. State Farm Fire and Cas. Co., Case No. 90651-3 (June 18, 2015), broadly interpreted the term “collapse” to mean “substantial impairment of structural integrity.”  The decision was made in response to the following certified question from the Ninth Circuit Court of Appeals:

What does “collapse” mean under Washington law in an insurance policy that insures “accidental direct physical loss involving collapse,” subject to the policy’s terms, conditions, exclusions, and other provisions, but does not define “collapse,” except to state that “collapse does not include settling, cracking, shrinking, bulging or expansion?

State Farm Fire and Casualty Company (“State Farm”) issued a property liability policy to plaintiff Queen Anne Park Homeowners Association (“the HOA”).  The HOA sued State Farm after the insurer denied HOA’s claim that its two-building condominium had collapsed.  The HOA supported its claim with an engineer report that found hidden decay in the condominium’s walls which had substantially impaired the walls’ ability to resist loads.  State Farm, on the other hand, asserted that the building had not collapsed.

Prior to this decision, Washington courts were split as to the meaning of the term “collapse.”  Some lower courts strictly defined “collapse” to require an actual collapse (i.e. the structure has to break down or come apart in order to collapse).  Other courts interpreted “collapse” to include structures exhibiting imminent collapse and/or substantial structural impairment.  The Washington Supreme Court itself declined to address the issue in Sprague v. Safeco Ins. Co. of American, 276 P.3d 1270 (Wash. 2012).  There, in a 5-4 split decision, two justices filed a concurring opinion applying the following dictionary definition of “collapse”: “to break down completely: fall apart in confused disorganization: crumble into insignificance or nothingness…fall into a jumbled or flattened mass.”  Four dissenting justices felt that the Washington Supreme Court should adopt the more liberal “substantial impairment of structural integrity” standard.

Citing the division of the Washington Supreme Court and courts across the country, the court in Queen Anne Park HOA determined that the undefined term “collapse” was ambiguous because it was susceptible to more than one reasonable interpretation.  Thus, the court agreed that “collapse” should mean “substantial impairment of structural integrity” because it was reasonable and most favorable to the insured.  “Substantial impairment of structural integrity,” the court explained, “means the substantial impairment of the structural integrity of all or part of a building that renders all or part of the building unfit for its function or unsafe….”  However, under the restrictions in the State Farm policy, the court cautioned that “collapse” must mean more than mere settling, cracking, shrinkage, bulging, or expansion.

Until the term “collapse” is defined, insurers should expect more claims in Washington under policies affording coverage for losses to property involving collapse.

Special Licenses Would Stall the Ascent of Self-Driving Cars

June 22nd, 2015

By Hilary Rowen, Sedgwick San Francisco

I will be a guinea pig. Shortly, I will be sitting in a simulator at the Stanford University Center for Design Research generating data on how ordinary drivers respond when required to take control of a self-driving car.

Most of us are fairly good at keeping our attention on the road while we are actively driving. (Although when our attention strays, the chance of being in an accident increases.) As cars increasingly drive themselves, drivers will be able to take their eyes off the road, but will need to retake control of the vehicle on occasion. Most of us are likely to find these rare occasions somewhat challenging.

As self-driving cars move closer to “deployment” – i.e., sales to the general public – the question has arisen whether a special license, by analogy to separate license requirements for motorcycles or trucks, should be required for the operator of a self-driving car.

Classifying Self-Driving Cars

First, we need to take a short detour into the classification of self-driving cars. Two systems for classifying the level of autonomous driving functions are in current use. In 2013, the National Highway Transportation and Safety Administration issued a four-level classification system; in the same year, SAE International, a professional organization of automotive and aerospace engineers, issued a five-level system.

The NHTSA and SAE classification systems are quite similar. Level 1 in both the NHTSA and SAE classifications refers to stand-alone driver assistance features, such as automatic braking. Both the NHTSA and SAE systems also include a Level Zero, where there is no automation. Level 2 in both systems refers to partial automation. The vehicle performs significant vehicle control functions, such as distance maintenance and lane maintenance. Level 2 cars can be operated in “hands free” and “foot free” mode, at least in some driving environments, but require that the driver remain alert and actively monitor the driving environment. A wide range of cars that qualify as Level 2 will be on the market in the couple of years.

Under both the NHTSA and SAE classifications, Level 3 cars delegate all driving functions to the vehicle. Level 3 car retain steering wheels and brake pedals, and will signal the driver when driving conditions require the driver to retake control. An alert could sound because of a change in driving conditions – such as heavy rain – that reduced the quality of the sensor data below the level required for autonomous operation or because the vehicle entered a geographic area where autonomous operation was not authorized.

A number of manufacturers and technology company – most notably Google – are testing prototypes of Level 3 cars. There are various estimates regarding when Level 3 cars will be on the market; it is likely that a number of auto manufacturers will offer Level 3 cars within a decade.

NHTSA has a single classification, Level 4, for vehicles that dispense with operator controls for steering and braking. SAE bifurcates this category into two subsets: SAE Level 4 vehicles cannot operate in all conditions and all geographic locations. Prototype SAE Level 4 cars are currently being tested. It is quite possible that some Level 4 autonomous vehicles will be deployed on a limited basis within the next five years. Such deployment will likely involve low maximum speeds (in the range of 25 to 35 miles an hour) and very limited geographic travel zones. Due to these limitations, the initial deployment of Level 4 cars is likely to be as people-mover fleet vehicles.

SAE Level 5 can operate anywhere, any time; including driving situations that would be challenging to a human driver. SAE Level 5 vehicles are still in the speculative vision stage. The sheer versatility of a human driver is hard to match, even though the current technology can easily exceed our reaction time and does not have blind spots and other deficiencies of human drivers.

Special Licenses for Level 3?

Level 3 vehicles offered for sale to the public will have a lower incidence of accidents – and quite likely will produce less severe bodily injuries in the event of an accident – compared with conventional cars. The relative incidence of accidents in Level 2 and Level 3 cars is more difficult to predict, but it is likely that less competent drivers will pose a lower aggregate risk in Level 3 cars.

Nevertheless, Level 3 vehicles pose particular challenges to drivers in the event of a transition from autonomous to driver-controlled operation. Under the NHTSA definition, Level 3 cars will be required to provide the driver “with an appropriate amount of transition time to safely regain manual control.” Even with alerts, some drivers will fail to take control timely and cause accidents. With Level 3 cars, there will be some high risk miles, even though Level 3 cars on average will generate fewer accidents per mile traveled.

The ability to respond quickly when the mind is engaged in an activity unrelated to driving – texting, reading, talking on the phone, watching a movie – will affect a given driver’s chance of being involved in an accident when signaled to re-take control of a Level 3 car. The existence of high risk miles and the varying ability of drivers to respond has led to suggestions that operators of Level 3 cars be required to hold a separate driver’s license.

This would be a bad idea. As a matter of public policy, higher risk drivers should not be deterred from purchasing and operating autonomous vehicles. The people who are likely to have the poorest response times (and worst judgment) when faced with the sudden need to take control of a Level 3 car are also likely to pose the highest risk when behind the wheel of a conventional car. From a public safety perspective, we want teenagers, the very elderly, and people who simply are not very competent drivers – but hold driver licenses – to be in Level 3 vehicles.

Imposing special drivers’ license requirements for Level 3 cars – similar to the separate license required to operate a motorcycle – will inhibit the introduction of Level 3 cars. Less competent drivers might not pass a separate autonomous vehicle test; but would continue to drive. Many drivers who could easily pass an autonomous vehicle driving test would be deterred from buying a Level 3 car by the need to get a new license. As a result, the potential for accident reduction offered by Level 3 cars would not materialize.

The hypothetical autonomous vehicle driving test might be very similar to sitting in the simulator at Stanford. Hopefully, this experience will not become a prerequisite for Level 3 car purchasers.

This article was originally published in the Daily Journal on July 19, 2015.

United Kingdom Budget 2015 – Pension Reform Implications for Financial Advisers and Their Insurers

June 19th, 2015

By Richard Booth, Sedgwick London

Insurers providing professional liability coverage should be aware of certain changes in the way individuals in the UK may use their defined contribution pension savings, as new claims activity may result.

The March 2015 Budget announcement revealed the Chancellor’s intention to take pension reforms even further in 2016, including allowing pensioners who already have taken out annuities to sell the income they receive. Previous reforms announced in 2014 mean that, as of April 2015, individuals reaching 55 are now given the options of:

  1. Taking a number of smaller lump sums, and in each case 25% of the sum will be tax free.
  2. “Cashing-in” all of their pension savings for one lump sum.

As the Liberal Democrats’ pensions minister warned last year, the reforms raise the spectre of pensioners blowing their hard earned pension contributions on Lamborghinis, rather than making more prudent investment decisions.

The reforms (those implemented in April 2015 and proposed for 2016) have been welcomed by many commentators for giving individuals more choice in terms of how they spend their savings. The Government has recognized, however, that there are accompanying risks, and the Citizens Advice Bureau will provide individuals with guidance via the “Pension Wise” service. Because the service will not provide advice, many people will consult an Independent Financial Advisor (IFA).

Some IFAs will be expecting new work as a result of the reforms. With a wide variety of investment options available to individuals, and “low risk” products still offering disappointing returns, IFAs will be presenting pensioners with products that offer the potential for higher income and growth, but with higher levels of risk attached. This inevitably will bring further claims activity to the sector relating to the quality of advice provided. It will be a matter of when, rather than if, the first complaints to the Financial Ombudsman Service and claims in the civil courts start to emerge.

The decisions that individuals will need to make in relation to pension contributions will potentially have huge consequences for their retired life. A correspondingly high level of importance will attach to the advice IFAs provide. They must, therefore, ensure that:

  1. They fully understand the reforms including the potential tax implications for their clients’ specific circumstances.
  2. They adequately “fact find” their clients; for example, finding out if they require income from their investment or whether their circumstances merit prioritising capital growth.
  3. They advise on the impact receiving a lump sum payment will have on any entitlements they may need to state benefits.
  4. They record their recommendations, and rationale for them, in sufficient detail so that complaints and claims can be responded to with contemporaneous evidence.

Professional indemnity insurers should consider whether Proposal Form documentation should include specific questions in relation to what pension advice IFA’s are providing, what percentage of an insured firm’s business is related to pension advice, and what risk management processes and procedures are in place to ensure sound advice and to limit claims.

Connecticut Supreme Court’s Insurer-Friendly Decision on Data Breach Incident

May 22nd, 2015

By Carol J. Gerner, Sedgwick Chicago

On January 27, 2014, the Sedgwick Insurance Law Blog posted the following summary entitled, “Highway Data Dump – Who are You Going to Call to Recover $6 Million?,” addressing the appellate decision in Recall Total Info. Mgmt., Inc. v. Fed. Ins. Co., No. AC34716 (Conn. Ct. App. Jan.14, 2014). On May 18, 2015, the Connecticut Supreme Court affirmed the judgment of the appellate court.  Recall Total Info. Mgmt., Inc. v. Fed. Ins. Co., No. SC 19291 (Conn.  May 18, 2015).

As discussed in the original Insurance Law Blog article, the Appellate Court had affirmed the trial court’s decision which held that comprehensive general liability (“CGL”) and commercial umbrella liability (“umbrella”) insurers did not have a duty to defend “negotiations” that took place following a data breach incident, and did not waive their coverage defenses. Furthermore, the losses associated with the data breach were not “personal injuries” under Federal’s comprehensive general liability policy or Scottsdale’s commercial liability umbrella policy.

The Connecticut Supreme Court adopted the Appellate Court’s opinion as the “proper statement of the issue and the applicable law concerning that issue.” The Connecticut Supreme Court concluded that the Appellate Court’s “well-reasoned” opinion fully addressed the certified issue of whether the Appellate Court properly affirmed the trial court’s summary judgment rendered in favor of the defendant insurers.

The Connecticut Supreme Court’s decision is good news for insurers on coverage issues that may arise when an insured tenders a data breach incident under a CGL or umbrella policy.

Minding Your (Policy) Language – Indiana Supreme Court Certifies Pro Rata Allocation Ruling From Lower Court

May 22nd, 2015

By Michael J. McNaughton, Sedgwick Chicago

Courts have struggled between two approaches on how to allocate damages when multiple, consecutive CGL policies have been triggered in situations involving continuous injury or property damage. The majority approach, pro rata allocation, spreads the injury or damage across the entire time period of harm, and each triggered policy only pays for that portion of damage allocated to its specific policy period. In contrast, the minority “all sums” approach requires any triggered policy to be jointly and severally responsible for the full amount of liability up to policy limits, regardless of the actual amount of personal injury or property damage taking place in each policy period.

Indiana has been firmly in the “all sums” camp since the Indiana Supreme Court’s seminal decision in Allstate Ins. Co. v. Dana, 759 N.E.2d 1049 (Ind. 2001). On May 15, 2015, however, the Indiana Supreme Court turned down a petition to accept jurisdiction in Thompson Inc. v. Insurance Co. of North America, 11 N.E.3d 982 (Ind. App. 2014) (“Thompson”). Instead, the Court entered an order that certified as final the appellate court’s decision applying a pro rata allocation to the underlying class action’s bodily injury claims by former plant workers in Taiwan after they developed cancer from exposure to chemical solvents.

In applying pro rata allocation, the Thompson appellate court had distinguished Dana based on the differences in the policy language at issue – the insuring agreement before the Dana court included the phrase “all sums”, while the insuring agreement in Thompson used the phrase “those sums” and, additionally, contained language expressly limiting coverage for damages to “bodily injury which occurs during the Policy Period.” Thus, any damages due to bodily injury that did not occur during the policy period was simply not covered. This straightforward analysis of the policy language, untouched by the Indiana Supreme Court, recognized that the words “all sums” do not exist in a vacuum. Instead, all the terms and conditions must be looked at as a whole to determine the scope of coverage.

The Indiana Supreme Court’s certification of Thompson is a positive sign that even jurisdictions which have been entrenched in the “all sums” approach for years or decades may reconsider how to apportion damages when presented with the appropriate policy language.

On remand, the trial court will now have to determine how to apply pro rata allocation to the facts and issues in the underlying case. It will need to determine the start and end dates of injury, how to consider the insured’s applicable self-insured retentions, and address any uninsured or exhausted periods of coverage that may exist.

The Flying Insurance Adjuster—Implications of Insurers’ Use of Drones

May 14th, 2015

By Hilary Rowen, Sedgwick San Francisco

Insurers perform property inspections in connection with underwriting to determine if the property meets their standards for issuing coverage, and to determine the appropriate premium classification. Insurers inspect damaged property to evaluate the extent of the damage, whether the damage resulted from a covered cause of loss and to estimate the cost to repair or replace the insured property.

In the future, inspections of buildings and other insured property by insurers may be done through still photos, videos or data from more sophisticated sensors obtained by an unmanned aircraft. Rather than having inspections done by a person peering up from the ground, on a ladder or walking through a field, the inspections will be done by a person looking at photos taken by a drone or reviewing a computer analysis of data collected through drone-mounted sensors.

Several property-casualty insurers, including State Farm, USAA and AIG, have recently received approval from the Federal Aviation Administration (FAA) to test and use drones in insurance underwriting and claims operations. However, to date, the approvals that the FAA has issued to insurers contain restrictions that effectively limit the insurers to testing drones for use in inspections under limited conditions. Deployment of drones in insurers’ operations will not “take off” until the FAA’s recently issued draft regulation governing commercial use of drones is adopted.

The Regulation of Drones by the FAA: Entering a Period of Rapid Change

After being subject to criticism for its stringent restrictions on commercial use of drones, the FAA announced in March 2015 that it would streamline its process of reviewing “Section 333 exemption” filings for use of drones weighing less than 55 pounds (25 kilograms) in commercial operations. (Section 333 of the FAA Modernization and Reform Act of 2012 authorized the Secretary of Transportation to determine requirements for commercial use of unmanned aircraft systems.) In March the FAA also exempted entities with approved Section 333 exemptions from filing flight plans for each drone use, provided that the drone is flown below 200 feet. The FAA’s move to speed Section 333 approvals and to lift some of the restrictions on commercial drone use is likely to increase insurers’ interest in the use of drones for a wide range of property inspection purposes.

Restrictions in Section 333 Exemption Approval Issued to Insurers

Today, even with the recent changes, the FAA approvals of commercial use of drones have significant restrictions. Although lightweight drones may weigh less than 5 pounds, the operator must have a pilot license (which, under the FAA’s recent relaxation of commercial drone requirements, can be a recreational or sports pilot license). A second observer must be present for all drone flights. The drones can only be operated within line-of-sight of both the pilot and the observer.

Perhaps most significantly for insurers’ use of drones, the FAA’s approvals of insurers’ Section 333 exemption applications contain the following restrictions:

1. A drone cannot be flown within 500 feet of any structure or vehicle without the permission of the owner or person in control of the structure or vehicle; and
2. A drone cannot be operated within 500 feet of a person other than the operator and observer, unless the people within 500 feet are inside a structure that would protect them from debris in the event that the drone crashes.

These limitations impose significant restrictions on testing property inspection drones in real-life situations in urban and suburban areas. The FAA is testing whether to relax some of these restrictions.

On May 6, the FAA announced three drone initiatives: one will allow a drone manufacturer to survey crops in rural areas with drones flying outside of the pilot’s direct line-of-sight; a second initiative will allow a railroad to inspect rail infrastructure beyond line-of-sight in isolated areas; the third initiative will allow CNN to test the use of drones for news-gathering in populated area, under the current line-of-sight restrictions. None of the FAA initiatives involves insurer operations.

The Proposed FAA Regulation

The FAA issued a proposed unmanned aircraft system regulation for comment in February 2015. Under the proposed regulation, a new unmanned aircraft system (“UAS”) airman certificate would be created and the requirement that operators of drones hold traditional pilot licenses would be eliminated. The currently required observer would be optional. The line-of-sight requirement would be modified to provide that either the operator or the observer, if one is present, must maintain eye contact with the drone, rather than the current requirement that both the operator and a mandatory observer maintain a line-of-sight view of the drone.

As perhaps the most significant change with respect to insurers’ use of drones, the proposed regulation eliminates the requirement that drones remain at least 500 feet from structures, vehicles and people, although drones may not be flown directly over people other than the operator and observer. Under the proposed regulation, the operator is responsible for taking measures to mitigate risk to persons and property in the event that the operator loses control of the drone. The Notice of Proposed Rulemaking for the proposed regulation provides an example of a mitigation measure: Where the drone is operating in a residential area, the operator could ask that people in the area of operation remain inside while the drone is flying.

The proposed UAS regulation creates a separate and more relaxed set of requirements for drones weighing less than 4.4 pounds (2 kilograms) that fly at low speeds and at low altitudes. Operators of these very small drones would need to obtain a “microUAS” operator certificate from the FAA. Unlike the larger drones weighing up to 55 pounds, microUAS drones could be operated directly over people.

The proposed regulation requires that any accident involving injury to persons or property (other than the drone itself) be reported to the FAA.

It is unclear when the FAA regulation on the commercial use of small drones will be issued and whether it will be significantly modified based on comments from interested parties. However, the FAA is under pressure to create a regulatory environment more favorable to commercial use of drones, in part because testing and deployment of small drones is moving to other countries with less restrictive requirements.

The Evolution of Insurers’ Use of Drones

It is likely that insurers’ use of drones will move from the testing stage to operational use within the next few years. Possible developments include:

On-Site Inspections Will Be Severed From Data Evaluation

As a general matter, the person performing an insurance underwriting or claims inspection will have the expertise to evaluate the state of the property. The person on-site will usually provide a written assessment of the state of property in underwriting inspections, or the extent of damage, nature of the damage and the likely cause of the damage in claims inspections. These reports typically will include photographs and, sometimes, videos as documentation of the findings. However, the assessment is made by the on-site inspector.

As insurers start utilizing drones in inspections, it is likely that the expertise needed to perform a given underwriting or claims inspection will be split among several individuals. The on-site “inspector” will need to hold an FAA drone operator license and will need to have sufficient insurance training to collect the data relevant to the underwriting or claims evaluation. The drone operator will not need the substantive expertise in building construction and maintenance currently needed for underwriting inspections or the expertise in extent of damage, loss causation and other issues currently needed for claims inspection. Some insurers may outsource the drone inspections to companies that specialize in flying drones, rather than have drone operators on staff. Instead of having experienced claims personnel in the field, insurers will likely perform the analytic portion of the inspection remotely, using personnel who rarely, if ever, go into the field.

Drone Inspections Will Collect Different Data Than Current In-Person Inspections

In contrast to a human on a ladder checking for dry rot with a screwdriver, drones in the near future will not have capabilities to physically probe buildings or take samples. The type of sophisticated instrumentation utilized in space probes will not be practical for drones used for insurance inspections.

While on-site physical inspections will remain an option for insurers, it is likely that as inspection operations change in response to increased use of drones, physical inspections will become a rarity only performed in unusual circumstances where physical sampling is essential.

Current inspections, whether of buildings, crops or other insured property, tend to utilize visible light. The Mark 1 human eyeball, supplemented by photos and, sometimes, videos, is the primary inspection tool. Devices such as infrared detectors generally are only employed where there is some indication of a problem.

It is possible, although by no means certain, that insurance inspection drones will routinely collect data using non-visible light sensors. This could lead to more sophisticated analyses of the condition of buildings and the extent of damage. With a wider range of data, insurers may increasingly utilize computer algorithms to evaluate the inspection data. The use of a range of drone-mounted sensors may prove to be an effective substitute for a diminished reliance on physical probing of buildings.

Impact of the Relaxed FAA MicroUAS Requirements

If the proposed FAA regulation is promulgated with the relaxed requirements for drones weighing less than 4.4 pounds, insurers—and many other commercial users of drones in urban and suburban areas—may favor micro drones. Where it is not practical to get pedestrians, neighbors and other bystanders under cover before launching a lightweight drone, there will be significant incentives to use drones below the 4.4-pound threshold. Absent a set of “safe harbor” guidelines from the FAA regarding what set of precautions, other than moving everyone other than the operator and the observer under cover, is reasonable, commercial users of drones will probably favor microUAS.

It is unclear whether inexpensive microUAS will be able to carry sensors more sophisticated than a camera, given the 4.4-pound weight limit. Many current microUAS use the relatively inexpensive ultralight camera technology in smartphones. However, there is no comparable off-the-shelf source for ultralight, non-visible light sensors. Insurers alone would not be able to generate enough demand for such equipment. In the future, it is possible that there will be enough demand from all commercial uses for microUASs to spur the development of such sensors. Alternatively, the FAA may create an intermediate

category between drones weighing 4.4 pounds and drones weighing 55 pounds that allows less stringent deployment requirements for drones that can carry somewhat heavier payloads than the microUASs.

Drones and Disaster Response by Insurers

Much of the discussion of insurers’ use of drones has focused on handling disaster claims. It has been suggested that use of drones in damage assessments after disasters will allow insurers to handle claims more quickly. This is likely to be true in some disaster scenarios, but not all.

Large-scale disasters, whether hurricanes, earthquakes or Western wildfires, often strain insurers’ claims adjusting resources, even with the reassignment of claims inspection personnel from other regions of the country and the use of independent adjusters. Drones may alleviate at least part of the post-disaster claims resource crunch. As claims inspections increasingly are performed remotely, the need to redeploy claims personnel will diminish and the insurer’s ability to handle a surge in claims in one geographic region will improve. However, a limited supply of drones and qualified drone operators may simply replace a limited supply of claims adjusters as a key post-disaster claims adjusting resource issue.

Potential Issues Relating to Insurers’ Use of Drones

Any change in insurer underwriting or claims handling practices is likely to trigger charges that the insurer is treating policyholders and claimants inappropriately. Potential issues arising from insurer use of drones include:

Failure to Properly Inspect and Investigate a Claim

A shift from in-person inspections to remote inspections based on drone-collected data will inevitably lead to allegations that a claim was improperly denied due to the failure of the drone to collect necessary information or the misinterpretation of the data by a remote claims center. In many ways, these likely future complaints are not materially different from garden-variety challenges to in-person claims inspections. However, it is possible that regulators could impose a requirement that drone inspections be supported by in-person inspections whenever there is a challenge to the drone-collected data, at least where the in-person inspection does not pose a risk to the adjuster. It is unclear whether such a requirement would deter insurers from utilizing drones in adjusting claims; although if challenges became frequent, the cost of duplicate inspections would reduce the use of drones.

Flawed Computer Algorithms for Underwriting and/or Claim Damage Evaluation

If the use of drones is combined with the use of computer algorithms to assess the drone-collected data, there may well be challenges to the accuracy of computer-driven claims review. Challenges to computer models used to estimate replacement costs and other uses of computer programs in claim adjusting have been common in recent years. These lawsuits typically have been brought as class actions. Future litigation over computer algorithms used to assess drone-collected data are also likely to be framed as class actions, increasing insurers’ potential exposure.

Conclusion

Use of drones in insurance inspections will start as a fairly minor supplement to the traditional in-person inspection, primarily used to examine inaccessible portions of structures and other property. As lightweight sensors and the computer software needed to evaluate drone sensor data are developed, drones may trigger a more fundamental reorganization of insurers’ property inspection operations—with the collection and evaluation functions severed from each other.

Whether this more seismic shift occurs will depend both on technological developments and on the legal infrastructure for commercial use of drones. It is a fairly safe bet that the technology will be developed. The only question is whether the legal infrastructure creates an environment in which widespread use of drones makes sense for insurers.

This article was originally published in the Bloomberg BNA’s Daily Report for Executives on May 14, 2015.

Challenges for the London Insurance Market

April 30th, 2015

By Duncan Strachan, Sedgwick London

The London insurance market is in a fight to remain competitive and maintain its role as a leading market international insurance and reinsurance business.

A strong preference is emerging for commercial entities around the world to place business with a local carrier instead of in London. At the same time, there is increased competition from other insurance markets for those risks, particularly where they cannot be placed locally.

Economic growth in the emerging economies of Asia, Latin America and Africa has driven increased local demand for insurance and reinsurance since 2010, and it is in these locales that the London market has struggled to develop market share.

There has been a slight decrease in the share of commercial lines being placed in London. There also has been a drop in London’s share of the global reinsurance market. As well as competition from Zurich and Bermuda, hubs are strengthening in Singapore, Hong Kong, and Miami to address regional demand for reinsurance.

The main reasons for the increase in the use of local market carriers are: increased capacity and expertise, a perception that they have a better understanding of how things are done locally, and a willingness to offer more favourable terms and conditions. There is also the issue of local regulations restricting access to the market for foreign insurers and reinsurers. These factors have led global insurers and reinsurers to take things into their own hands, by setting up local operations to ensure they can compete for business that is no longer coming to London.

However, in more specialised lines of business, such as energy, general liability, financial institutions, and aviation, customers rank expertise and financial security over price and the speed at which claims are paid. This is where London retains an advantage, thanks to its concentration of specialised underwriters, brokers and, of course, service providers. The high level of capital available also means that the London market is less vulnerable to soft market conditions and able to absorb large claims.

London’s expertise and reputation for innovation means it is well-positioned to build on its position as the first choice for large and complex risks. The subscription market also puts London at an advantage when it comes to providing solutions for high risk exposures. Where the London market needs to improve is in selling its unique expertise to emerging markets.

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