Policyholder Perspective

Insurance Coverage Legal Audits are Not a Luxury

Doug Widin — Tue, 26 Jan 2010 12:43:49 -0800

This post was written for Boardmember.com

Most executives view insurance with disdain, because it makes no immediate contribution to production, research and development or marketing. Ordinarily, insurance has no tangible results and does not improve the balance sheet. It does not increase stock value. Generally, insurance represents a pure expense detracting from the bottom line. Few officers and directors truly appreciate insurance and even fewer actually understand it. Properly assessed insurance, however, can be one of the best investments the corporation will hopefully never use.

Insurance protects directors’ and officers’ personal assets if the corporation runs into problems. Officers and directors wear many hats today, and their actions are scrutinized more than ever before. Serving as trustee for an employee health or welfare plan, or on the board of a subsidiary or other corporation can present personal liabilities. Litigation arising from employee workforce decisions may come home to roost with directors and officers. If the company’s financial projections founder, or unforeseen economic circumstances such as the subprime mortgage crisis affect the corporation, directors and officers may be targeted in class action investor lawsuits. Proper directors and officers insurance can protect against personal economic effects from these risks, as well as protect the company.

And what about protecting the company assets, both financial and physical? Physical plants and equipment, whether bricks and mortar production facilities or technological, can be wiped out by catastrophes. The wide-spread effects of the World Trade Center attacks and Hurricane Katrina illustrate the potential devastation. Proper property insurance, including different types of business interruption coverage, is an absolute necessity. Separate flood or earthquake policies may be required. Fidelity insurance protecting against theft and other dishonesty can be critical.

Liability insurance, in its myriad forms, is necessary. Insurers have trimmed the scope of formerly standard general liability insurance, so they can sell additional specialized coverage for increased premiums. Negotiated enhancements to today’s standard policies must be explored. Product liability, professional liability, media liability, personal injury liability, and product recall coverages are just a few of the additional types of liability insurance that must be considered. Your corporation’s needs may require tailored manuscript policies. In day-to-day operations, these coverages may make no difference. But nothing teaches their value better than an uncovered liability, once it happens. Worry about insurance then comes too late; survival of the company may, instead, be the issue.

If a cataclysmic event –whether natural disaster, economic downturn, or potential liability –shakes the company’s financial foundations because proper insurance was not in place, shareholders and others will look to the officers and directors for an explanation. Assuring there is proper insurance means more than just buying standard insurance offerings in the marketplace. Assuring proper insurance health requires a check-up in the form of an insurance coverage legal audit. These audits require engaging lawyers working for policyholders and schooled in the arcane and nuanced law of insurance coverage. Policyholder insurance coverage lawyers are independent of the insurance industry and, through a coverage audit, can assess the quality of your coverages, gaps in your coverages, potential enhancements to your insurance program, and wording in your phone-book-thick policies ripe with the potential for denied claims or litigation by your insurers.

An insurance coverage legal audit assesses your needs and identifies potential problems with your coverage before a loss or claim happens. This allows you to negotiate around the pitfalls or buy additional needed coverages. The time to do an audit is now. Once a loss or claim happens, it is too late to ask the insurer to clarify or broaden the coverage terms. For better or worse, the battle lines are then already drawn.

If they want to sleep well at night, directors and officers should view an insurance coverage legal audit as an absolute necessity. It is an ounce of prevention against potential financial catastrophe for which no pound of cure may well exist.

Bond Insurer FGIC Ordered To Stop Writing Policies and To Cease Paying Claims; ISDA Announces FGIC 'Failure to Pay' Credit Event

Ann Kramer — Fri, 11 Dec 2009 12:15:22 -0800

This post was written by David Schlecker and Andrea Pincus.

3rd Quarter Financials Lead to Action By NYS Superintendant of Insurance and ISDA

On November 24, 2009, Financial Guaranty Insurance Company ("FGIC"), a New York- domiciled monoline financial guaranty insurer, was ordered by New York's Superintendent of Insurance to cease writing any new policies and to suspend payment of all claims. The Superintendent's order follows FGIC's Quarterly Statement for the third quarter of 2009, in which FGIC reported that as of September 30, 2009, it suffered an impairment of its required minimum surplus to policyholders of $932,234,577.

FGIC presented the Insurance Department with a proposed "Surplus Restoration Plan" intended to remediate its exposure to certain residential mortgage-backed securities ("RMBS") and collateralized debt obligations of asset-backed securities ("ABS CDOs"). Under the plan, FGIC proposes to take the following steps:

1.      Commence a tender offer for the acquisition or exchange of certain RMBS guaranteed by FGIC;

2.      Continue to pursue commutations with the holders of ABS CDOs; and

3.      Commute, terminate or restructure FGIC's exposure with respect to other obligations for which it had established statutory loss reserves.

Under the Superintendent's order, FGIC has until January 5, 2010 to submit a detailed and final proposed Surplus Restoration Plan to the Insurance Department. If the plan is not submitted by that date, the Superintendent will seek an order of rehabilitation or liquidation, in essence commencing an insurance company insolvency proceeding. Any liquidation or rehabilitation would be conducted pursuant to New York insurance law since insurance companies are not eligible to be debtors under the United States bankruptcy laws. The Superintendent would serve as a rehabilitator or liquidator in any such state court proceeding.

FGIC also has been ordered to bring its minimum policyholder surplus into compliance with New York's surplus and capital requirements by March 25, 2010, unless the Superintendent gives it additional time. Until such time as FGIC is in compliance with the New York surplus and capital requirements, it is limited to operating only in the ordinary course of business and to effectuating the Surplus Restoration Plan. Further, the Superintendent retains the right to seek an order of liquidation or rehabilitation against FGIC at any time, so long as it is not in compliance with these capital and surplus requirements.

On December 3, the International Swaps and Derivatives Association, Inc. ("ISDA") announced that a "failure to pay credit event" occurred with respect to FGIC as a reference entity for credit default swaps ("CDS"), triggering the termination and settlement of these over-the- counter derivatives. ISDA's America's Credit Derivatives Determinations Committee also voted to hold an auction to determine the cash settlement price of these CDS transactions, and will be publishing auction terms in due course.

What Does This Mean For You?

FGIC Policyholders, creditors of FGIC, parties to swap agreements with FGIC, and parties to CDS contracts which reference FGIC or securities issued by FGIC each need to review their respective agreements and assess carefully their potential exposure and rights in light of these developments. Although the actions by the Insurance Department are just the beginning of a process that may lead to full-blown insurance company insolvency proceedings, these developments also may have an immediate and tangible effect on clients' insurance coverage, payment of claims and contractual rights under financial guaranty policies and derivatives contracts. Further, for counterparties to derivatives contracts with either FGIC or referencing FGIC securities, termination, closeout and netting rights may have been triggered and must be reviewed as soon as possible to maximize your position and minimize losses. Reed Smith can assist you in this process and help you to preserve and assert your rights now, as well as during and after an insolvency proceeding, should that occur.

Pushing Back on Insurance Coverage Denials for Sexual Abuse Claims

Ann Kramer — Mon, 16 Nov 2009 07:19:16 -0800

This post was written by John B. Berringer

It has become routine in the past ten years or so for liability insurance companies to deny insurance coverage for sexual abuse claims, often on the theory that sexual abuse is intentional in nature. Many liability insurance policies commonly adopt the definition of “occurrence” which requires that a claim must arise from an “accident.” Under these policies, whether allegations of sexual abuse are encompassed by the term “accident” will determine whether the abuse claims are covered.

Until recently, the law in New York and elsewhere appeared settled that sexual assault could never be an “accident.” The courts’ reasoning was that allegations of sexual assault involve intentional acts which cannot be deemed an “accident” for purposes of triggering occurrence-based coverage. Under this line of cases, injuries caused by an assault were not caused by a covered, triggering “occurrence.” See e.g., Green Chimneys School for Little Folk v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA, 244 A.D.2d 386, 664 N.Y.S.2d 320 (1^st Dep’t 1997); Public Mutual Ins. Co. v. Camp Raleigh, Inc. 233 A.D.2d 273, 650 N.Y.S.2d 136 (1^st Dept. 1996) (“the inclusion in the underlying complaint of causes of action sounding in negligent hiring and supervision does not alter the fact that “the operative acts giving rise to any recover are the intentional sexual assaults’.”); but see Public Service Mut. Ins. Co. v. Goldfarb, 53 N.Y.2d 392, 399, 425 N.E.2d 810, 442 N.Y.S.2d 422, (N.Y., 1981) (holding that “[w]hether [coverage for underlying sexual abuse] is permissible depends upon whether the insured, in committing his criminal act, intended to cause injury”).

In recent years, however, the New York Court of Appeals has called into question the holding in those cases. See RJC Realty Holding Corp. v. Republic Franklin Ins. Co., 2 N.Y.3d 158, 777 N.Y.S.2d 4 (2004) (“RJC”). In RJC, the insurer of a health spa was denied coverage for an action in which a customer of the spa alleged a sexual assault by a masseur. The policyholder in RJC sought insurance coverage for claims by the customer against the spa including, among others, negligent hiring, supervision and retention of the masseuse.

Considering the issue of “whether a liability insurer is obligated to defend and indemnify its insured . in an action brought against the insured based on an alleged sexual assault by the insured’s employee,” the court reversed the Second Department’s denial of coverage. The Court of Appeals reasoned that because, pursuant to its decision in Judith M. v. Sisters of Charity Hosp., 93 N.Y.2d 932, 693 N.Y.S.2d 67 (1999), the masseur’s alleged intentional assault could not be attributed to the spa on the basis of respondeat superior, the assault was an “accident”

from the spa’s standpoint.

The parties here agreed that the policy would cover only an “accident” and would not apply to certain acts “expected or intended” by RJC. When they did so, they could reasonably have anticipated that the rules of respondeat superior would govern the question of when a corporate entity is deemed to expect or intend its employee’s actions. Since the masseur’s actions here were not RJC’s actions for purposes of the respondeat superior doctrine, they were “unexpected, unusual or intended” by RJC. Accordingly, they were an “accident” within the coverage of the policy, and were not excluded by the “expected or intended” clause.

RJC, 2 N.Y.3d at 164-65.

Since the Court’s ruling in RJC, a number of New York courts have adopted the Court of Appeal’s reasoning as to coverage for claims arising from underlying acts of sexual abuse. See e.g., ACE Fire Underwriter’s Ins. Co. v. Orange Ulster Bd. Of Cooperative Educational Services, 8 A.D.3d 593, 779 N.Y.S.2d 545 (2d Dept. 2004); NYAT Operating Corp. v. Gan National Ins. Co., 8 Misc.3d 975, 977-79, 900 N.Y.S.2d 272 (N.Y. Sup. Ct. 2005) (“where an employee departs from his or her duties for solely personal motives unrelated to the furtherance of the business, the doctrine of respondeat superior does not apply.”); NWL Holdings, Inc. v. Discover Property & Cas. Ins. Co., 480 F.Supp.2d 655 (E.D.N.Y. March 20, 2007); see also Sweet Home Central School District v. Aetna Commercial Ins. Co., 263 A.D.2d 949, 951-52, 695 N.Y.S.2d 445 (4^th Dept. 1999) (dissent) (arguing that “where the gravaman of the complaint against Sweet Home is negligence . . . “ the “expected or intended” exclusion for bodily injury damages does not apply “[b]ecause no evidence was presented that Sweet Home expected or intended the acts upon which the underlying complaint is based [sexual abuse]”).

These decisions are consistent with decisions by New York courts which have found the term “accident” in liability policies to be ambiguous. Citing multiple New York cases, the First Department in Tortoso v. MetLife Auto & Home Ins. Co., 21 A.D.3d 276, 799 N.Y.S.2d 506, (1^st Dept. 2005) explained that when analyzing coverage for “accidents,” a greater degree of importance must be placed upon the expected or intended nature of the offense as opposed to blanket offense-specific exclusions.

The policy requires that Metropolitan provide a defense where there has been an occurrence, i.e., an accident that results in bodily injury. Exactly what constitutes an accident is not defined in the policy. However, an accident may be considered “an event which is unanticipated and the product of thoughtlessness rather than willfulness.” McGroarty v. Great Am. Ins. Co., 36 N.Y.2d 358, 363, 368 N.Y.S.2d 485, 329 N.E.2d 172 (N.Y. 1975). Indeed, “No all-inclusive definition of ‘accident’ is possible, nor any formulation of a test applicable in every case, for the word has been employed in a number of senses and given varying meanings depending upon the relevant context.” Matter of Croshier v. Levitt, 5 N.Y.2d 259, 262, 184 N.Y.S.2d 321, 157 N.E.2d 486 (N.Y. 1959).

An intentional act may, but need not necessarily, result in intended consequences. “Clearly more than a casual connection between the intentional act and the resultant harm is required to prove that the harm was intended.” Allstate Ins. Co. v. Mugavero, 79 N.Y.2d 153, 160, 581 N.Y.S.2d 142, 589 N.E.2d 365 (N.Y. 1992).

Tortoso, 21 A.D.3d at 278-279, 799 N.Y.S.2d at 509 (1^st Dept. 2005).

Thus, it is possible that coverage may exist for sexual abuse and other intentional torts even when a policy’s definition of “occurrence” requires an “accident.” Don’t take no for an answer, push back.

Predictable Responses to Benmosche Leak

Ann Kramer — Wed, 11 Nov 2009 11:17:32 -0800

This morning’s WSJ report that Robert Benmosche, recently appointed CEO of AIG, is unhappy with government pay restrictions, has elicited predictable, less than sympathetic responses. “Tiny Violins” is the headline from the Daily Beast. New York Magazine’s Daily Intel responded with sarcasm:

Apparently, someone told Robert Benmosche that running the world's largest and most [expletive withheld] insurer was going to be a cakewalk, because three months into the job and two months after returning from a vacation at his Croatian villa, the CEO is considering throwing in the towel, owing to the restrictions placed on him by the company's new owners, the good old United States government.

… But wait: Didn't he know that when he took the job? We'd assumed he was like the David Blaine of CEOs; you know, that he liked putting himself into impossible situations and getting out against all odds, but apparently, Benmosche was on a media blackout for 2008-2009 and had no idea what he was getting into. What did the board tell him, we wonder? That he was being hired to run an insurance company?

Clusterstock goes with outrage:

Robert Benmosche should not be given the opportunity to step down as the chief executive of AIG. He should be fired immediately.
The scope and scale of the arrogance of Benmosche is almost stunning. Except that we've become so accustomed to financial big shots acting like they were divinely anointed that we hardly notice.

If this kind of PR ploy actually works with Ken Feinberg, well …; more likely, it will just continue to backfire. In any event, the parlor game of predicting Benmosche’s successor has begun.

Feinberg’s letter to AIG can be found HERE.

UPDATE: In response to the uproar (e.g. "AIG's Benmosche is a drama queen") created by the WSJ story, Benmosche has sent a letter to AIG employess saying he's "totally committed" to the job.

NY High Court Holds that "Self-Serving" Testimony from Underwriter is Insufficient for Rescission

Ann Kramer — Tue, 27 Oct 2009 11:57:34 -0800

This post was written by J. Andrew Moss

The New York Court of Appeals rejected an effort by Continental Casualty Company (CNA) to rescind an excess professional liability (E&O) policy issued to the law firm Pepper Hamilton LLP, in a decision under Pennsylvania law that also affirmed summary judgment in favor of two of the firm’s other excess E&O insurers based on the application of a “prior knowledge” exclusion in their policies. Executive Risk Indemnity Inc. v. Pepper Hamilton LLP, No. 130 (N.Y. Oct. 20, 2009).

The dispute centered on Pepper Hamilton’s work on behalf of the now-defunct Student Finance Corporation, which eventually led to significant litigation against Pepper Hamilton. According to the opinion, in March 2002 Pepper Hamilton and one of its partners learned that SFC and its principal (the now twice convicted Andrew Yao),

had engaged in securities fraud in connection with SFC’s securitization of student loans. The firm terminated its representation of SFC one month later and in June SFC was forced into involuntary bankruptcy. Pepper Hamilton’s professional liability (or E&O) insurance came up for renewal the following October. In connection with its renewal process, the firm’s general counsel asked all its attorneys whether any were aware of any fact or circumstance, act, error, omission or personal injury that might be expected to be the basis for a professional liability claim. In early August, the partner who was aware of the SFC fraud advised the firm accordingly, but the application submitted by the firm in September did not disclose any information concerning SFC. In April 2004, a new bankruptcy trustee proposed that Pepper Hamilton enter into a tolling agreement with respect to potential claims against the firm by the estate and its creditors. At that point, the firm gave notice to its insurance companies. Lawsuits were filed against the firm in early 2005 and the firm’s primary insurer, Westport, defended the claims.

The Pepper Hamilton ruling on rescission is instructive. CNA had submitted an affidavit from its underwriter stating that he would have treated the application differently had the information been disclosed. The court concluded that CNA failed as a matter of law to meet its high burden, which requires proof by “clear and convincing evidence,” for rescission:

[E]ven if the law firm defendants' omission of the SFC incident is a known false statement, [CNA] failed to establish as a matter of law that the false statement was material to the reinsurance [sic] determination and that the false statement was made in bad faith. Here, the self-serving affidavit of [CNA's] underwriter -- that Pepper Hamilton's renewal application would have been treated differently had it disclosed the underlying circumstances which led to the denial of coverage -- is insufficient to meet the insurer's heightened burden of proof.

On the “prior knowledge” exclusions, the court reversed the pro-policyholder ruling of the intermediate appellate court. Rather than the First Department’s requirement that the insurer had to prove knowledge of "wrongful conduct on the part of the insured" (Executive Risk Indem. Inc. v Pepper Hamilton LLP, 56 AD3d 196, 204 [1st Dept]), the New York high court held that the prior knowledge exclusion

excludes coverage of "any act, error, omission, circumstance ... occurring prior to the effective date of the [policy] if any [insured] at the effective date knew or could have reasonably foreseen that such act, error, omission, circumstance … might be the basis of a [claim]."

On the basis of this stricter standard, the court granted summary judgment to the two excess insurance companies with policies containing this exclusion.

UK's Solvent Schemes Dealt Another Blow: Hopefully, the Coup de Grâce

Ann Kramer — Mon, 19 Oct 2009 09:21:34 -0800

The travesty that is the Solvent Scheme of Arrangement has been dealt another blow; one hopes a fatal one. A month after issuing a blistering attack on the practice, Lord Glennie entered final judgment this week refusing to sanction the Scottish Lion scheme. It is worth taking a long look at Lord Glennie’s lengthy opinion.

The issue, succinctly stated by the court, was: “Can it ever be fair to sanction a ‘solvent’ scheme of arrangement in the face of continuing creditor opposition to having their occurrence cover compulsorily terminated?” The court’s answer was, Probably Not.

Under UK law, an insurance company can wind up its operations under either an Insolvent Scheme of Arrangement or a Solvent Scheme of Arrangement. An Insolvent Scheme has US equivalents in our state-run insurance liquidation processes. However, Solvent Schemes are unique to the UK. They allow an otherwise solvent insurance company, including companies that sold occurrence policies for which the company has largely unquantifiable continuing obligations to its policyholders, to wind up operations by forcing policyholders to accept policy commutations.

Solvent Schemes are governed by Section 899 of the Companies Act 2006 (although they have been around longer). The act requires 75% of the value of each class of creditors to approve the Scheme. The attacks on the British Aviation Insurance Scheme led to the current requirement that creditors with IBNR (Incurred But Not Reported) claims be treated separately from those with existing claims, with separate meetings and votes.

The valuation of IBNR claims by Scheme administrators have led to numerous attacks. Those valuations are critical to the voting, since they determine the weight of each creditor’s vote. Objectors usually are US policyholders with IBNR long-tail claims under occurrence policies, usually environmental, product liability and toxic tort claims. That was the case in Scottish Lion as well. Whatever the merits of “actuarial science” in the context of liability coverage may be, it is certain that the projected value of the IBNR claims will be wrong, whether too high or too low. These valuations also determine the amount paid in the eventual commutation, once the Scheme is sanctioned.

The objections to Solvent Schemes can be summarized as follows:

Policyholders paid substantial premiums for occurrence-trigger policies, which are valuable and now irreplaceable assets
No amount of money paid in commutation will allow a policyholder to replace this coverage.
Unless the policyholder is in need of short-term cash, there is no benefit to these commutations for policyholders; all of the benefit goes to the insurance company and its owners and managers.
Nothing prevents a policyholder which wants a commutation from seeking one; there is no reason to force unwilling policyholders to do so.

In the end, the court agreed, following the reasoning of the court which refused to approve the British Aviation scheme in 2006:

"If individual policyholders wish to compound the company's contingent liabilities to them, and to accept payment in full of an estimate of their claims, there is nothing to stop them doing so. But to compel dissentients to do so would ... require them to do that which it is unreasonable to require them to do."

That unreasonableness seems to me to stem from the fact that where the company is solvent it is unnecessary for the body of creditors or class of creditors to as a whole that there should be any scheme, still less a scheme forced upon unwilling participants. I respectfully agree with that reasoning.

The Court of Session is Scotland’s supreme civil court. The case may eventually end up before the new Supreme Court of the United Kingdom which opened on October first.

--------------------

UPDATE [November 3, 2009]: PricewaterhouseCoopers, Scheme Advisors to Scottish Lion and many other effective and proposed solvent schemes has announced their intent to appeal Lord Glennie's decision.

Delaware Chancery Court Opens the Door to "All Sums" Allocation in New York

Ann Kramer — Fri, 16 Oct 2009 14:37:02 -0800

On October 14^th, Vice Chancellor Leo E. Strine, Jr. of the Delaware Court of Chancery blew some much needed fresh air into New York allocation jurisprudence. The Viking Pump consolidated cases, C.A. 1465-VCS, have already yielded very interesting and thoughtful rulings on the transfer of insurance in connection with complicated corporate transactions. Viking Pump, Inc. v. Liberty Mutual Insurance Company and Warren Pumps LLC, 2007 WL 2752912 (Del. Ch. Apr. 2, 2007 (unpublished opinion).

The latest decision, the first nearly fifty pages of which is also devoted to corporate transaction issues, then spends the next 40 pages [yes, it is 88 pages long] delving into the arcana of allocation law.

Viking Pump and another formerly related entity, Warren Pumps, are on the receiving end of asbestos personal injury claims. The policies that cover these entities were issued to their former parent, Houdaille Industries, formerly headquartered in New York. The primary and first layer umbrella policies, sold by Liberty Mutual were exhausted, thus, the issue before the court was allocation of liability for the asbestos claims among the excess insurance companies. The excess argued that under controlling New York precedent – Con Edison v. Allstate Ins. Co., 774 N.E.2d 208 (NY 2002) – there must be a pro rata allocation.

After pointing out that New York had not taken a public policy position on allocation (unlike, for example, New Jersey) but instead looks to the policy language, the court nodded to the Court of Appeals reliance on the “during the policy period” phrase in its Con Ed decision and took a swipe at the Second Circuit’s approach in Olin. Because of New York’s policy language-centered approach to allocation, Vice Chancellor Strine wrote: “the fact that one decision held that a particular policy embraced the pro rata approach does not make New York a ‘pro rata state.’” [p. 68]

The court then turned to the impact of non-cumulation and prior insurance clauses that appear in many excess policies. The non-cumulation clauses appeared in the Houdaille excess program courtesy of follow-form endorsements; the excess policies following to Liberty Mutual forms. Liberty Mutual, thanks to Gilbert Bean, was the only insurance company to come to grips with the consequences of gradual injury claims under the new “occurrence” form in 1966-67. Liberty incorporated either “deemer” or “non-cumulation” clauses into nearly all of its policies in order to prevent “stacking of limits.

The court found that these non-cumulation and prior insurance clauses “unambiguously provide for all sums allocation.” [p. 68] and “cannot sensibly be applied within a pro rata allocation scheme.” [p. 71]. In this, the court was not breaking new ground. See Spaulding Composites (NJ), Outboard Marine (IL), Dow Corning (MI), Liberty Mutual (PA), and Hercules (DE).

Helpfully, the insurance companies could not agree amongst themselves how to sensibly marry pro rata allocation relying on “during the policy period” with their non-cumulation and prior insurance clauses (footnote 170 is illuminating). Vice Chancellor Strine concludes with brio:

It is a fundamental New York rule of contract interpretation that a court should read a contract in order to give full effect to every term therein. The Excess Insurers would have me interpret the Houdaille Policies as embracing the pro rata method of allocation by having me jettison explicitly bargained-for provisions of those Policies that benefit them, and therefore reconciling the evident conflict between explicit provisions of the Policies and the pro rata method the Excess Insurers say is implicitly called for by the Policies. In other words, the Excess Insurers would have me elevate their self-interested policy preference over the only method of allocation that permits the sensible operation of all of the Houdaille Policies’ material terms. New York law does not permit such a result but instead requires giving effect to the parties’ contractual choice.

***

Most important, the contractual language only works if all sums is the approach. The Excess Insurers bargained for an all sums method of allocation greatly tempered by exposure-reducing Non-Cumulation and Prior Insurance Provisions. They cannot now prospect for more by having a court substitute a different allocation method for that which best fits with all of the terms of the relevant Policies.

Id. at 80-81.

Stay tuned for the New York courts’ reaction to Vice Chancellor Strine.

Insurance Company Pays Up, Resolving Unallocated Settlement and Defense Costs

Ann Kramer — Wed, 26 Aug 2009 07:39:48 -0800

This post was written by John Ellison and Luke Debevec.

On August 13, 2009, the City of Sterling Heights, Michigan received a check from United National Insurance Company for over $15.4 million, satisfying a judgment awarded by the federal district court for the Eastern District of Michigan and upheld on appeal by the Court of Appeals for the Sixth Circuit. Apart from this payment, United National and Sterling Heights will continue to litigate the amount of additional damages that the Sixth Circuit determined to be due to the City.

In 2003, after several years of litigation, the City settled for $31 million various civil rights and defamation claims brought against it by Hillside Productions, Inc., the owners and operators of the Freedom Hill Amphitheatre located in Sterling Heights. Since then, the City sought to recover this payment, as well as the costs of defending the Hillside claims, from its various insurance companies. Once the Sterling Heights’ litigation with Hillside ended, it found itself in a new lawsuit with its insurance companies, none of whom wanted to pay for the Hillside litigation. In 2005 and 2006, two of the City’s insurers settled with the City for $18.75 million, leaving only United National.

Throughout its dispute with the City, United National had contended that it was only responsible for defamation-related allegations, which the insurer argued represented only a small fraction of the total value of the City’s global settlement with Hillside. In addition to defamation, that settlement had also resolved numerous claims that the trial court determined were not covered by United National’s insurance policies, such as violations of Hillside’s civil rights. In 2006, the trial court ruled that at least one-third of the total value of the City’s settlement, defense costs, and consequential damages should be United National’s responsibility, using a pro rata time-on-the-risk formula, given that it was one of three insurance companies that provided insurance for claims that had been settled. In 2007, the City was awarded a judgment against United National that was worth in excess of $14.6 million.

United National appealed the City’s judgment, arguing among other things that the defamation-related claims could not reasonably represent one-third of the City’s settlement with Hillside. United National protested that allocation was not appropriate to resolving an insurer’s liability for an unallocated global settlement of several types of covered and uncovered claims. On March 31, 2009, the Sixth Circuit ruled handing a complete victory for Sterling Heights. The Sixth Circuit held that the one-third allocation was an appropriate means of estimating those damages relating to covered defamation allegations. The Court accepted the City’s arguments that pro rata allocation was “fair” due to the indivisibility of harm alleged by the underlying plaintiffs flowing from both uncovered and covered causes of action, the failure of the insurance company to participate meaningfully in the settlement process, as well as the “impossibility” of requiring the City to prove the value of its covered causes of action after the fact.

The City will now pursue an additional $875,000 in damages because the appeals court also accepted the City’s arguments that the trial court significantly undervalued the City’s consequential damages. The Court of Appeals agreed with the City that it should be entitled to consequential damages from the date United National breached its insurance policy, not the later date originally selected by the district court.

Insurers Denied De Facto Win After Losing Daubert Motion

Ann Kramer — Wed, 26 Aug 2009 07:08:43 -0800

This post was written by John B. Berringer and Michael N. DiCanio.

In a recent decision Magistrate Judge David A. Baker rejected insurance company Daubert motion to exclude the expert testimony of an architect, a structural engineer, and an accountant designated in an insurance coverage case. Bray & Gillespie v. Hartford et al, Case No. 6:07-cv-00326 –DAB (M.D. Fla. April 20, 2009).

The defendants’ had moved to exclude the testimony of B&G’s accountant and his conclusions regarding the amount of business interruption loss suffered. They did not challenge the methodology of his calculations, but rather took issue with the fact that he allegedly used the wrong numbers and did not provide a period of restoration. Denying the motion, Judge Baker held that this was not a proper ground for excluding the testimony under Daubert, see Quiet Technology, 326 F.3d at 1345-46 (using incorrect numbers in a reliable formula is not grounds for exclusion), and held that the particular issue of limiting the damage calculation with respect to a period of restoration is a matter of factual and legal dispute in this case.

The defendants’ also attacked the proposed testimony of B&G’s architect as unreliable, alleging that he misapplied the pertinent development codes. The court denied the motion, holding:

Interpreting code requirements and estimating building damage and repair or rebuild costs is exactly the sort of thing architects do, well within an architect’s expertise for Daubert purposes. To the extent Defendants disagree with his analysis or find it factually unsupportable, they can challenge these conclusions by cross examination or offer the testimony of their own expert witness, and the jury can decide the matter by weighing the testimony of the competing experts.

Finally, the defendants argued that B&G’s engineering expert could not testify as to the existence of mold and asbestos in a building, could not rely upon second-hand knowledge to make conclusions and should have performed all testing personally. Denying these arguments, Judge Baker found that a professional engineer is qualified to testify as to a generally accepted proposition such as the existence of mold and asbestos in a building. In addition, the court held that defendants’ remaining arguments regarding the expert’s first hand knowledge were not a proper Daubert challenge:

There is no requirement that an expert has to have first hand information as to all relevant facts and verify same; nor is there a requirement that the expert must perform all testing personally. Just as a physician may reliably interpret an X-ray taken by a technician, a Professional Engineer is qualified, by training and experience, to review the work of others and opine to matters within his expertise. To the extent Defendants find fault with the assumptions underlying the opinions, that is not an attack on the methodology, but on the application of an established methodology to a disputed set of facts.

Trial is scheduled for September 14, 2009.

A Flush Beats a Straight and Excess Other Insurance Beats Pro Rata Other Insurance

Dan Winters — Wed, 29 Jul 2009 08:58:16 -0800

W9/PHC Real Estate LP and Grubb & Ellis Management Services, Inc. v. Farm Family Casualty Insurance Co., N.J. App. Div. May 20, 2009

In a declaratory judgment action presented to the New Jersey Appellate Division, defendant Farm Family Casualty Insurance Company (Farm Family) appealed from an order directing it to reimburse W9/PHC Real Estate LP and Grubb & Ellis Management Services, Inc. for half of the defense costs and indemnification of a slip-and-fall suit for damages. Crabtree Landscaping and Turf Management, LLC (Crabtree), a company hired by plaintiffs to remove snow from their property, was also a defendant in that action. W9/PHC sought coverage as additional insureds under Crabtrees’s liability insurance policy with Farm Family.

In its opinion, the appellate division succinctly described the issue before it as follows:

This appeal presents the issue of the obligation to pay for a liability insurance claim and counsel fees where two insurers have conflicting “other insurance” clauses, one providing for “pro rata” payment, and the other for payment only when the other insurer’s limit is exhausted.

The W9/PHC maintained insurance with Zurich North American. The Zurich policy contained an other insurance clause that provided for contribution by equal shares if another policy also covered the risk, or contribution by limits if the other insurance did not permit contribution by equal shares. This is commonly referred to as a pro rata provision.

W9/PHC was an additional insured under the Farm Family policy, which contained an other insurance clause that provided for contribution only in excess of the amount covered by other insurance, whether collectible or not.

Following a slip and fall accident at W9/PHC building, W9/PHC sought coverage from Zurich and Farm Family. Farm Family denied coverage in part based on the assertion that it was excess to Zurich. In a declaratory judgment action, the trial judge ruled that the two other insurance clauses essentially cancelled each other out and both insurers had to contribute equally.

Farm Family appealed, causing the appellate division to weigh the other insurance clauses to determine if one clause was superior.

As the court explained, “other insurance” clauses generally fall into three categories: pro-rata, excess and escape. The court noted that where two carriers have responsibility for a claim, the other-insurance clause of each policy must be examined to determine whether there exists language which may govern the contribution each party should make. Universal Underwriters Ins. Co., v. CNA Ins. Co., 308 N.J. Super. 415, 417 (App. Div. 1998).

First, the court noted that, in New Jersey, where the two policies in question each have an other-insurance clause stating that it is excess over any other policy, the provisions are “mutually repugnant,” and are disregarded. Cosmopolitan Mut. Ins. Co. v. Cont’l Cas. Co., 28 N.J. 554, 562 (1959).

In the event the other-insurance clause of each policy contains a pro-rata provision stipulating that each shall bear a proportion of the loss to the extent of the applicable insurance, then under New Jersey law, the policies are not mutually repugnant and each carrier must bear its respective proportionate share of the loss.

Lastly, as to the specific issue before the court in this matter, allocating loss among insurers where one policy has an other-insurance clause calling for a pro-rata sharing of the loss, while the other policy has an other insurance clause providing for excess coverage, the court held such a determination was essentially an issue of first impression in New Jersey.

The court began its analysis by noting that other jurisdictions had considered the issue of conflicting pro rata and excess other-insurance clauses. From that analysis, the court concluded that cases from other jurisdictions generally fell into two types. In the first type, the pro rata clause in one policy and the excess clause in the other are not held mutually repugnant and the policy containing the pro-rata provision must be exhausted first up to the policy limits. The court found this to be the majority rule. In the second type or minority view, commonly referred to as the Lamb-Weston rule (because it was developed in Lamb-Weston, Inc. v. Oregon Auto. Ins. Co., 341 p.2d 110 (Or. Ct. App. 1959)), all other-insurance clauses, escape, excess or pro rata, are treated the same. Thus, any conflict between such clauses is considered to be mutually repugnant and the loss is apportioned according to the limits of each policy. This approach has been deemed the minority view.

The New Jersey Appellate Division then decided to adopt the majority rule. In doing so the court held that, “In the absence of controlling precedent, the specific language of the policies should be applied, and given its ordinary meaning.” (citing Universal Underwriters Ins. Co. surpa, 308 N.J. Super. at 419).

As a result of that decision, the appellate court overturned the trial judge here who had ordered that Farm Family contribute an equal amount to the $115,000 settlement.

While arguments can certainly be made in favor of either the majority view or the minority view, the real benefit of this ruling is the clarity it brings to assessing the impact of dueling other-insurance clauses. Competing excess clause are “mutually repugnant” and therefore disregard. Two pro-rata clauses are enforceable and each carrier responds in accordance with its share. Finally, when faced with excess and pro-rata clauses, the excess trumps the pro-rata and the pro-rata policy must be exhausted first. Before going all in at a poker game, it helps to know if your hand is likely to be stronger than the other players. Likewise, a policyholder dealt coverage under multiple policies now knows how to play its hand when facing other-insurance clauses.

When will the chickens come home to roost? Insurers Use Reserve Releases to Buff Up Underwhelming Financials

Ann Kramer — Wed, 08 Jul 2009 08:04:23 -0800

Releasing reserves based on early developments is an optimist’s view, [Evan Greenberg, chairman and chief executive officer of ACE Limited] said. “Good news comes early in the casualty business. The bad news always comes late,” he said.

“I do think some companies have released reserves early in an effort to goose earnings,” he said. “It may come back to bite them.”

Link to entire story Here.

As discussed in my prior post P&C fundamentals are pretty bad. According to reports, the only way that insurers showed profits in recent periods was by playing games with their reserves. That is, they revised downward their view of prospective losses to allow them to release reserves, improving the bottom line (on paper, anyway). Such releases covered up “a multitude of sins.”

A report of a Standard & Poor’s June conference on the subject is enlightening and alarming:

… insurers will likely face “temptation to help earnings by underreserving,” particularly if there isn’t a strong recovery. “And we’re not expecting that either,” [John Iten, a Standard & Poor’s credit analyst] said. “We think that any hardening of the cycle will be fairly modest over the next couple years.”

The trend in the industry of releasing reserves possibly prematurely raises questions on reserve adequacy for the future. “Currently, we are witnessing a healthy amount of reserve releases for recent accident years, with a particular focus on longer-tail, commercial product lines,” Mr. Gross said. In 2008, prior-year commercial line reserve releases nearly doubled to approximately $11 billion in 2008 from $5.7 billion in 2007.”

D&O line reserves are of particular concern according to Michael Angelina, Chief Risk Officer and Chief Actuary at Endurance Specialty Holdings Ltd..

"Now is not the time to be releasing reserves," he said. "It's a little premature to be taking good news on that business." At the same time, he said insurers are celebrating that rate decreases have declined, which is not a sign of a hard market. Also, in the 2007-2008 period, given the credit crisis and the associated exposure to directors' and officers' (D&O) liability for financial institutions of a number of commercial lines writers, he said it's unclear whether insurers have underreserved. Many market observers expect a $6 billion-$10 billion reserve need for the D&O product line.

This week, alarm bells have gone off concerning Chubb, a major D&O writer:

The investor report released Monday by Barclays Capital, a unit of London-based Barclays Bank P.L.C., said D&O insurer losses could reach as high as $10 billion, which “implies up to a $2 billion loss (over several years) at (Chubb) based on its market share.”

Barclay's said, “given a potential for a wave of D&O litigation, Chubb does not appear appropriately reserved because its 2008 U.S. D&O loss ratio (estimate) of 78% is mostly in line with its median developed loss ratio over the past 10 years, despite D&O prices declining 50% from the peak in 2002.”

Michael Gross, an S&P analyst said:

“Predicting future claims is key to profitability and financial strength,” … “The question for me is why are they emptying their tanks?”

The answer is obvious, to make abysmal quarterly financials look better. As the Wall Street Journal reported in April:

At Travelers, 34% of net income came from reserve releases in 2008, up from 7.6% in 2007. For Chubb, 31.3% of net income in 2008 was due to reserve releases, compared with 16.2% in 2007.

But this “buffing” cannot go on forever.

"You just won't be able to keep your combineds low based on reserve releases, the way you could in '07 and '08," says [Adam Klauber, director of U.S. equity research for Fox-Pitt Kelton Cochran Caronia Waller].

Earlier this spring, Moody's issued a report estimating that, of the $5 billion to $12 billion in excess loss reserves the industry had at the start of 2008, about $9 billion had been depleted in the first nine months, with estimates rising to $14 billion for the entire year. Moody's Vice President Paul Bauer says he believes the industry has exhausted its cushion, portending dipping profits for 2009.

"In addition, the decline in reserve adequacy implies a further weakening of balance sheet strength in what is already a difficult market environment," he says.

Link to full story Here.

Eventually, analysts will sit up and take notice, as S&P did last month and Barclay’s did this month. After those flares have gone up, soon-to-be-released second quarter reports should be interesting. Stay tuned.

Insurers Wait for a Hard Market: If Only Wishing Could Make It So

Ann Kramer — Wed, 08 Jul 2009 07:35:27 -0800

P&C insurance companies are in a tough spot right now. According to a recently released Insurance Services Offices report, their margins have dropped below break-even. Investment income has fallen through the floor, and the commercial mortgage backed securities market hasn’t even begun to take the hit that analysts predict it will. On top of that, premiums are shrinking, not rising. Not only are rates still dropping but so are the sales and payroll numbers on which the premium rates are computed. As reported in BestWire

… the recession has left commercial insurance buyers with fewer employees and fewer risks to insure. "Our customers are smaller than they were a year before," [Mario P. Vitale, chief executive officer of global corporate for Zurich Financial Services] said.

How does the shrinking customer impact rates? As succinctly explained by Steve Tuckey:

Any serious decline in exposure units, whether it is employees, fleet vehicles or buildings, will make raising prices more difficult because more capacity is chasing fewer such units. And it will also make year-over-year numbers less than impressive even if prices do rise …

Link to full story Here.

This makes infinitely more sense than Marsh’s Brian Duperreault who, along with other industry cheerleaders, has discovered an “invisible hard market”:

But other factors are at work, he added, combining to undermine any positive impact. Thus, he said he coined the phrase “‘invisible hard market,’ because we cannot see its normally positive effects for the industry.”

With available exposures to insure on a steep decline during a deepening recession, he said, “that means no dramatic change in the top line—which, combined with falling investment income, means no dramatic impact on the bottom line, either.” As a result, he observed, “the instant gratification that usually comes from a hard market won’t be available this time around.”

Still, for the moment at least, “[insurance] supply has gone down more swiftly than demand,” due to “staggering investment losses” for many carriers, he observed, prompting insurers to raise prices to compensate.

Link to full story Here.

Small problem, however, is that, talk of underwriting discipline notwithstanding, rates aren’t rising; they are just falling more slowly than before. This focus on first and second derivatives, often decried by blogger Felix Salmon, seems designed to make everyone feel better about dismal statistics. There are exceptions (e.g. financial industry D&O cover) but they won’t carry the whole industry.

These falling rates are below levels analysts deemed inadequate before 2009 began. According to MarketScout:

“At the end of every year we calculate the rate adequacy of the property and casualty industry,” said Mr. Kerr, “According to our calculations, the property and casualty rate index fell [7 percent] below ‘rate adequacy’ in the fourth quarter of 2008.”

Link to full story Here.

In January, MarketScout declared the beginning of the end of the soft market but hedged its bet: “It may take as much as a year for rates to actually start increasing but the soft market trend has turned.” In other words, rates should rise, they just aren’t.

If only wishing could make it so.

Travelers v. Bailey

Ann Kramer — Fri, 19 Jun 2009 12:50:48 -0800

Yesterday, the United States Supreme Court handed a win to Travelers (and indirectly to chapter 11 debtors using insurance proceeds to fund bodily injury trusts), getting Travelers out of further liability arising from its actions “related to” its role as the primary insurer of Johns-Manville. These were not suits seeking proceeds of the insurance policies issued by Travelers to Johns-Manville, but suits alleging that Travelers had an independent duty to claimants arising from its knowledge of the dangers of asbestos.

Resting on res judicata and the finality of settlements and judgments, the Court refused to address whether the Bankruptcy Court’s 1986 Orders had exceeded its authority. That time, according to the Court, had long passed:

Almost a quarter-century after the 1986 Orders were entered, the time to prune them is over.

The Court reserved for another day (never?) the question of the proper scope of Bankruptcy Court authority in these matters:

Our holding is narrow. We do not resolve whether a bankruptcy court, in 1986 or today, could properly enjoin claims against nondebtor insurers that are not derivative of the debtor’s wrongdoing.

Of interest to me is the Court’s commentary on the wording of the Insurance Settlement Order, which will be familiar to anyone who is a student of insurance policy exclusions and insurance company releases. As described by the Court:

The December 18, 1986, order of the Bankruptcy Court approving the insurance settlement agreements (Insurance Settlement Order) provides that, upon the insurers’ payment of the settlement funds to the Trust, “all Persons are permanently restrained and enjoined from commencing and/or continuing any suit, arbitration or other proceeding of any type or nature for Policy Claims against any or all members of the Settling Insurer Group.” The Insurance Settlement Order goes on to provide that the insurers are “released from any and all Policy Claims,” which are to be channeled to the Trust. The order defines “Policy Claims” as “any and all claims, demands, allegations, duties, liabilities and obligations (whether or not presently known) which have been, or could have been, or might be, asserted by any Person against … any or all members of the Settling Insurer Group based upon, arising out of or relating to any or all of the Policies.”

Citations omitted, emphasis added. The Respondents had argued that the scope of these orders was limited to “actions against insurers seeking to recover derivatively for Manville’s wrongdoing.” Not so, said the Court, even if that was the intent of some of the parties to the settlement on which these orders were based.

The Court addressed the phrase that strikes fear in the heart of every contract and insurance recovery lawyer: “based upon, arising out of or relating to.” In the apt words of one former client: “What the hell does that mean? What doesn’t it include?” The Court, with a slight nod to its absurdity, ducked the question:

These actions so clearly involve “claims” (and, all the more so, “allegations”) “based upon, arising out of or relating to” Travelers’ insurance coverage of Manville, that we have no need here to stake out the ultimate bounds of the injunction. There is, of course, a cutoff at some point, where the connection between the insurer’s action complained of and the insurance coverage would be thin to the point of absurd. See California Div. of Labor Standards Enforcement v. Dillingham Constr., N.A., Inc., 519 U.S. 316, 335 (1997) (Scalia, J., concurring) (“[A]pplying the ‘relate to’ provision according to its terms was a project doomed to failure, since, as many a curbstone philosopher has observed, everything is related to everything else”); New York State Conference of Blue Cross & Blue Shield Plans v. Travelers Ins. Co., 514 U.S. 645, 655 (1995). But the detailed findings of the Bankruptcy Court place the Direct Actions within the terms of the 1986 Orders without pushing the limits.

I, for one am interested in those “ultimate bounds” and how “thin” the “point of absurd” actually is.

Latching on to this point, Justice Stevens in dissent argued (in a passage that will warm the heart of many a policyholder lawyer) that the term “Policy Claims” is “not amenable to a purely literal construction [so] the Court must look beyond the four corners of the Insurance Settlement Order to ascertain its meaning.” The dissent looked to then-existing and subsequent bankruptcy law, as well as to Travelers’ subsequent behavior, for a better understanding of what the 1986 Orders meant. In a particularly trenchant passage, Justice Stevens wrote:

… it is worth asking why Travelers paid more than $400 million in 2004 to three new settlement funds in exchange for the Bankruptcy Court’s order “clarifying” that the independent actions “are—and always have been—permanently barred” by the 1986 injunction. If the 1986 injunction were as clear as the Court assumes, surely Travelers would not have paid $445 million—more than five times the amount of its initial contribution to the Manville Trust—to obtain a redundant piece of paper.

Citations omitted.

Finally, the Court remanded to the Second Circuit the very interesting Due Process question of who is bound by these broad Bankruptcy Court orders:

Chubb … has maintained that it was not given constitutionally sufficient notice of the 1986 Orders, so that due process absolves it from following them, whatever their scope. The District Court rejected this argument, but the Court of Appeals did not reach it. On remand, the Court of Appeals can take up this objection and any others that respondents have preserved.

Citations omitted. Thus, the semi-amusing grudge match between lawyers for Travelers and Chubb can continue.

Have NJ Court Rules, Will Travel: NJ Court Holds Insurer Must Pay Counsel Fees Incurred in Illinois Declaratory Judgment Action

Dan Winters — Fri, 19 Jun 2009 08:45:24 -0800

On June 5, 2009, in response to the appeal filed by Myron Corporation, a New Jersey appellate court held that Atlantic Mutual Insurance Corp. was responsible for Myron’s counsel fees incurred in fending off Atlantic’s Illinois declaratory judgment action pursuant to NJ Rule 4:42-9(a)(6). The coverage dispute centered on defense coverage for numerous cases filed against Myron, alleging that junk faxes sent by Myron violated the Telephone Consumer Protection Act (“TCPA”). Atlantic defended Myron in the cases under a reservation of rights. After the Seventh Circuit ruled that insurance coverage was not available for TCPA claims in an unrelated case [Am. States Ins. Co. v. Capital Assoc. of Jackson County, Inc.], Atlantic decided it was a good time to file a DJ action against Myron in Illinois federal court.

The problem with this brilliant strategy was that, as the Illinois court wrote, dismissing the case: “a New Jersey court has the greatest interest in resolving an insurance coverage dispute arising from policies which appear to have been issued in New Jersey to a New Jersey corporation with its principal place of business in New Jersey.” Once in the hands of a New Jersey court, Atlantic lost. The court held that Atlantic owed a defense to Myron for the TCPA cases. The parties then settled, except on the issue of whether Myron was entitled to counsel fees for both the New Jersey and Illinois insurance coverage litigations under NJ Rule 4:42-9(a)(6).

Things didn’t improve for Atlantic on appeal:

We agree with Myron that, unless the insured can recover its counsel fees for out-of-state litigation in this situation, an insurer could wear down the insured financially through forum-shopping. In this case, there is no doubt that Atlantic filed its action in Illinois to take advantage of a favorable Seventh Circuit ruling on coverage. While this may have been good legal strategy from Atlantic's point of view, it imposed costs on Myron to fight its way out of what the Illinois court found was an inappropriate forum, and to get the case back into an appropriate venue.

Myron v. Atlantic Mutual, ___ N.J.Super. ____, slip op. at pp. 12-13 (App. Div. June 5, 2009). Myron sought approximately $160,000 in legal fees and costs it incurred in defending against Atlantic’s Illinois federal court declaratory judgment actions, which had been denied by the NJ trial judge.

In its reversal of the trial court, the Appellate Division cited with approval the prior decision in Liberty Village Associates v. West American Insurance Co., 308 N.J. Super. 393. 406 (App. Div.), cert. denied, 154 N.J. 609 (1988), which held:

The theory is that one covered by a policy is entitled to the full protection provided by the coverage, and that benefit should not be diluted by the insured’s need to pay counsel fees in order to secure its rights under the policy. Under New Jersey jurisprudence, even if an insurer files a declaratory judgment action in good faith to contest its obligation to cover a claim, it must pay the insured’s legal fees if it loses.

The court then expanded its holding by finding that, “In addition to harming the insured, an insurer’s refusal to provide liability coverage may also, as a practical matter, preclude an innocent injured party from being able to recover for the injury. Hence, third-party beneficiaries may also sue an insurer to establish coverage and may recover counsel fees if successful.”

The appellate court noted that after successfully fending off Atlantic’s effort to litigate the coverage issue in Illinois federal court, Myron litigated the merits of the coverage issue in New Jersey and obtained a favorable result. Its right to counsel fees, according to the court, therefore stemmed from its success in the New Jersey litigation. Finally, the court addressed Atlantic’s claim that Myron was not a “successful claimant” under the rule. According to the Appellate Division, once the insured obtained a favorable determination on the coverage issue, it was entitled to recover its counsel fees, wherever those fees were incurred.

It is not uncommon for corporations headquartered in one state to face law suits filed in multiple jurisdictions throughout the United States, and to have insurance with a company headquartered in another state. As such, it is not uncommon for coverage actions to begin with a race to the courthouse as the parties seek the most favorable forum. Thanks to the New Jersey Appellate Division, however, insurers can no longer rest assured that such a strategy is without a significant down-side. New Jersey enacted Court Rule 4:42-9(a)(6) to ensure that policyholders received the full benefit of the bargain, and that insurers could not simply wear down the insured. The Myron decision serves those laudable goals well.

MMSEA 111: Are You a Responsible Reporting Entity (RRE)?

Ann Kramer — Wed, 17 Jun 2009 13:53:26 -0800

Because this is a policyholder blog, you might think this is an odd question since RREs are usually insurers or TPAs; but the fact is that most large corporate policyholders probably are RREs ― not just for worker’s comp claims, but for tort claims as well.

MMSEA-111 [Medicare Secondary Payer Mandatory Reporting Provisions in Section 111 of the Medicare, Medicaid, and SCHIP Extension Act of 2007 (See 42 U.S.C. 1395y(b)(7) & (b)(8))] is designed to give the government the information it needs to collect on Medicare liens against, among other things, tort settlements and awards. For those of you who have no idea of what I’m talking about, the excruciating backstory of these rules can be found Here and Here. The government’s pathway into an abyss of Orwellian proportions can be found Here and download links Here . And, just so your attention doesn’t wander, the fines for non-compliance are $1,000 per day per claimant.

The key passage to determining who is an RRE in the 180-page MMSEA-111 guide is found on page 56:

The key in determining whether or not reporting for 42 U.S.C. 1395y(b)(8) is required for these situations is whether or not the payment is to the injured claimant/representative of the injured claimant vs. payment being made to self-insured entity to reimburse the self-insured entity. Where payment is being made to reimburse the self-insured entity, the self-insured entity is the RRE for purposes of the payment made to the injured individual and no reporting is required by the insurer reimbursing the self-insured entity.

Thus, if you have a self-insured retention or “indemnify,” rather than “pay on behalf of,” insurance policies, you are the RRE, not your insurers.

Fortunately, most implementation deadlines have been delayed. However, the registration period has already begun and must be completed by Sept. 30, 2009. An impenetrable “Quick Reference Guide” to registration can be found Here.

Testing begins in the first quarter of 2010 and substantive reporting in the second quarter.

Substantive reporting, as opposed to testing, begins in the first quarter of 2010. To paint with the broadest possible brush, RREs must report claims

where the injured party is/was a Medicare beneficiary, that are addressed/resolved (or partially addressed/resolved) through a settlement, judgment, award or other payment on or after July 1, 2009

Why? Because the government wants a piece of the action. The way to get it is to require the people who pay those settlements or judgments to report every possible fact that the government can possibly imagine.

How do you know which claims to report?

RREs must implement a procedure in their claims review process to determine whether an injured party is a Medicare beneficiary. RREs must submit either the Social Security Number (SSN) or Medicare Health Insurance Claim Number (HICN) for the injured party on all Claim Input File detail records. RREs are to report only with respect to Medicare beneficiaries (including a deceased beneficiary if the individual was deceased at the time of the settlement, judgment, award or other payment). If a reported individual cannot be identified as a Medicare beneficiary based upon the information submitted, CMS will reject the record for that individual. … It is not acceptable for an RRE to send information on every claim record without regard to the injured party’s Medicare status. CMS will monitor ongoing Claim Input File submissions to make sure that RREs have implemented a procedure to reasonably identify an injured party as a Medicare beneficiary rather than dumping their entire set of claims to satisfy Section 111 reporting requirements.

Plaintiff and defense lawyers will have to collect necessary information to satisfy the government’s appetite either formally during discovery, or informally in connection with settlement negotiations. The government is seeking more than 100 fields of data for each claim that has to be reported.

This post just skims the surface. I see expensive consultancies lining up to help … for a small fee of course.

What Obama's Proposed Financial Regulatory Reforms Mean for Insurance -- The New Office of National Insurance

Ann Kramer — Wed, 17 Jun 2009 10:46:01 -0800

This post was written by Paul Walker-Bright.

On June 17, 2009, the Department of the Treasury released its “white paper” detailing proposals for comprehensive reform of financial industry regulation, entitled “Financial Regulatory Reform, A New Foundation: Rebuilding Financial Supervision and Regulation.” The entire report can be found here. Among the reforms advocated by the Treasury Department is the creation of an Office of National Insurance within the Department. Treasury, which would “gather information, develop expertise, negotiate international agreements, and coordinate policy in the insurance sector.”

The ONI would be responsible for “monitoring” all aspects of the insurance industry, but would have no regulatory authority or oversight. This may come as a disappointment to advocates of an optional federal charter for the regulation of the insurance industry, as it leaves in place the current state-controlled regulatory scheme. According to media reports, the Obama administration does not want to push for federal regulation at this time, given the deep divisions within the insurance industry over the need for such regulation, and the consequent political fight that undoubtedly would develop.

However, the text of the white paper indicates that the Treasury Department may not be thrilled with the current regulatory paradigm, and may intend to use the ONI to push for better regulation of insurance. For example, the white paper takes this swipe at state regulation:

For over 135 years, insurance has been primarily regulated by the states, which has led to a lack of uniformity and reduced competition across state and international boundaries, resulting in inefficiency, reduced product innovation, and higher costs to consumers.

Treasury then states that it will support proposals to “modernize and improve our system of insurance regulation” based on six principles:

Effective systemic risk regulation with respect to insurance;
Strong capital standards and an appropriate match between capital allocation and liabilities for all insurance companies;
Meaningful and consistent consumer protection for insurance products and practices [a federal bad faith and unfair claims handling practices act?];
Increased national uniformity through either a federal charter or effective action by the states;
Improve and broaden the regulation of insurance companies and affiliates on a consolidated basis, including those affiliates outside of the traditional insurance business [e.g., AIG’s Financial Products Division, responsible for selling the credit default swaps that sank AIG];
International coordination.

Moreover, the white paper notes that the European Union recently passed legislation that will require a foreign insurance company operating in its member states to be subject to supervision in the company’s home country comparable to the supervision required in the EU. Treasury proposed that the ONI will work with other nations to meet this requirement.

Thus, it appears that Treasury intends to take a much more active role in the oversight of the insurance industry, and will use the ONI as a means to push for further regulatory reforms, up to and including a possible eventual federal charter. Rumors of the death of federal regulation of insurance may be greatly exaggerated.

A copy of the White Paper, titled "Financial Regulatory Reform: A New Foundation" can be found Here (discussion of ONI begins on p.40) and President Obama's statement can be found Here.

Third Circuit Misses the Mark in CPB International

Ann Kramer — Tue, 16 Jun 2009 09:29:36 -0800

This post was written by Douglas R. Widin.

Recently, the Court of Appeals for the Third Circuit decided Nationwide Mutual Insurance v. CPB International, Docket No. 07-4772 (April 14, 2009). CPB supplied chondroitin to Rexall for use in compounding tablets, including chondroitin and glucosamine. CPB supplied two batches of chondroitin that turned out to fall short of contractual specifications and to contain impurities. By the time these defects were discovered, Rexall had already compounded the CPB-supplied material with glucosamine, so that both compounds had become useless.

In the lawsuit that ensued, Rexall brought a claim for breach of contract against CPB seeking return of the purchase price it had paid for the first batch, and also seeking consequential damages for the damage to the glucosamine and economic losses. CPB tendered that claim to its CGL carrier, Nationwide, which defended under a reservation of rights and also brought a declaratory judgment action to avoid any duty to defend or indemnify.

The Third Circuit held in favor of Nationwide and discharged it from any coverage obligations.

The court first observed that the matter clearly involved a claim of property damage, so it didn’t focus on that issue. It then examined the claim made by Rexall against CPB and concluded it was solely based on breach of contract. Turning to the crux of the coverage issues, the Third Circuit, premised on the Pennsylvania Supreme Court's decision in the Kvaerner case [Kvaerner Metals Div. of Kvaerner US, Inc. v. Commercial Union Ins., 908 A.2d 888 (PA 2006) determined that the simple allegation of delivery by CPB of defective chondroitin was an allegation of faulty workmanship that is not covered by the CGL policy. The Third Circuit went further than Kvaerner, however, deciding that, since faulty workmanship is not sufficiently fortuitous to be an accident or an occurrence, the consequential damages flowing from the faulty workmanship, being the foreseeable consequences of that faulty workmanship, are also not an accident or an occurrence. Therefore, the court held that the consequential damages were also not covered. In conclusion, the Third Circuit wrote, "We are, therefore, confident that the Supreme Court of Pennsylvania would conclude that an underlying claim alleging breach of contract would not trigger coverage under a CGL policy."

Adding insult to injury, the court held as an alternative ground for denial of the claim that the contractual liability-exclusion of the policy applied. The policy at issue contained a standard contractual liability-exclusion stating that the "insurance does not apply to … ‘property damage’ for which the insured is obligated to pay by reason of the assumption of liability in a contract or agreement." We have all seen this exclusion in various forms many times. We all recognize that it is designed, as is often stated expressly, to apply to a situation where the insured assumes the tort liability of another in a contract, such as by giving an indemnity. The Third Circuit did not consider this reading of the exclusion at all. This leads to the most disturbing element of this case, which is that the court did not even consider the potential alternative reading of this exclusion, such that it is interpreted as only applying to assumption of a third party's liability. Instead, the court effectively turned the normal rules of insurance policy construction—ambiguities are construed against the insurer as drafter—on their head and gave the insurer the benefit of an inherently ambiguous policy provision.

Although the Third Circuit's decision is unquestionably flawed, denials of coverage by insurance companies for consequential damages based on this case can be anticipated. Policyholders faced with this should point out to their carriers that the CPB case is limited to purely contract-based claims, so any suit involving a tort claim should be analyzed differently.

Even more disturbing, the CPB case may well be invoked by first-party insurers by applying and interpreting faulty workmanship exclusions in a much broader sense in first-party claims. Finally, carriers will likely be pushing the limits of their contractual liability exclusions, even when based on more traditional phrasings than the one found in CPB, to try to preclude claims wherever there is a contract involved that forms any basis of the allegations of liability on the part of the insured. It is hoped that in the not too distant future, a case will come up in the Pennsylvania state court system that will provide the Pennsylvania Supreme Court with the chance to correct some of the Third Circuit's mistakes. Until then, however, policyholders will need to contend with the unfortunate and flawed decision in CPB.

2003 Blackout Held to Involve 'Property Damage' Sufficient to Support Claim Under Property Policy

Ann Kramer — Mon, 15 Jun 2009 11:05:18 -0800

This post was written by Douglas R. Widin.

On April 22 , 2009, the Appellate Division of the New Jersey Superior Court published its March 9, 2009 opinion holding that the massive Aug. 13, 2003 electrical blackout of the eastern United States and portions of Canada inflicted “property damage” sufficient to support a property insurance claim. The court held that the loss of functionality that resulted when protective safety equipment shut down the power grid and caused the blackout of August 2003 qualified as “physical damage” for property insurance purposes. See Wakefern Food Corporation v. Liberty Mutual Fire Insurance Company, No. A-2010-07T3 slip op (March 9, 2009). As a result, insurers were not entitled to summary judgment in their favor on Wakefern’s claims for food spoilage and business interruption at their supermarkets resulting from the blackout.

On Aug. 14, 2003, three sagging power lines contacted trees in northern Ohio and, ultimately, caused a cascading power outage in the Eastern Interconnection of North American power grid. The Eastern Interconnection encompasses the eastern two-thirds of the United States and much of Canada. The cascading outage was caused by successive overloading of portions of the grid as other portions were taken off-line by protective devices within the grid designed to prevent dangerous overloading and damage to equipment. The protective devices in the system performed their functions well and prevented destruction of the expensive transformers and other transmission equipment interconnected into the power grid, but those same protective devices also locked up this equipment and prevented it from being restarted for as long as four days after the outage began. This deprived customers of electricity for extended periods. “The event contributed to at least 11 deaths and cost an estimated $6 billion.”

Many businesses, including the supermarkets that were plaintiffs in Wakefern Food, suffered property and business interruption losses from the outage. The Wakefern Food plaintiffs claimed the cost of food spoilage and loss of business as a result of the power outage under their all-risk policies, which provided coverage for off-premises electrical power interruptions. That coverage applied “only if the interruption results: … [f]rom physical damage by a peril insured against.” The insurers denied the claims, stating that there had been no physical damage to the power grid apparatus, only a lack of operation. In the ensuing litigation, the Appellate Division overturned the trial court ruling in favor of the insurers, and held that the loss of functionality of the power grid equipment constituted “physical damage” for purposes of insurance coverage.

Undoubtedly, many policyholders faced similar denials of their property insurance claims arising out of the blackout. The general New Jersey contract statute of limitations is six years, so there is still a small window of time in which to challenge denials of coverage subject to that limitation period. Even in situations where there is a shorter suit-limitation period applicable to the insurance, there may still be a chance to challenge a denial, because New Jersey, as well as some other states, follows a practice whereby the statutorily mandated one-year suit limitation period in fire insurance policies is tolled from the time of reporting the claim to the insurer, until there is a definitive denial of the claim. If there was never any definitive denial, there may still be time remaining in which to resurrect the claim.

If you had a claim for damage to your property as a result of the 2003 blackout that was denied, it may be time to take another look.

The Future of Monolines?

Ann Kramer — Wed, 10 Jun 2009 14:07:18 -0800

Felix Salmon reads the tea leaves left by Warren Buffet and concludes that the already disastrous monoline situation is unlikely to improve any time soon. Money quote:

Given all these reasons to buy bonds rather than insure them, I do wonder what’s going to happen to the monoline market. Historically, it’s been a license to print money — but it might be a very long time before it re-emerges.

Read his entire post Here.

Remember, when Buffett’s Berkshire Hathaway Assurance Corp. rode in to rescue the imploding monoline municipal bond insurance market at the request of the NY Insurance Department? Now, after little more than a year in the business, Buffett wants out .

Berkshire Hathaway Assurance Corp. insured $3.3 billion of new long-term municipal issues in 2008, taking almost 5 percent of the insured market in its first year of business, based on data compiled by Thomson Reuters. In the first quarter of 2009, Berkshire’s share of insured municipal new issues shrank to 3 percent on $354 million of deals, the data show.

“We basically don’t like the pricing,” Buffett told reporters after a press conference in Omaha on May 3. “If you have the wrong pricing, you can lose a lot of money.”

Berkshire guaranteed $15.6 billion of existing debt in the secondary market and $3.7 billion in new issues, Buffett said in the annual letter.

Salmon’s analysis unpacks Buffett’s remark about pricing.

Most importantly, if Buffett has been buying up munis cheap in the secondary market, he’s probably getting much higher yields than he could ever charge in the primary market as an insurer. He might be able to charge a percentage point or two to insure an issuer against default, but I’m sure he can find munis for sale at spreads much wider than that.

Who Was Minding the Store?

Ann Kramer — Tue, 09 Jun 2009 07:23:47 -0800

For those of you interested in the role of regulators in the implosion of AIG [see prior posts Here and Here,] Planet Money (an award-winning joint project of NPR News and This American Life) had a fascinating program this past weekend: “The Watchmen”. Although it has already aired, it is available to listen to on-line or for download Here. The NPR News story is available Here.

The Office of Thrift Supervision comes in for the brunt of the criticism. Although I think they got it mostly right, IMHO they let the state insurance regulators off too easy. They were responsible for securities lending and didn’t stop it.

My favorite part is the tape of Supt. Dinallo and a bunch of assistants trying to figure out what proportion of AIG’s assets were regulated by the New York Insurance Department. The answer? 7 percent (ish).