By Aaron F. Mandel, Sedgwick New York

Courts often require insurers to return premiums (or at least offer to return them) when rescinding an insurance policy.  Some states may even require it under statute.  The reason is that rescission is an equitable remedy intended to place the parties in the same position they were before the policy was issued, and the insurer obviously does not receive any premiums until the policy is issued.  On Monday, the U.S. Court of Appeals for the First Circuit rejected this general rule and determined that an insurer was entitled to retain premiums as special damages when it seeks to rescind an insurance policy based on rampant fraud.

In PHL Variable Insurance Co. v. P. Bowie 2008 Irrevocable Trust, No. 12-2243, 2013 WL 1943820 (1st Cir. May 13, 2013), an insurance broker (“Rainone”) and an attorney acting on behalf of a trust (“Baldi”) submitted an application on behalf of Peter Bowie seeking a $5 million life insurance policy naming the trust as the beneficiary.  The application stated that Bowie had an annual salary of $250,000, and a personal net worth of approximately $7.5 million.  Rainone and Baldi represented that the policy premiums would not be paid by any third-party, the policy was not being purchased as part of any program to transfer the policy to a third-party within the first five years, and neither Bowie nor the trust had any agreement for any other party to take legal or equitable title to the policy.  Bowie confirmed this information to a third-party inspector working for PHL, and PHL issued the policy. 

The representations made by Rainone, Baldi, and Bowie were false.  Bowie turned out to be a retired city worker, used car salesman, and blackjack dealer who did not have a personal net worth anywhere near the $7.5 million he, Rainone, and Baldi claimed.  Bowie also could not personally afford the policy’s premium.  The premium was actually being paid by a company (“Imperial”) “whose business model consists of lending money to pay for life insurance policy premiums and, when borrowers default on those loans, taking possession of the policies as collateral”; indeed, Imperial’s loan terms made its loans virtually impossible to pay back.  A subsequent amendment to the trust documents provided that the policy would be assigned to Imperial if its loan was defaulted on and, if PHL rescinded the policy, any premiums refunded to the trust would be delivered to Imperial.

PHL eventually discovered the scheme and filed an action against the trust in the U.S. District Court for the District of Rhode Island seeking to rescind the policy.  PHL also sought to obtain the premiums paid in order to offset the damages it suffered in connection with issuing the policy.  These included costs to underwrite and issue the policy, payment of commissions and fees in connection with issuing and servicing the policy, costs incurred to investigate the scheme, and costs to initiate its rescission action.  Alternatively, PHL advised that it was ready, willing, and able to refund the premiums if the court required it to do so, and tendered the premium into the court’s registry.

Resolving cross-motions for summary judgment filed by PHL and the trust, the court determined that the sole issue was whether PHL was required by law to return the premiums, or if the court’s equity powers enabled it to permit PHL to retain the premiums as special damages.  The court determined that it could permit PHL to retain the premiums, and the trust appealed.  The First Circuit affirmed. 

Initially, the court rejected the trust’s argument that Rhode Island case law required an insurer to return premiums when seeking to rescind an insurance policy.  The court instead determined that the case law “do[es] not stand for such a broad and inflexible proposition,” and focused on equity principles that Rhode Island law permits courts to consider in attempting to make whole a party defrauded into entering a contract.  Those principles include: (1) rescission seeks to create a situation the same as if no contract ever existed; (2) parties should gain no advantage from their own fraud; and (3) a court in equity can grant all relief necessary to make the aggrieved party whole so long as it is permitted by the pleadings.  Because it concluded that PHL was deceived into issuing the policy as the result of a conspiracy, the First Circuit determined that:

these equitable principles provide ample support for the district court’s decision to make PHL whole by allowing it to retain the premium.  PHL paid a commission to Rainone of $172,365 that it would not have paid but for the misrepresentations that led it to issue the Policy.  Mere rescission of the contract would not have compensated PHL for this expense.  While PHL apparently did not provide a precise accounting of the other costs in incurred with respect to the Policy, it was reasonable for the district court to conclude that the costs alleged in PHL’s complaint — including underwriting, administration, and servicing of the Policy, as well as investigation into the misrepresentations in the application — justified awarding PHL the remaining $19,635 from the premium, particularly in light of the Trust’s fraud.

Although insurers generally are permitted to rescind policies only when there is no other adequate remedy at law, PHL Variable acknowledges that even permitting an insurer to rescind may not make it whole.  Rescission by itself does not compensate the insurer for all of the costs necessary to issue a policy, and even qualifying those costs as “overhead” does not acknowledge the insurer’s lost opportunity costs.  Accordingly, unless a statute or case law absolutely requires an insurer to return premiums in order to rescind its policy, insurers should consider their right to retain premiums as special damages.

In honor of Earth Day, which recently celebrated its 43rd birthday, the lead article in the current issue of our Construction Defect Coverage Quarterly addresses potential coverage issues implicated by green construction. We also continue the analysis of how various states define “occurrence” under liability policies, and highlight a recent opinion from a Washington federal court enforcing a broad EIFS exclusion.

Please click here to read the CDCQ and let us know if you are intrested in being placed on the mailing list for this quarterly newsletter.

On April 12, 2013, Judge Richard Jones of the U.S. District Court for the Western District of Washington ruled that in a bad-faith lawsuit against a liability insurer, the judge would presume that the insurer has no attorney-client privilege or work-product protection. Judge Jones’ ruling thereby materially extended the holding of the Washington Supreme Court’s recent decision in Cedell v. Farmers Insurance, in which a 5-4 majority presumed that a first-party insurer may not assert the attorney-client privilege or work-product protection in a bad-faith lawsuit. 

Click here for the Insurance Law Blog’s previous coverage of Cedell.

By Kimberly L. Steele, Sedgwick Dallas

A recent federal opinion from Judge Sam Lindsay of the Northern District of Texas, Dallas Division, found that an insurer’s payment of an appraisal award was insufficient to defeat the insured’s breach of contract claim, and that the insured’s statutory and common-law bad faith claims remained viable as well. In the case of Church On The Rock North d/b/a North Church v. Church Mutual Ins. Co., No. 3:10-CV-0975-L (N.D. Tex. Feb. 11, 2013), North Church sued Church Mutual over its handling of a claim for damages arising out of an April 2010 thunderstorm. The parties agreed on the cost of a number of repairs, but differed on others, including the amount to be paid for replacement of North Church’s roof. Church Mutual invoked the appraisal process, and while appraisal was ongoing, North Church sued.

Church Mutual removed the lawsuit to federal court, and the case was administratively closed (subject to a potential future motion to re-open) so that appraisal could be completed. Upon receipt of the appraisal award, Church Mutual issued two checks, one for the remaining unpaid balance of the loss owed, and a second for the withheld depreciation. Church Mutual later moved to re-open the lawsuit and for summary judgment on North Church’s claims for breach of contract, common law bad faith, and violations of the Texas Insurance Code and the Deceptive Trade Practices Act. According to Judge Lindsay’s order, “[b]oiled down to its essence, [Church Mutual’s] contention is that without a viable contract claim, North Church’s other claims necessarily fail, and North Church cannot succeed on its contract claim because it is estopped by the alleged binding appraisal award and [Church Mutual’s] timely payment of that award from pursuing a contract claim[.]”

Judge Lindsay rejected Church Mutual’s position in all respects. Specifically, he concluded that Church Mutual had failed to establish as a matter of law that the appraisal award was binding and enforceable, but only assumed that it was true. Moreover, Church Mutual did not present sufficient evidence to prove that North Church intended to be bound by the award, failed to prove that its payments were timely, and did not establish as a matter of law that its calculations of deductible, depreciation, and prior payments were correct. Thus, Church Mutual’s motion for summary judgment on the contract claims was denied.

Judge Lindsay likewise denied Church Mutual’s summary judgment in relation to the insured’s extra-contractual claims. He did so not only because their contract claims remained viable and because mere payment of an appraisal award, without more, did not preclude an award for pre-appraisal violations of the Insurance Code. He also noted that North Church’s statutory claims were based on timing of payment and purported misrepresentations, not allegedly wrongful underpayment or denial of policy benefits, so the statutory claims would not stand or fall with the common-law bad faith claim. In closing, Judge Lindsay expressly stated that he was not commenting on the strength or weakness of North Church’s case, but only that Church Mutual had not met its summary judgment burden.

The Insurance Law Blog has looked at appraisal awards in Texas in earlier posts.  Please click here for a post from December regarding appraisal clauses and the disputes in Texas over the appraisal process.

By Greg Lahr

For our readers who are keeping tabs on developments in the hydraulic fracturing (“fracking”) industry, we thought you would be interested in Sedgwick’s latest Hydraulic Fracturing News Flash regarding a recent proposal in California to regulate fracking, which can be viewed here.

Here are some recent developments that we are following in other states:

In New York, the Department of Environmental Conservation (“DEC”) has prepared a Revised Draft Supplemental Generic Environmental Impact Statement (“SGEIS”) on the Oil, Gas and Solution Mining Regulatory Program. The SGEIS pertains to issuing well permits for horizontal drilling and high-volume hydraulic fracturing for extracting oil and natural gas from the Marcellus Shale and other low-permeability gas reservoirs. Since making the SGEIS available for public review in September 2011, the DEC has drafted proposed regulations, which are available for comments from December 12, 2012 to January 11, 2013. At least until the regulations are finalized, it appears that the DEC’s moratorium on issuing well permits for horizontal drilling and fracking will continue.

In Pennsylvania, appellate review of the constitutionality of Act 13 of 2012 (“Act 13”), 58 Pa. C.S. §§ 2301 et seq. (signed into law on February 14, 2012), continues with the filing of appellate briefs to the Pennsylvania Supreme Court in September 2012. According to the General Assembly, Act 13 broadly reformed the laws that govern the development of oil and gas resources in Pennsylvania by establishing uniformity and promoting growth in the industry though the pre-emption of local ordinances that impose conditions or limitations on oil and gas operations. The General Assembly intended to allow oil and gas development as a permitted use in any zoning district, and mandate that restrictions placed on oil and gas development by municipalities be no greater than those placed on other industrial uses. A number of municipalities sought a declaratory judgment that Act 13 is unconstitutional, and requested that the Act be permanently enjoined. After the Pennsylvania Attorney General filed preliminary objections based primarily on standing and justiciability grounds, the municipalities filed a motion for summary judgment. On July 12, 2012, the Commonwealth Court issued a decision that granted in part and denied in part the summary judgment motion, and in part sustained the Attorney General’s objections. Significantly, the court declared a section of Act 13, which provides for uniformity of local ordinances, to be unconstitutional. Cross-appeals were filed by the municipalities and the Attorney General.

In New Jersey, a one-year moratorium on fracking signed by Governor Christie is set to expire in January 2013. However, a New Jersey assemblyman is currently sponsoring legislation that would extend the ban on fracking until the state Department of Environmental Protection reviews the federal Environmental Protection Agency’s study on the effects of fracking, which may not be out in final form until 2014.

The onset of the new year brings lists of all types: holiday gift lists, the best movies of 2012, New Year’s resolutions. The Sedgwick Insurance Law Blog has made a list of the insurance cases to watch in 2013. Some are just getting off the ground and we will be watching to see how they move through the courts, while others are ongoing and we are watching for decisions from the appellate courts. Our list crosses various lines of insurance coverage and issues, but we know it is far from complete. Please vote for your pick(s) and/or tell us what case you are watching.

Survey can be found here.

Please look out for the post in early January with the results.

By Scott Bloom

Insurers can expect increasingly frequent and severe data breach claims, a panel of data and privacy breach experts told the Professional Liability Underwriting Society’s International Conference in Chicago, November 7-9, 2012.

According to a recent study, incidences of data breach have nearly doubled over the last 12 months, as regulators, insurers and institutions struggle to respond to security risks and the proliferation of shared data storage (so-called “cloud computing”).  It can take a hacker or malicious computer virus minutes to gain access to stored data, leading to months or even years of costly remediation.  Lost laptops and storage drives present another risk.  At a cost of about $194 per record, the price of remediation is high and claims can easily run into the millions.  Loss due to data breach includes the cost of credit monitoring, ID restoration, investigatory costs, repairing damage caused by the breach, and the costs of notice and reporting.

Currently, federal guidelines require health care companies to notify the public and the Federal Trade Commission (FTC) of a data breach within 10 to 60 days of its discovery (the deadlines vary depending on the number of consumers involved).  Violators face fines and public rebuke by regulators.  In June, the FTC filed a lawsuit against the Wyndham Hotels chain, alleging that the chain failed to take sufficient security measures to avoid the repeated loss of customer credit card data.

Not every attack on a computer network causes a data breach.  Determining whether private information has been purloined is an important task, according to attorney Ted Korbus, an expert in the area of privacy breach.  Korbus told the panel that state Attorneys General are exerting increased pressure on companies to react quickly to any breach of data, no matter how severe.  Determining whether an incident should be reported is critical, because an unnecessary report can be expensive, whereas a late report can be costly from a regulatory perspective.  A close relationship with state and federal regulators is critical to a company successfully resolving a data breach incident, Korbus said.

All of the panel members agreed that “cloud” computing presents the greatest threat to insurers and their policyholders.  Cloud-computing vendor agreements are often heavily weighted in favor of the host company, but provide little assurance to customers.  Cyber-risk insurance policies do not always cover a data breach that occurs on another (non-insured) computer network.  When insurers try to evaluate an insured’s cyber-risk, the use of cloud computing should be closely examined, technology E&O underwriter Michael Carr said.  “From a business standpoint, the cloud is very compelling and may be safer.  It’s here to stay.”  Carr cited examples of online data storage companies that were shut down by regulators as a result of users exchanging copyright-protected materials on the cloud.  Innocent users lost all of their data when the servers were shut down, with no recourse in their own cyber-risk policies.

Panel members agreed that the application and vetting process was critical to underwriting.  “Ultimately, you have to understand the culture of your insured [when underwriting],” Carr said. Other concerns for insurers include aggregation of multiple claims, and coverage for regulatory investigations.  Korbus expects that insureds will closely analyze their cyber-risk and privacy policies.  All of the panel members emphasized proactive measures to prevent data breach in the future.  Educating workers and providing anonymous tip lines are two examples of how to lower the risk of a data breach event.

PLUS: http://plusweb.org – FTC suit: http://www.ftc.gov/opa/2012/06/wyndham.shtm

Advisen study: http://corner.advisen.com/pdf_files/Reputational_Risk_Data_Breach_2012NAS.pdf

We thought our readers would be interested in this case from Connecticut involving the state’s cap on self-insurers’ liability for un/underinsured motorists.  Although the case came down from the Connecticut Supreme Court in September, we thought it was worth noting in light of the upcoming holiday travel season.

In Garcia v. City of Bridgeport, 51 A.3d 1089 (Conn. Sept. 11, 2012), the Connecticut Supreme Court determined that Connecticut law caps self-insurers’ liability for uninsured/underinsured motorist coverage at $20,000 per person and $40,000 per occurrence.   

There, Garcia, an employee of the City of Bridgeport, suffered injuries in a motor vehicle accident caused by an underinsured motorist.  Garcia recovered $50,000 from the motorist’s insurer, and filed a claim with the city for the balance of his damages.  The city, which self-insured its uninsured/underinsured obligations, denied Garcia’s claim on the ground that he already recovered damages in excess of the minimum $20,000-per-person limit for uninsured/underinsured motorist coverage.  Garcia sued, alleging that the city’s uninsured/underinsured motorist coverage was unlimited because there was no pre-accident writing demonstrating the city’s election to provide lesser limits of liability.    

Although Connecticut law requires that “insurers” notify and obtain the informed consent of their insureds of this election prior to an accident (see Conn. Gen. Stat. § 38a-336(a)(2)), the Connecticut Supreme Court concluded that this notification requirement did not apply to self-insurers.  The court reasoned that “a self-insurer is both the insurer and the insured, so a construction of this statute that requires an equivalent notice by a self-insurer and a corresponding request by a self-insured is untenable and unnecessary to protect the insured.”  After noting that the “essential and fundamental concern of [Connecticut's] motor vehicle liability scheme” was to guarantee minimum coverage, the court concluded that, under section 38a-336(a)(2), a self-insurer’s uninsured/underinsured motorist coverage obligations are limited to the statutorily prescribed minimums of $20,000 per person and $40,000 per occurrence. 

By Aaron Mandel

First, we wish our readers well in the Northeast in the continued clean up and recovery from Super Storm Sandy.

We also wanted to let you know about two industry-shaping efforts by our partners. Richard Geddes, a partner in Chicago, was named a winner, along with his co-authors, of the 2012 British Insurance Law Association Charitable Trust Book Prize for their book, “The Bermuda Form: Interpretation and Dispute Resolution of Excess Liability Insurance” (Oxford University Press, 2011). The annual book prize is awarded by the trustees of the BILA Charitable Trust to the authors of a published work constituting “in the opinion of the Trustees the most notable contribution to literature in the field of law as it affects insurance.” Mr. Geddes has been advising clients on the drafting of this policy form, and acting for them in disputes under the form, for more than 25 years.

In addition, Bruce Celebrezze, the chair of our Insurance Practices group. is a founding member of the Board of Regents of the American College of Coverage and Extracontractual Counsel. The College was created in November 2012 by leading lawyers in the U.S. and Canada to improve the quality of the practice of insurance law. The College focuses on the creative, ethical and efficient adjudication of disputes between policyholders and insurers over insurance coverage and extracontractual claims alleging bad faith or unfair claims-handling practices. Its members represent the interests of both insurers and policyholders. The College’s mission includes educating all sectors involved in insurance disputes — including the judiciary, legal and insurance professionals, and businesses — on critical topics such as best practices in policy formation and claims handling, developing trends in insurance law, and bad faith. Another important component is the drive to increase civility and professionalism in the field, thereby improving relations between insurer and policyholder counsel and resulting in better representation for all clients. The College will engage in a wide variety of activities, including seminars and the sharing of scholarship, to promote these goals. (Link to college website – americancollegecec.org.)

We thought our readers would be interested in an article by Alex Potente and Jason Chorley.  They discuss interpleader actions related to entitlement to life insurance proceeds in situations when the policyholder has been murdered.

From the article:
A typical fact pattern involves the uncertainty regarding distribution of life insurance benefits when the policyholder has been murdered and the primary beneficiary has not been ruled out as a person of interest.  While this context generally warrants prompt interpleader of the policy benefits, insurers must engage in careful claims handling to avoid potential claims by the primary beneficiary, secondary or tertiary beneficiaries or the decedent’s estate for breach of the implied covenant of good faith and fair dealing.

Click here to read more.

How To Handle Life Insurance Interpleaders – Law360