NC legislative retirements present challenges for captive insurance industry

The North Carolina House of Representatives and Senate will undoubtedly see leadership changes in 2016 because several senior leaders and incumbents have already announced they are not standing for re-election.  Additionally, some of the lawmakers in Raleigh who were involved in the initial passage of captive insurance legislation in North Carolina in 2013 have stepped down from the legislature in the past two years.  The cumulative result is that the captive industry will have at least a half-dozen new faces on Jones Street in 2016 to introduce and explain captive insurance to. 


Notably, Senator Tom Apodaca, current co-chair of the Senate Standing Committee on Insurance and Chair of the Senate Rules Committee, has announced his retirement.  Additionally, Senators Bob Rucho (Mecklenburg), and Josh Stein (Wake County) have also announced they will not be standing for relection.  Josh Stein has announced he will be running for Attorney General.


In the House of Representatives, one of the original sponsors of North Carolina's captive insurance enabling act, Rep. Paul Tine (Dare County) will be stepping down.  Additionally, Leo Daughtry (Johnston County) and Paul Stam (Wake County) have both announce their retirement from the General Assembly as well.   


Each of these six lawmakers supported North Carolina's initial foray into captive insurance in 2013 and technical corrections bills in 2014 and 2015.  Their replacements - regardless of party affiliation - will likely have to be educated regarding the benefits to North Carolina and middle market businesses which the captive insurance industry has brought to the state. 

Cyber insurance tips, courtesy of Lloyd's of London

On November 9th, Lloyd's of London issued a market bulletin to its syndicates on managing catastrophe-risk and exposures.  While the memo is directed at the syndicates which make up the Lloyd's insurance market and in assisting those syndicates in managing their cyber exposure (and the accumulated cyber exposure risk to the entire Lloyd's market), it also provides some insight into how this insurance market leader believes its constituents should be approaching cyber insurance. 

The memo's guidance can be applied to business owners and purchasers of cyber insurance as well.

The memo suggests that the syndicates "create and develop their own lists of 'plausible but extreme' types of cyber-attack scenarios, with associated lines of business that may be affected."  This is good advice for anyone purchasing cyber insurance.  It is important for policyholders to understand what types of cyber attacks would most effect their business, what is the possible scope and scale of the attack, and what is the possible expense.  With that information, a business can plan for what types and how much insurance to purchase.

For example, the memo also notes that "there are different types of cyber-attack, which could cause different types of harm: denial of service, data-theft, data-damage, reputational harm, physical damage etc.  The economic damage for each type may differ, with consequences including direct financial loss, bodily injury or property damage."  These are just some of the questions that businesses should be asking themselves when considering the purchase of cyber insurance.   

Nearly half of cyber claims come from Middle Market companies

The recently released NetDiligence 2015 Cyber Claims Study illuminates the data breach dangers for Middle Market* companies. 

Unlike many other cyber-risk studies, this one is focused on insured claims and insurance claims payments. 

Along with a great infographic, the study showed that:

• Nearly half (43%) of the reported cyber insurance claims came from Middle Market companies.
• "Insider involvement" was responsible for more losses than outside hacking
• While Middle Market and smaller companies accounted for 71% of claims, they were responsible for only about a third of records exposed.  While smaller companies may be more prone to data breaches, they typically house less records.
• The per-record cost of response for the last two years has been in the range of $955 to $965.

*Although there are different definitions of Middle Market, for the purposes of this post, I used the $50 million to $2 billion in annual revenues definition. 

Scottsdale Ins. Co. v. B&G Fitness Center, Inc. - when is the injured plaintiff an indispensable party to a coverage action under Rule 19?

A common question in insurance coverage litigation is whether the injured plaintiffs in the underlying litigation are necessary parties to the coverage case. A recent, detailed opinion from Judge Fox in the Eastern District of North Carolina squarely deals with this issue and lays out a roadmap for dealing with the issue in future cases. Judge Fox concludes that the underlying plaintiffs are not necessary parties to the coverage action.  Whether the plaintiffs from the underlying litigation are necessary to the insurance coverage action - between the defendant from the underlying action and its insurance company - has broad implications for many procedural questions, as well as strategic implications.   


In Scottsdale Ins. Co. v. B&G Fitness Center, Inc., 2015 WL 4641530 (Aug. 4, 2015 E.D.N.C.), the defendant had been sued by five plaintiffs in two separate lawsuits regarding alleged surreptitious video recording in the tanning bed area of a gym (the “Underlying Actions”). Scottsdale, the insurer, then filed a declaratory judgment action in federal court, seeking a declaration that there was no coverage under its insurance policy for the torts alleged in the Underlying Actions.


The defendant, the policyholder gym who had been sued in the Underlying Actions, moved to dismiss the case under Federal Rule of Civil Procedure 12(b)(7) for the failure to join the five individual plaintiffs from the Underlying Actions as co-defendants, arguing that these were necessary parties to the insurance declaratory judgment action under Rule 19.


The Court first explained that whether a party is indispensable under Rule 19 requires a two-step inquiry. The party must be “necessary” under Rule 19(a) and if the “necessary” party cannot be joined, the party has to be determined to be “indispensable” under Rule 19(b). The moving party – here, the gym defendant – bears the burden of showing that the missing party is indispensable. The gym argued that the underlying plaintiffs were both necessary and indispensable because under Rule 19(a)(1)(B)(i) they claimed an interest in the action and that interest would be defeated or impeded by the failure to join them to the coverage action.


Judge Fox concluded that the underlying plaintiffs were, “at best, incidental beneficiaries to the insurance contract at issue” and because they were not parties to the insurance contract and did not already have a judgment against the gym, they lacked standing to have the insurance contract construed. See also, Whittaker v. Furniture Factory Outlet Shops, 145 N.C. App. 169, 172 (2001). “Without having obtained a judgment or settlement against [the gym], the third party claimants have no legal rights under the insurance contract. Because the third party claimants lack a recognized legal interest in this action, they cannot be necessary parties.” B&G Fitness Center, Inc., at *4. Judge Fox further concluded that, even if the plaintiffs from the Underlying Actions had an interest in the coverage litigation, it was aligned with the gym – they both were seeking insurance coverage under the Scottsdale policies – and thus the gym would adequately represent the interests in maximizing the insurance recovery available for the plaintiffs. In other words, only “when the insured was not actively defending the lawsuit” or is subject to a default judgment is it proper to hold that the absent third-party is indispensable. Id. at *5. But as a normal matter, “the insured’s position protects the interest of the absent party because both parties want the insurance to be viable.” Id., citing CFI Wis. Inc. v. Hartford Fire Ins. Co., 230 F.R.D. 552, 554 (W.D. Wis. 2005).


The question of whether underlying plaintiffs must be joined in the coverage action has to be considered in every coverage action. And, the outcome of this determination may be different in different jurisdictions. There are a number of federal cases from other jursidictions which hold that absent third-party tort plaintiffs are required to be joined under Rule 19. B&G Fitness is ongoing and it remains to be seen whether Judge Fox’s decision will be appealed or reviewed by the Fourth Circuit.


This question also has major implications for whether the coverage action can even succeed in federal court. Sometimes, a single federal district court may not be able to obtain personal jurisdiction over (1) the insurer, (2) the insured, and (3) the underlying tort plaintiffs. Even if a federal district court has adequate personal jurisdiction, insurance coverage litigation in federal court is typically premised on diversity jurisdiction under 28 U.S.C. § 1332. In some cases, that diversity jurisdiction only exists in the absence of the underlying plaintiffs; i.e., if the underlying plaintiffs have to be joined as indispensable parties under Rule 19, and joinder destroys diversity, then the coverage action can only be litigated in state court. Those facts typically arise when the policyholder sues the insurance company, joining the underlying tort plaintiffs as defendants in the coverage action. Of course in that case, the insurance company could move to have the parties re-aligned to reflect the true adverse interests in the suit, in which case diversity may exist. See, e.g., Earnest v. State Farm Fire and Cas. Co., 475 F.Supp.2d 1113, 1117 (N.D. Ala 2007). I have previously written about the topic of realignment in coverage cases in the Fourth Circuit, which you can find here: http://www.law360.com/articles/396074/builders-v-dragas-an-important-reminder-for-insurers

 

All Risks Covered: what's in a (blog) name?

All Risks Covered is Womble Carlyle’s new blog devoted to business insurance issues in North Carolina. This includes commercial property insurance, commercial general liability insurance, employment practices liability, insurer bad faith, directors & officers insurance, agents and brokers issues, errors & omissions insurance, cyber insurance, captive insurance, and insurance regulatory matters.


The blog’s name, All Risks Covered, will sound family to anyone who has ever bought an “all risk” insurance policy. “All risk” was, for a long period of time, considered the desirable property insurance policy for homeowners and many small and middle-market businesses. But understanding “all risk” coverage means understanding some of the basics of property insurance.


An insurance policy is a written contract between two parties; the insurance company and the policyholder. A property policy obligates the insurance company to pay for certain losses if they fall within the scope of the policy, subject to certain exclusions and conditions. Because all commercial policies have some exclusions, even policies named “all risk” do not actually cover all possible risks. These policies are still subject to certain exclusions.


The use of “all risk” differentiates certain property policies from policies that only cover specific named risks. As a result, policies are either “named peril” or “all risk” (which is now often called “comprehensive” or “open peril” to avoid confusion and to account for the exclusions).


A named peril policy only provides coverage for risks which are specifically named in the policy. The quintessential example would be a 19th century fire insurance policy; that was a property insurance policy that insured a property owner against loss by “fire” but nothing else. Today, popular commercial property insurance named perils policies typically provide coverage for physical losses as a result of:

• Fire
• Lightning
• Explosion
• Windstorm or Hail
• Smoke
• Riot or Civil Commotion
• Sinkhole Collapse
• Volcanic Action

As a result, if a loss is sustained by perils which are available as additional coverage, such as “weight of snow, ice, or sleet,” “water damage,” or “flood,” those would not be covered under the named peril policy. Any recovery must fall within one of the named perils. However, because the insurance policy only covers certain discrete categories of risk, it will be less expensive to purchase compared to an “all risk/open perils” policy.


An “all risk” or “open perils” policy works in the opposite way. It is designed to cover all types of physical loss, only excepting items that are specifically excluded in writing by the insurer. In other words, the named peril policy is a contract of inclusion (future losses are only covered if they are specifically included) while an all risk or open perils policy is a contract of exclusion (all future physical losses are covered unless they are specifically excluded).


Because the scope of coverage for an all risk policy is so much greater, these policies are more expensive than a named perils policy. The choice between the two policy types is often dictated as much by the policyholder’s financial condition as anything else. Lenders often have specific insurance requirements to protect the collateral which secures their loans. If a lender requires your business to have a comprehensive, open perils policy, that is simply a reflection of the lender’s desire to protect their investment against a broader array of risks and accidents which could occur.
 

As a legal matter, if there is a dispute as to insurance coverage under a property policy, the burden of proof at trial is different between an all risk policy compared to a named perils policy. Under a named perils policy, the burden of proof is on the policyholder to prove that the loss falls within one of the specifically named perils contained in the policy. In contrast, under an all risk policy, the burden of proof at trial rests on the insurance company to prove that one of the exclusions applies.
  

As I mentioned above, there has been a shift in the industry away from using the term “all risk” for these policies because they do not literally cover all risks which a policyholder may face. Indeed, the scope of coverage is really determined by the exclusions (and any exceptions to the exclusions). Most all risk/open peril policies continue to have numerous exclusions, including flooding (which can include or exclude sewage backup), ground shifting or earth movement (which can include or exclude earthquakes, mine subsidence, and mudslides), nuclear hazards, government action, war, and many others.