Fooled by a Phisher; Business or Hobby; Hurricanes and Civil Authority Orders; Cat Bonds Come of Age

Aqua Star, a New York fish importer, received an email supposedly from one of its suppliers, a fish exporter in China, instructing Aqua Star to change the bank information it used to wire payments to the supplier. Aqua Star’s employees complied with the request. Unfortunately, the supplier’s computer had been hacked and the instruction came from the hackers not the supplier. Aqua Star wired $713,000 in payments to the new bank address before the fraud came to light. It was too late to reverse the transaction. Aqua Star’s only hope to recoup the $713,000 was its commercial crime policy with Travelers.

The commercial crime policy included Computer Fraud coverage which applies to loss caused by the fraudulent entry of electronic data into any computer system owned, leased, or operated by the insured. At first glance, it appears that Aqua Star had a valid claim. Not so, said Travelers. It pointed to an exclusion that eliminated coverage for losses caused, even in part, by an authorized user’s entry of electronic data into the company’s computer system. The court agreed with Travelers, ruling that the employee was clearly an authorized user. The fact that the employee was deceived by the email from the hackers did not trigger coverage. [1]

Is coverage available for such a loss? Yes, it is. There’s an ISO endorsement called “fraudulent impersonation coverage” (CR 04 17 11 15). Other insurers refer to it as “social engineering” coverage. I wrote about this coverage in the October 12, 2015 issue of the Insurance Advocate.

Fraudulent impersonation losses are all too common. Three of the first four items in a Google search for “cyber coverage for phishing loss” dealt with claims for multimillion-dollar fraudulent impersonation losses. Unfortunately it appears that $250,000 is generally the most coverage currently being offered. That may change. Nobody asked me, but insurers should be providing $100,000, $250,000, or the policy limit, if lower, as an automatic additional coverage for computer fraud with an option to purchase higher limits.

Your insureds should alert accounting personnel to watch out for email phishing fraud. More importantly, counsel clients to add fraudulent impersonation or social engineering coverage to their crime policies.

Homeowners Policies and Business Pursuits: Can a Hobby Be a Business?

In 2011, an Ohio couple, Annie and Samuel Bullock, bought a home on 10.5 acres that included a pool house and an unused barn. In 2012, Annie surprised Samuel with a gift of chicken and turkey chicks. Most such gifts wind up in the garbage pail, but the Bullocks were the exception. They liked raising chickens and turkeys. In 2013, they bought three or four hundred more chickens, plus 75 turkeys and bought more still in 2014. They sold the eggs at their church, from their home, and at a farmer’s market where they rented space.

In 2014, the barn burned down. The Bullocks submitted a claim to Erie Insurance. The claim was denied by Erie, citing the exclusion of structures used for a business. The policy defined business as “a trade, profession or occupation engaged in on a full-time, part-time or occasional basis.” (That’s standard ISO wording.) The Bullocks sued.

The Bullocks didn’t record their sales and didn’t keep bills or receipts. To them, it was a hobby; a wholesale chicken butcher was interested in having them raise chickens for him, but they turned him down. Samuel Bullock testified that it was “just for fun” and that it “helped me cope with PTSD.” Furthermore, he was not making any money based upon the costs of the operation. They did obtain the required licenses from the Department of Agriculture and registered with the County Health Department using the name “Nickel Plate Farms.”

The Bullocks lost. The court ruled that there was “no genuine issue of material fact as to whether appellants’ operation was a business pursuant to the definition provided in the homeowner’s insurance policy.”[2]

PRACTICE POINT: Make clients aware that what they think of as a hobby can be a business that can trigger a policy exclusion. Second, when you get information about a hobby that may cross the line into a business, alert your clients of potential insurance problems. An interesting sideline of this case is that the Bullocks called their agent to ask about liability coverage should someone become sick from eating the eggs. The agent told them that their homeowners policy would not cover that exposure. That should have set off an alarm about the application of the business pursuits exclusion to a property loss. The agent was sued for not having the policy amended, but the Bullocks lost that claim also. But, even an E&O claim that you win is a blemish on your record and your reputation.

Hurricanes and Civil Authority Orders

Governor Cuomo orders evacuation of beach-front towns on Long Island due to an impending hurricane. (Governor Christie shuts down the George Washington Bridge.) Most everyone remembers Sandy and evacuates. Businesses can’t operate; there are no employees and no customers available.

Those fortunate enough, or smart enough, to have business income insurance call their insurance advisers who in turn scramble to read the policy.

If it’s the current version of ISO’s business income form or one of the many forms patterned on ISO, here’s what they find:

When a Covered Cause of Loss causes damage to property other than property at the described premises, we will pay for the actual loss of Business Income you sustain and necessary Extra Expense caused by action of civil authority that prohibits access to the described premises, provided that both of the following apply:

(1) Access to the area immediately surrounding the damaged property is prohibited by civil authority as a result of the damage, and the described premises are within that area but are not more than one mile from the damaged property; (emphasis added) and

(2) The action of civil authority is taken in response to dangerous physical conditions resulting from the damage or continuation of the Covered Cause of Loss that caused the damage, or the action is taken to enable a civil authority to have unimpeded access to the damaged property.[3]

The requirement that property within one mile of the insured’s property be damaged to trigger coverage was introduced in the 2007 revision of the form. Prior to that there had been court decisions allowing civil authority claims for hurricanes that never made landfall in the US, but did do damage in other countries.

A test: In which of the following situations would there be coverage for the loss of business income sustained by insureds with coverage provided by ISO Business Income and extra expense form CP 00 30 10 12 and Basic, Broad or Special Perils coverage?

1. The hurricane veers offshore with only heavy rain and some coastal flooding. There is no wind damage.
2. The hurricane materializes, and damages property a mile-and-a-half away from the insured’s premises.
3. The hurricane materializes and damages property adjacent to the insured’s premises, but because there’s no problem with access to the area, the state does not issue any further orders to evacuate.

The answer, of course, is none of the above. (For coverage under scenario one, your insureds need flood as a covered peril. And Federal flood coverage won’t do. It doesn’t cover business income losses.)

ISO homeowners policy language is different and probably worse for the insured:

Here’s the wording from ISO HO 00 03 05 11 (the other current ISO HO forms contain similar language):

3. Civil Authority Prohibits Use

If a civil authority prohibits you from use of the “residence premises” as a result of direct damage to neighboring premises by a Peril Insured Against, we cover the loss as provided in

1. Additional Living Expense and
2. Fair Rental Value above for no more than two weeks.

Note that instead of a one-mile requirement, it’s damage to “neighboring premises.” In our part of the world, most insurers would define “neighborhood” as much less than a one-mile radius. I don’t know about the wilds of Alaska. Also notice that coverage is limited to two weeks.

Some insurers of commercial property (but not ISO) provide what is known as “ingress/egress” (entry and exit) coverage. One such endorsement reads:

Loss of Ingress or Egress:

This policy covers loss sustained during the period of time when, as a direct result of a peril not excluded, ingress to or egress from real and personal property not excluded hereunder, is thereby prevented.

Not the most felicitously worded endorsement, but it would provide coverage when, for example, trees blown down by a windstorm block the roads leading to or from the insured’s premises. If a policy providing flood coverage has ingress-egress coverage, it would respond when roads are washed out, something that might shut down an insured for a long time.

ISO endorsement  Civil Authority Change(s) CP 15 32 06 07 can extend both the radius of coverage and the number of days of coverage for civil authority losses. Thirteen square blocks surrounding the World Trade Center were closed for more than two months following 9/11. Insurers may resist extending the coverage, but if you can get it, it’s another way for you to stand out in the eyes of your clients.

Cat Bonds Come of Age

Catastrophe bonds have been around since the 1990s. They are designed to tap the credit market to provide reinsurance to insurance companies or to directly insure entities looking to manage their own risks. An example of the second use of cat bonds was the sale of $200 million in bonds issued by the Metropolitan Transit Authority to cover the damage NY City’s transit system might suffer from another Sandy.

Today there are $72 billion in cat bonds outstanding. The bonds outstanding amount to 12% of the capital invested in the reinsurance business.[4] The increase in capacity is creating downward pressure on reinsurance rates. Cat bonds are attractive because of the low interest rates available on traditional investments; cat bond purchases receive higher interest rates to compensate purchasers for the possibility that they may lose their investment should the stipulated catastrophe materialize.

Reinsurers argue that they are more reliable sources for protection. To evaluate that assertion, Standard & Poors examined 13 cat bond issues that made claim payments. They found “no evidence that cat bonds lack the ability or willingness to pay claims in a timely manner.”[5]

Should Insurers Look First for Coverage not Exclusions?

Gene Killian, a New Jersey attorney who frequently represents policyholders in claims against their insurers, publishes an interesting blog. In his July 6, 2016 posting he quotes this from a Travelers 1980-era claim handling manual: “Ambiguity…means that the words are capable of being understood in two or more reasonably logical ways. Ambiguity should be resolved in favor of the insured. Prompt decisions must be made and effectively communicated to the insured. Defense obligations are broader than the obligation to pay. More and more jurisdictions require the insurer to look beyond the allegations in a lawsuit to determine if the loss is covered. Underlying these principles is the requirement to meet the duty of good faith to the insured. The most positive way to do that is to look for coverage in our policies, and not to look for ways to deny coverage.’”  (Emphasis his.) Those were the days.

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[1] Aqua Star (USA) Corp v. Travelers Casualty and Surety Company of America, No. 2:2014cv01368 – Document 101 (W.D. Wash. 2016)

[2] Erie Insurance Exchange v. Samuel E. Bollock, etal. Court Of Appeals Stark County, Ohio Fifth Appellate District 2015-Ohio-5406.

[3] Business Income (and Extra Expense) Coverage Form  00 30 10 12 © Insurance Services Office, Inc., 2011

[4] Leslie Scism and Anupreeta Das, “Catastrophe Bonds Shake Up Insurance Industry” The Wall Street Journal August 7, 2016. (This comparison understates the capacity of standard reinsurance. $1 of capital held by a reinsurer can support as much as $2 or more of insurance writings; cat bond protection is limited to the face amount of the bond.)

[5] “Cat Bond Payments Match Traditional Reinsurers on Reliability Scale: S&P” Carrier Management August 31, 2016