Court Rules for the Insured in First Late Notice/Prejudice Case; Expand Contingent Bi/Dependent Properties Cover For Your Clients; Short Takes: Large Exposures

Court Rules for the Insured in First Late Notice/Prejudice Case

In what may be the first appellate court case involving the 2009 New York law requiring the insurer to show that it was prejudiced by the insured’s giving late notice of an occurrence, the Fourth Judicial Department1 ruled in favor of the insured. The decision highlights the difficulties insurers will have in denying coverage for liability claims in New York due to late notice.

On July 29, 2012, Lisa Slocum was riding in a car that was struck in the rear by another vehicle. On September 11, 2012, Lisa (probably through her attorney) found out that the policy covering the car that hit hers had a $50,000 limit. On June 6, 2013, she underwent cervical fusion surgery. She was entitled to underinsured motorist coverage via her mother’s Progressive Northwestern auto policy.

In August, 2004, more than two years after the accident, Lisa notified Progressive of the accident and sought coverage under the supplemental uninsured/underinsured motorist (SUM) endorsement of the policy. Progressive disclaimed coverage due to late notice and Lisa started suit. The lower court rejected Lisa’s motion for summary judgment and Lisa appealed.

The policy required that the insurer be given notice of an occurrence as soon as practicable. The appellate court held that meant “with reasonable promptness after the insured knew or should reasonably have known that the tortfeasor (wrongdoer) was underinsured,”2 and that Lisa did not meet that requirement. However, the court further ruled that Insurance Law § 3420 (a)(5) added the requirement that the insurer show that it was prejudiced in order to deny liability for late notice.

Progressive submitted an affidavit from one of its claims representatives stating “that it was prejudiced because of its inability to examine the vehicles involved in the accident,” and that the insurer “suffered prejudice because it was unable to conduct an examination under oath or an independent medical examination of plaintiff before she underwent cervical fusion surgery in June 2013.”3 The court decided that the cars would have been repaired in the time between the accident and the date that plaintiff was required to give notice under the policy. With regard to Progressive’s loss of the opportunity to conduct an independent medical exam, the court concluded that Progressive failed to show that post-surgery examinations and medical records would not yield the information. Obviously, prior to the new law requiring the insured to show prejudice, the court would have ruled in favor of Progressive.

There was an interesting complication in this case. The amended law provides that after two years, the burden of proof shifts to the claimant to prove that the insurer was not prejudiced, rather than the insurer having to prove that it was prejudiced. Satisfying the burden of proof in a matter as subjective as prejudice is difficult. Progressive argued that the two years should start with the date of the accident. The court ruled, as noted above, that the two years starts when the claimant should have known that the other party was underinsured. The appellate court ruled in Lisa’s favor. Many insurance attorneys feel it will be difficult for insurers to win late-notice cases in New York if the report is made before the end of two years, when the burden of proof shifts to the insured.

Expand Contingent BI/Dependent Properties Cover for Your Clients

The insurance industry is tripping over its terminology. When you talk to clients about Contingent Business Interruption and Dependent Properties coverage, do you get anything but a blank stare? Two names for the same, and to the public, undecipherable coverage. “Dependent properties” is the new name for what the industry has long referred to as contingent business interruption coverage. It has the advantage of being somewhat decipherable ? when you explain it to clients, they should have some idea how the name came about. I defy anyone to find any relationship between the title “contingent business interruption” and the coverage. After all, every insurance coverage is contingent. Fire insurance coverage is contingent on fire damaging the property.

By whatever name you refer to them, dependent property or contingent business interruption4 are widely-overlooked coverages that result in large uninsured losses even for large insureds that have sophisticated brokers and/or skilled risk management departments. A case in point is a loss sustained by DIRECTV.5

DIRECTV provides digital entertainment via satellite. Its satellite dishes pick up signals and transmit them to a DIRECTV set-top box (or “STB”), which is linked to the subscriber’s television. DIRECTV demonstrated good risk management diversification by contracting with four different manufacturers to produce the STBs. However, it turned out that all four depended on just two firms, Western Digital and Seagate, to supply the hard drives that were the key part of the STB. DIRECTV knew that the hard drives were manufactured by just the two firms as it discussed specifications and components for the drives with them. However, DIRECTV had no contracts or agreements with the hard drive manufacturers.

In October 2011, extensive flooding, caused by the monsoons that year, severely damaged Western Digital’s hard drive manufacturing plant in northern Thailand. Western Digital was able to make up some of the lost manufacturing capacity by overtime work in its plant and DIRECTV was able to get some additional drives from Seagate. DIRECTV calculated that the resulting price increase for Western Digital hard drives and the expense of obtaining substitute drives from Seagate, cost DIRECTV approximately $22 million in extra expense. It looked to its insurer, Factory Mutual, for coverage for the loss.

DIRECTV’s policy included coverage for business income and extra expense losses resulting from damage to facilities of direct suppliers. But Factory Mutual said that coverage did not apply to losses resulting from damage to those firms that supplied the suppliers. DIRECTV sued.

DIRECTV argued that the phrase “direct supplier” should be defined according to its usage in the electronics supply chain industry. However, the court pointed out that DIRECTV provided no evidence that the parties intended “direct supplier” to have some technical or industry-specific definition, nor was there any usage of that phrase either within or outside the policy that would suggest a definition other than the ordinary and popular one. Furthermore, the court noted that the policy does include specialized definitions such as “location,” “occurrence,” “wind,” “earth movement,” “flood,” “terrorism,” “contamination” and others, as well as definitions of less common phrases such as “soft costs.” The court concluded that “The fact that ‘direct supplier,’ in contrast, is not defined anywhere in the policy suggests that the parties did not intend the term to carry any technical or specialized meaning.”6

Apparently DIRECTV had contingent business interruption coverage, but did not have coverage for secondary dependencies. ISO introduced secondary dependency coverage in 2013 to cover business income and extra expense loss resulting from damage at secondary contributing and recipient locations not listed for dependent coverage. A secondary dependent location is defined as follows:

“Secondary contributing location” is an entity which:

a. Is not identified in the Schedule;

b. Is not owned or operated by the Contributing Location identified in the Schedule; and c. Delivers materials or services to the Contributing Location identified in the Schedule, which in turn are used by that Contributing Location in providing materials or services to you.

A road, bridge, tunnel, waterway, airfield, pipeline or any other similar area or structure is not covered as a “secondary contributing location.” Nor are water supply services, power supply services, wastewater removal services, communication supply, Internet access, and network access services.

Coverage is similarly available for secondary recipient locations that receive materials or services from a recipient location identified in the schedule. An example should clarify these points; DIRECTV’s operations provide examples of both secondary contributing and secondary recipient locations. It’s two sides of the same coin.

From DIRECTV’s point of view, Western Digital is a secondary contributing location; Western Digital manufactures hard drives that others incorporate into the product that DIRECTV needs. Vice-versa, from Western Digital’s point of view, DIRECTV is a secondary recipient location; DIRECTV purchases a product from others that incorporates the hard drives manufactured by Western Digital. Such coverage would be triggered by damage to DIRECTV’S facilities that prevented DIRECTV’s direct contributing location from selling it set-top boxes that incorporated Western Digital’s hard drives.

Thus, DIRECTV and Western Digital can sustain business income and extra expense losses by damage to property owned or operated by the other, even though they have no direct or contractual relationships.

However, ISO’s Dependent Property form would not have applied to DIRECTV’s loss in this case. ISO’s form does not apply to losses that occur outside the policy’s coverage territory. ISO does offer limited international coverage in another endorsement (CP 1501 1012 Business Income From Dependent Properties Limited International Coverage). But it is, as the title implies, limited coverage.

Factory Mutual and others can provide worldwide coverage and other enhancements, including contingent or dependent property direct and secondary coverage. Factory Mutual offers a coverage they call Contingent Time Element Extended (CTEE). The title is not exactly a model of clarity, but the coverage would apply to the DIRECTV loss. It states that “It’s unique in the marketplace—the only contingent time element coverage that extends, without limit to the length of the supply chain, beyond your direct suppliers and customers.”7

Apparently, DIRECTV’s Factory Mutual policy didn’t include CTEE. I haven’ t been able to determine if it was offering it at the time of the loss or if DIRECTV didn’t buy it. Either way, I’m surprised.

It’s true that ISO did not have an endorsement to provide that coverage until 2013. However, Factory Mutual prides itself on offering superior coverage and caters to large enterprises that are more likely to have the exposure that the typical ISO insured. As to DIRECTV, it had risk management professionals on staff even before their incorporation into the AT&T behemoth. Risk managers should have spotted the gap.

PRACTICE POINT: You’re probably already asking about suppliers, customers, etc. on which the insured is dependent. Now add this question to your fact-finding interview: are any of your suppliers, customers etc. themselves dependent on their own suppliers or customers?

Short Takes on Significant Topics: Large Exposures

Big losses catch the insured’s attention. Watch for them. Here are three that I saw in the April 6th online edition of “Advisen Front Page News.”

Flooding

“The concrete block perches absurdly atop a piling, elevated about 10 feet above the beach sand. Is it art? A bulky milepost?” That’s the opening sentence in a NY Times Online posting about erosion at the Kennedy Space Center at Cape Canaveral.8 The block was once at grade level to secure antenna towers and was 150 feet from the shoreline. Now the block is 10 feet in the air and just 10 feet from the shoreline.

Florida has 72 miles of ocean front, but New York, New Jersey and Connecticut have lots to worry about also. For clients, risk management theory dictates combining insurance with loss control whenever possible.

A suburban New York school district has had two flood losses in the past 10 years that caused $25 million in damages in total. In partnership with the municipality, they are building a pumping- and holding-tank system. The school district is contributing the land for the tanks and about $1,000,000 to fund the project. In addition to avoiding the cancellation of classes and the sturm und drang that follows a major flood, they’re hoping to lower their insurance cost.

Theft

Huge theft losses still occur.In the middle of the night of March 14, 2010, in what sounds like the plot of a Hollywood movie, thieves broke through the roof of an Eli Lilly warehouse in Enfield,CT, rappelled to the floor, disabled the alarm system, and loaded more than $42 million worth of prescription drugs onto a truck they had parked at a loading dock. The roof area and the loading dock were the only areas not covered by security cameras. The gap had been identified in a security survey by Tyco (formerly ADT) which provided alarm service for the Eli Lilly building.In a no-good-deed-goes-unpunished scenario, Eli Lilly’s insurer, National Union, sued Tyco as subrogee of Eli Lilly. It was the report of the lawsuit, which National Union lost, that alerted me to this incident.9

Another School District Flood Loss – This Time Under Insured.

A school district in Deweyville, Texas faces an $11.5 million shortfall in its flood insurance coverage.10 Although the district carried a $30 million property policy, school officials were shocked to learn that the flood coverage was sub-limited to a much lower amount. Four hundred homes in the

town were also caught in the flood and most of them were entirely uninsured. There are many markets that offer excess flood coverage. They should have looked for them.

PRACTICE POINT: Be sure clients are aware of policy sub-limits. In addition to helping your clients, you may sell added coverages that your clients need. What’s more, you’ll avoid irate clients and E&O claims at the same time.

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