Computer Fraud Is Not Cyber Coverage; FEMA to Buy Reinsurance; Flood Damage Not Restricted to Special Flood Zones; Late Notice Can Still Doom Liability Claims; Embezzlements Continue to Bedazzle; What is Vacant Land?

Computer Fraud Cover Is Not Cyber Coverage

Another sign of the increasing incidence of cyber fraud troubles is the frequent reports of insureds looking for coverage for cyber fraud under their crime coverage. (It also shows that many insureds lack cyber coverage.) A case in point is Apache Corporation v. Great American Ins. Co.[i]

Apache Corporation (Apache) is a Texas oil company. An Apache employee received a call from someone who identified herself as a representative of Petrofac, one of Apache’s suppliers. The caller asked that the bank account information Apache used to transmit payment to Petrofac be changed. Apache’s employee replied that a written change request was needed to make such change. In a few days, Apache received the change request letter attached to an email. The letter included a contact number. When Apache’s employee called the number in the request letter, she was advised to make the change, which she did.

That was a mistake. The call verifying the request to change payment information should be made to a previously established phone number, not the one included with the request for a change. Seven million dollars later, Apache found out that the payments had gone to someone other than its supplier. It was able to stop almost two-thirds of the payments before they were completed, but still suffered a $2.4 million loss.

When it investigated, Apache discovered that the email transmitting the written letter requesting the transfer came from @petrofacltd.com instead of @petrofac.com. (Would you notice such a discrepancy? Would your insureds?)

Apache didn’t have specific cyber fraud coverage. It did carry crime insurance that included computer fraud coverage. The computer coverage insuring agreement in its crime insurance read

“We will pay for loss of…money, securities and other property resulting directly from the use of any computer to fraudulently cause a transfer of that property from inside the premises…”

Apache submitted a claim arguing that the loss resulted from the use of a computer and should therefore be covered by computer fraud insurance. The insurance company declined coverage and Apache sued. The court held

“The email was part of the scheme; but, the email was merely incidental to the occurrence of the authorized transfer of money. To interpret the computer-fraud provision as reaching any fraudulent scheme in which an email communication was part of the process would…convert the computer-fraud provision to one for general fraud. We take judicial notice that, when the policy was issued in 2012, electronic communications were, as they are now, ubiquitous, and even the line between “computer” and “telephone” was already blurred. In short, few—if any—fraudulent schemes would not involve some form of computer-facilitated communication. This is reflected in the evidence at hand. Arguably, Apache invited the computer-use at issue, through which it now seeks shelter under its policy, even though the computer-use was but one step in Apache’s multi-step, but flawed, process that ended in its making required and authorized, very large invoice-payments…to a fraudulent bank account.”[ii]

Nice try, but no cigar. It was the invoices, not the emails or computer use that caused the loss. Therefore, there was no coverage. Apache needed cyber insurance. So do your clients.

FEMA to Buy Flood Reinsurance

FEMA has announced that it is buying reinsurance from Munich Re, Swiss Re, and Transatlantic Re to cushion the impact of future flood losses incurred by the National Flood Insurance Program. There will be two layers: the first is $1 million for flood claims that exceed $5 million and the second is another $1 million when flood losses from a single event exceed $5.5 billion. One or two million is, of course, almost a rounding error when talking about NFIP flood claims, but FEMA says it is starting small with this first risk transfer.

My question is: Why are they doing it at all?

There are many reasons insurers purchase reinsurance. Those commonly cited are:

Capacity Relief—Allows the reinsured to write larger amounts of insurance
Catastrophe Protection
Stabilization—Helps smooth the reinsured’s overall operating results from year to year.
Surplus Relief—-Eases the strain on the reinsured’s surplus during rapid premium growth
Market Withdrawal
Market Entrance
Expertise/Experience—Provides the reinsured with a source of underwriting information[iii]

Only catastrophe protection and stabilization would seem to offer any advantages to FEMA. In fact, for the US Government, it is really only stabilization. A typical insurance company also needs reinsurance if a loss would be big enough to break the bank. In that case, the reinsured needs the reinsurance to survive. But a flood loss large enough to bankrupt the US Government would also bankrupt its reinsurers many times over.

That leaves just stabilization as a rationale for the purchase. It’s hard to see the point in the US Government spending premiums to smooth fluctuations in flood losses. A reinsurer must cover its costs in addition to losses. Those costs include underwriting expertise, the cost of capital to support the risk and marketing expenses. I don’t see that these services have any value to the US Government. NFIP is not entering a new field—it has had years of underwriting experience. With regard to cost of capital, a reinsurer’s cost of capital is higher than that of the US Government. The Federal government can always borrow for less than even the most solidly capitalized reinsurer. Finally, paying for the reinsurer’s marketing costs only makes sense if FEMA needs the reinsurance.

FEMA/NFIP only needs reinsurance if you view it as an entity separate from the US Government, but they’re not separate any more than your right-hand pocket is separate from your left-hand pocket.

Flood Damage Isn’t Restricted to Special Flood Hazard Zones

A reader writes:

A friend lives in Portsmouth, VA and has USAA (she’s a retired vet). She got hammered by the last hurricane and is now dealing with big damage. She immediately contacted her agent who said “you have no flood insurance” (she’s not in a flood zone) and suggested she contact FEMA to “take out a loan.”

What stands out to me is “she’s not in a flood zone.” That’s a common misconception. One-third of NFIP flood losses occur outside of special flood hazard zones. We’ve got to get across that not being in a special flood hazard zone does not mean that you don’t need flood insurance.

Late Notice on Liability Claim—Who Has the Burden of Showing Prejudice?

There are lots of interesting twists in this case involving New York’s law that protects liability insureds from losing coverage for late notice.

Prince Plaza, a condominium in Flushing, NY, was sued by Fabrico Castillo, a contractor’s employee who claimed he was injured August 26, 2009 while working on construction of the Prince Plaza building. Castillo sued Prince Plaza and when it did not respond to the summons, he was awarded a judgment by default on January 9, 2012.

When it received a notice of the default, Prince Plaza notified its insurer, Century Surety, which denied coverage due to late notice. It would appear that Century had an open and shut case. The accident occurred in January, 2009 and it was not notified until February, 2012.

Not so fast. Prince Plaza argued that the notice was served via the NY Secretary of State—by statute the Secretary of State is an agent to receive service for corporations. The notice is then forwarded to the corporation. In this case, notice was never delivered to Prince Plaza because its address had changed. The court accepted Prince Plaza’s explanation. The court reopened the case on June 11, 2012, vacated the decision and restored the case to the calendar.

Century still denied liability, responding that under New York’s late notice law the burden to show that the insurer was not prejudiced shifts to the insured when notice is more than two years late.

However, the court ruled that the time limit to provide notice began not at the date of the accident, but when Prince Plaza would have received the notice if it had provided the Secretary of State with its address. That would have been in August 2011. Since Prince Plaza notified Century of the claim in March of 2012, the burden to show prejudice still fell on the insurer and the court felt that Century had not met its burden.[iv]

Once again, we see that late notice is not a thing of the past. Prince Plaza was lucky in this one, but change the dates just a little and it may have had to pay a substantial judgment on its own. However, Prince Plaza didn’t escape scot-free. There’s no coverage for costs of suing for coverage whether the insured wins or loses. Given that this case was heard both in a lower Court and the Appellate Division, the expense of just winning its suit for coverage was undoubtedly substantial. It shows that the burden of proof is just that: a burden.

Recent Embezzlements: They Keep on Stealing.

Good times or bad times, good weather or bad weather, they keep on stealing. Here are some recent embezzlements:

Pennsylvania Man Pleads Guilty to Stealing $1.8M from QVC Shopping Network. He did it the low-tech way—submitted phony invoices from an entity that was really just him. He was authorized to approve invoices. He approved them and the invoices were paid.[v]

Jericho Broker Pleads Guilty to Stealing More Than $800K in Insurance Premiums and Other Funds. The broker pocketed the insurance premiums and never made payment to the insurers. The stolen premiums amounted to $648,074.13. Perhaps the broker’s contract called for 100% commission.[vi]

The loss of premiums falls on the insurance company. In New York, payment of premiums to a broker is payment to the insurer. The insurer will have to chase the broker to get the money back.

What is Vacant Land?

Most homeowners’ policies include liability coverage for vacant land as part of the policy without any additional premium. The ISO HO form is clear; the definition of insured location includes “Vacant land, other than farm land, owned by or rented to an insured.” But what is vacant land?

The working definition used by most insurance authorities is land that has no man-made structures.

That definition has tripped up many insureds. It doesn’t correspond with what insureds may think. Writing in the Virtual University e-newsletter of the Big “I”, Mike Edwards listed numerous cases where courts have found that easily overlooked items were sufficient to classify land as not being vacant, including:

Acreage with a dock on a small pond,

Acreage with an abandoned well that was covered by a concrete pad,

Acreage with a road that had been constructed by a former owner.

The “other than farmland” part of the definition has also caused trouble. Mike cites some cases where the following were held to be “farmland” and therefore not covered by a homeowners’ policy:

Land on which the insured had permitted harvesting of the naturally growing alfalfa.

Pasture used for grazing cattle.[vii]

When an insured asks if there’s coverage for the vacant land he owns, beware. If possible, refer the question to the insurer; if not, cite the policy definition and point out that even slight man-made improvements or use as farmland can wipe out the coverage. After all, what can you expect for free?

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[i] Apache Corporation v. Great American Insurance Company U.S. Civil Court S.D. Texas 4:14-cv-00237 1/16/16

[ii] op cit.

[iii] “Functions of Reinsurance” A Basic Guide to Facultative and Treaty Reinsurance, Munich Re https://www.munichre.com/site/mram/get/documents_E96160999/mram/assetpool.mr_america/PDFs/3_Publications/reinsurance_basic_guide.pdf

[iv] Fabricio Ivan Hernandez Castillo, et al. v Prince Plaza, LLC, et al. NYS Appellate Division: Second Department (Index No. 18660/11) September 28, 2016

[v] Kurt Bresswein “QVC Manager From Lehigh Valley Pleads Guilty in $1.8M Scheme”, http://www.lehighvalleylive.com/news/index.ssf/2016/09/qvc_manager_from_lehigh_valley.html

[vi] Zachary R. Dowdy “Jericho Insurance Broker Pleads Guilty To Defrauding Clients”, http://www.newsday.com/long-island/nassau/jericho-insurance-broker-pleads-guilty-to-defrauding-clients-prosecutors-say-1.10926703

[vii] Mike Edwards “Insured’s Party Gives Her Insurance Agent Heartburn” Big “I” Virtual University http://www.independentagent.com/Education/VU/Insurance/PersonalLines/Homeowners/Definitions/EdwardsHolidayParty.aspx