Cyber Claims Insurance Protection is Tricky Business


PUBLISHED ON: November 20, 2015

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While the risks posed by data breaches are by now widely recognized, effective management of the risk is lagging. Statistics from PwC’s 2015 Global State of Information Security Survey indicate that concern about data breaches is up, yet half of all businesses have no plans to dedicate more resources to avert these perils. The purchase of dedicated cyber insurance products appears to be on the rise, but according to a new study from the Ponemon Institute many in the insurance brokerage community indicate that the marketplace is not yet as robust as one would expect given the staggering scope of recent data breaches and the ensuing headlines.1

Figuring out what kind of insurance is needed to respond effectively to cyber claims is challenging. For example, a recent decision from a federal court in Utah ruled that a Travelers CyberFirst liability insurance policy (marketed by Travelers as “a flexible approach to meet many of the specialty insurance needs of today’s innovative technology companies”)2did not cover a claim involving a corporate policyholder’s alleged failure to return stored data for a client. The trial court ruled that the policyholder was not entitled to a defense under the cyber liability insurance policy against a client lawsuit specifically alleging misconduct in the handling of data entrusted to the policyholder — a risk the policyholder likely thought it was buying insurance for. Travelers Property Casualty Company of America et al. v. Federal Recovery Services et al.3 The court not only found that the loss was outside the coverage of the policy, it held that there was no possibility whatsoever of coverage being triggered by the client’s claim. In short, given this court’s ruling, there was a complete disconnect between the allegations of the complaint and the language of the policy, indicating that the policyholder’s attempt to insure its cyber liability exposure by purchasing Travelers CyberFirst had been an utter failure.

Recent history teaches us further that the losses occasioned by cyber security breaches are not always predictable. The Sony Pictures breach is a prime example, as it imperiled or implicated in one fell swoop proprietary and intellectual property, employee personal information, sensitive management communications, reputation/goodwill, extortion, threats of bodily injury and business income.4 Now that hackers are extending the playing field of targeted data beyond the familiar categories of customer credit card numbers, addresses and health-related data, risk managers need to reprioritize certain protections5 (including insurance protection) that used to be lower down on the shopping list. For example, reputational and business income coverage becomes more important in hacks like that which targeted Sony Pictures.

Another example of the expanding risk involved a recent cyber attack on a European airline’s ground operations system that halted certain flight operations.6 Doubtless, this hack caused business interruption losses for the airline.

Further widening the scope of cyber claims, D&O insurance came into the picture last year after data breaches spurred derivative lawsuits against company directors and officers.7 While cyber insurance products are finally registering on the radar of senior corporate executives, D&O insurance policies remain nearest and dearest to directors’ and officers’ hearts. It is therefore essential that D&O insurance responds to suits targeting company managers and directors that have their genesis in data breaches.8

Purchasing adequate insurance coverage for technology-related insurance claims is challenging, as products lack uniformity and the claims history is thin. Following the 10 tips below will improve the chances of recovery from stand-alone cyber and D&O insurance policies.

1. Pursue Clarity

Buy an insurance policy that you can actually understand. Unfortunately, many cyber insurance policies are virtually incomprehensible. Since there is not a lot of uniformity of product in the marketplace right now, many policies are confusing and densely written, making it hard to determine the scope of actual protection provided. Also, comparison shop with a good insurance broker at your side to help you find the best forms.9

Once you have a good, comprehensible form to work with, the insurance company will often endorse it to provide protection that is better tailored to your needs if you know what to ask for. Choose a broker with a lot of experience with cyber insurance products to assist in this process.

2. Cover the Evolving Risk

Continuously monitor trends in computer hacks and data breaches. Remember that data breaches can still occur the old fashioned way through theft of sensitive hard-copy documents, as well as in cutting-edge ways not currently imagined.10 Your insurance policy needs to match the underlying exposure.

3. Cover Time-Element Losses

Business income coverage and reputational damage coverage take on added importance in the wake of recent hacking events.11 While a slew of insurance companies have offered cyber coverage for business income losses and reputational damage for several years, that coverage was not nearly as coveted as class action privacy litigation coverage, breach notification costs or regulatory proceedings coverage.12 Now, the reality that a breach can imperil the very core of the policyholder’s ability to continue business operations takes on much greater import for risk management objectives. As such, consider insurance coverage that pays time-element claims resulting from reputational damage and business interruptions, including ones that partially interfere with business income.13

4. Seek Retroactive Dates

Push for retroactive coverage whenever possible. Many insurance companies want to provide insurance protection only from the date that the first policy they sold you incepts. The problem is that some cyber threats occur well before the policyholder actually learns of them. Computer forensic specialists will tell you that computer hackers can intrude into a computer system weeks, months, and even years before the policyholder becomes aware of the threat. You can avoid disputes by negotiating with your insurance company for a retro date that pre-dates policy inception.14

If you purchase insurance coverage with a retroactive date that pre-dates the policy period, your cyber insurance company may ask you to provide a warranty letter.15 If you provide one, make sure it is carefully written and ensure that you do your due diligence in reaching out to other departments and employees within the company to ensure that your representations are fair.

Policyholders can expect that any statement warranted or otherwise set forth to the insurance company will be scrutinized by the insurance company should an insurance claim ensue after the letter. As such, policyholders should not “over-promise” in the letter. State what you can after a reasonable internal inquiry. When at all possible, try to underscore to other employees and departments within the organization the importance of bringing claims or circumstances that may reasonably be viewed as likely to result in claims to the attention of the risk management and/or law department. This process can be fostered further by establishing clear written protocols within an organization of the circumstances that should be reported to risk management and legal personnel. Routine reminders of the policyholder’s procedures are important too so that new hires are firmly aware of the protocols and existing employees are provided frequent reminders.

5. Avoid Breach of Contract and Warranty Exclusions

Resist efforts to include breach of contract exclusions in your coverage. These provisions should be obsolete in an era in which so many policyholders do business pursuant to a contract (whether with customers, credit card companies, financial institutions, etc.). These exclusions are used all the time by some insurance companies to challenge insurance claims. While some recent court decisions have curtailed this use, it is best not to have this fight in the first place.16

6. Avoid Cyber Security Reasonableness Clauses

Resist insurance company efforts to include exclusions, warranties, representations or “conditions” in insurance policies concerning the soundness or reasonableness of the policyholder’s data security efforts/protocol. These clauses are a recipe for disputes on potentially every security incident.17

Given the pace of technological innovation, almost every security step can be second-guessed with the benefit of 20-20 hindsight. Is it safe to log onto a secure network from your hotel room using the hotel’s Wi-Fi? Is it ever OK to have any unencrypted information stored on a mobile device? What about unencrypted information on the cloud? The answers depend on many factors that are difficult to pinpoint, including the development of alternative technologies, the trends of cybercrime, the burdensomeness upon necessary business tasks compared with the need to secure data, and the exact point in time in which attitudes collectively begin to change. Such questions are bound to end in disputes if the cyber claim is big enough.

7. Preserve D&O Insurance Coverage for Cyber Claims

Keep your directors and officers insurance program (primary, excess, Side A, etc.) clean from any cyber-related exclusions or sublimits. Management and the board will be highly concerned with any argued “gap” in coverage should a cyber event ensue and D&O coverage be contested on the basis of an exclusion or limitation for suits where cyber may be the underlying cause or context of the claim. Indeed, the Securities and Exchange Commission is very concerned that public companies carefully consider cyber risks and has continued its dialogue on the matter for the last few years.18

8. Be Thorough When Filling Out Cyber Insurance Policy and D&O Policy Applications

Complete insurance applications carefully and gather information from other business units where necessary when answering questions. Even if an insurance company must pay a claim under the plain terms of the insurance policy, coverage may still be contested, under certain circumstances, on grounds that application questions were not correctly answered. Do not give the insurance company this opportunity.19

9. Remember That Cyber Breaches Happen Off-Line Too

Make sure your cyber-specific coverage protects losses involving mobile devices, home offices, data that is off-line at the time security is breached and devices that may not be owned by the policyholder. A lost laptop or flash drive containing gigabytes of information can lead to a breach and possibly an expensive one.20 Make sure your insurance coverage is available for such a scenario — even where the device is not actively connected to a network when the data breach occurs.

10. Cover Cloud and Third Party Vendors

Make sure that your cyber-specific coverage protects against losses where others manage, transmit or host data for your company.21 Insurance coverage is available for cloud computing and instances where data is handled, managed or outsourced to a third party. Going back to point number one above, however, not all insurance policies are created equal and there are cyber insurance forms that on their face, appear not to provide express protection for cloud-like scenarios. Most of these policies can be modified to extend such protection — if requested.

A static assessment of data security risk management will not work in most instances, given the rapid pace of change in this area. Be vigilant and adaptable in managing the security risk. Work with your colleagues in other departments to reduce risk where you can — and secure the best insurance your company can afford to protect against losses stemming from cyber-related perils.

[see PDF for Endnotes]