Three Pain Points
From dealing with multi-million dollar claims by private equity funds to assessing the risk profiles of telehealth providers, professional liability (PL) underwriters and practitioners across a broad spectrum of sectors have plenty to ponder.
Ahead of this year’s Professional Liability Underwriting Society’s (PLUS) annual conference in Dallas, we asked a selection of PL experts to outline the key issues in their respective fields.
Cyber Cover: To Buy or Not
Sarah Stephens, partner and head of cyber, technology, and media E&O at broker JLT, is on a panel discussion entitled “When David Fells Goliath — Small Companies’ Role in Large Breaches,” which explores the threat that inferior IT networks of vendors, service providers and other counterparties can pose to larger, seemingly more secure organizations.
According to Stephens, PL practitioners need to be aware of the resource pressure on small vendors, while navigating a “web of interconnectedness” in both the liability and insurance arrangements of the various companies in the technology supply chain.
While large companies’ cyber insurance policies tend to cover them for expenses and third-party liability resulting from another vendor’s error or omission, small tech vendors are often required to buy tech PL liability insurance under their contract with larger vendors.
Stephens said it is important that practitioners help these vendors establish exactly what is and isn’t covered under their own policies, and whether procuring additional cover is necessary — particularly as in some cases, a small vendor may require tech PL cover with limits that far exceed the size of their own business.
“A vendor whose revenues are $5 million may, for example, provide niche services to a larger vendor and be handling the personal data of millions of retail customers,” Stephens said.
“It can be a real challenge for a broker to go to the market on behalf of a company whose revenues are $5 million and requests $20 million professional liability cover, but the exposure is real. This is the cost and reality of doing business if you are a small tech vendor.
“If I were a large company drafting the insurance requirements for my vendors, do I want PL coverage or do I want cyber coverage, or do I need both? And is it acceptable to request PL that includes cyber coverage?” Stephens asked.
“I think more education is needed as you don’t want to be requiring companies to buy cyber policies when they already have that coverage under a tech PL policy. A better understanding of the coverage and how people buy it will drive efficiencies for both large and small vendors.”
A broader industry challenge, Stephens said, is the overlap where third-party cyber liability coverage meets PL. With some doubting underwriters’ pricing sustainability, modelling and claims-paying ability, Stephens noted there has been a flight to quality cyber carriers with enough capital to pay large limit claims without being scared away from the risk or making knee-jerk price hikes.
“From a practitioner’s point of view, my focus is to help insureds choose a market that will be there in five or 10 years and will be relatively consistent rather than reacting unreasonably to inevitable claims in the market,” she said.
According to Stephens, the nature of a company’s business should probably determine whether they choose stand-alone cyber insurance. It makes little sense, she said, for tech/IT companies to buy stand-alone cyber coverage as cyber risk runs through all of their professional risks, while other sectors with long-established PL histories may be advised to buy separate cyber policies — not least for the valuable crisis response services that usually come as standard with this coverage.
Stephens also raised the question of whether simply not having a cyber exclusion in a PL policy (as opposed to affirmative language outlining specific cyber risk triggers) offers assurance of coverage.
“Some companies choose to rely on the breadth of silence in the PL contract; others aren’t comfortable with that uncertainty as they don’t want to have to litigate a claim, so they opt for a separate cyber policy,” she said.
Financial E&O: A Volatile Subprime Legacy
According to lawyer James Skarzynski, principal of Skarzynski Black and president of PLUS, there is also an overlap at the intersection between cyber policies and D&O coverage. Skarzynski focuses primarily on D&O and E&O in the financial sector — a segment experiencing some of the most volatile and expensive PL claims.
“There are still some fairly significant subprime credit losses being litigated and it is taking time for practitioners to sort through all the issues,” he said.
“One issue is the inter-relatedness of multiple claims within large towers of insurance. There could be multiple unrelated claims in several years of the tower, and when you have tower limits of quite easily $100 million, $200 million or more, this becomes a very substantial issue,” Skarzynski said.
These situations are being dealt with on a case-by-case basis, often with the help of mediators.
“The worst outcome is to fail to reach a resolution. It serves no one’s interest to have a dispute linger on, so that factor helps drive the parties to reach resolutions on how to allocate loss.”
But even if all parties agree and it is in their collective best interests to avoid litigation and reach a commercial resolution, negotiation challenges remain.
“Not surprisingly, the carriers at the top of the insurance towers think there should be full exhaustion of the claim from the ground up, while the insurers at the bottom of the tower may argue that if the claim would fully expose the limits of the entire tower, payment of the loss should be made pro rata so the tower shares equally in the loss.”
Even if the carriers at the top of the tower are willing to compromise and agree not to enforce full exhaustion from the ground up, they may insist that carriers in the lower portion pay a much higher proportion of their limits, Skarzynski said.
“These disputes can be very complex to resolve, and I and others in the D&O space have spent many hours in mediations, negotiating over how claims will be allocated as a prelude to mediating the underlying claims themselves, as you can’t resolve the underlying claim until you have agreed how funding will occur,” Skarzynski said.
Another post-crisis issue, he added, is the significant increase in regulatory investigations, with E&O insurers seeing the fees incurred reaching levels comparable to or above those in major 10B-5 securities litigations.
“Many years ago, no one would ever have guessed we would be routinely seeing seven- or eight-figure fees from regulator investigations and proceedings,” Skarzynski said, adding that variances in policy wordings mean that these governmental fees are not always covered under an E&O claim.
Meanwhile, increasing private equity in the corporate landscape has led to insurance around private equity “taking on a life of its own” — often involving large, volatile dollar sums.
“Private equity plaintiffs are often very serious about getting a large dollar recovery and the values can at times be proportionately higher than the recovery on losses to shareholders in a 10B-5 securities case,” Skarzynski said.
Health Care: An Evolving Risk Landscape
“Increasing settlement verdicts, hardening of the market, and a changing model of how health care is delivered through telehealth or retail clinic settings make a busy, swirling bucket for PL underwriters to get their heads around and put the right premium/price on the table,” said Bill McDonough, managing principal and broker for Integro’s national health care practice, who will be on a panel discussing whether the PL industry can keep up with “The Brave New World of Medicine.”
“The delivery of medicine is moving much quicker than how we analyze, underwrite and understand these risks.” — Bill McDonough, managing principal and broker for Integro’s national health care practice
“Whether it’s individual insureds or the lead layer for a large system, there’s a lot of moving parts. Underwriters have to be smarter and rethink how they have been underwriting for past seven or 10 years.”
The primary shift in the U.S. medical landscape is in the delivery of care, which is evolving from “brick and mortar” bedside care to “retail care” available in shopping centers other walk-up venues, and more recently “telehealth” platforms — through which the diagnosis and prescription of treatment is administered by practitioners via phone, computer or other smart technology.
“Now people are receiving care without ever being in front of a provider,” said McDonough.
“It’s a huge issue for PL underwriters. The concerns revolve around whether there are appropriate controls around the delivery of telemedicine care, whether underwriters can accurately measure the risk and understand how the risk differs to the risk they’ve been writing for the last 30 years.”
McDonough said the PL insurance market including brokers, underwriters and consultants needs to let go of its “antiquated mind-set” in order to redefine health care risk profiles, taking into account the new setting in which health practitioners — who in the case of retail and telehealth are primarily nurses rather than physicians — are operating and delivering services.
“The delivery of medicine is moving much quicker than how we analyze, underwrite and understand these risks,” he said.
“In the next three, five or 10 years, there will be a different way not only of delivering care but also in how we define that risk and insure it. As patients increasingly seek quicker, cheaper and more readily accessible health care, I believe a locus of control is being lost.
“Practitioners can operate very independently, and my sense is that offering cheaper and quicker care is going to lead to more risk.”
Yet, McDonough said, telemedicine nurses continue to be covered under the same PL policies that brick-and-mortar practitioners have been insured under for years — either from the PL market or through captives owned by health systems and providers.
“We have to think about the adequacy of coverage with the new risk profile we’re dealing with,” McDonough said.
He added, however, that practitioners are also concerned about the adequacy of coverage — primarily regarding the size of limits they can obtain.
The Contradictions of Marijuana
It’s an industry that could soon be worth upwards of $40 billion per year, yet its key participants can’t get hold of either a bank loan or a credit card. Welcome to the paradox that is the legal marijuana business.
Marijuana (cannabis) is a divisive substance; scourge of society and red hot investment; illicit high and essential medication; crime and cure. Whatever your opinion, the drug is already big business, and on the cusp of even bigger things.
“This is a murky and historic time period,” said Steve Gormley, chief business development officer at OSL Holdings, which offers financial management and financing for cultivators and dispensaries of legal marijuana across the United States.
“Just like the alcohol industry three or four years before prohibition was repealed, there are potentially enormous rewards, but without federal backing there is a higher risk level,” he said.
It’s already legal to cultivate and sell marijuana for medicinal purposes in 27 states, and for recreational use in four plus the District of Colombia. Yet at the federal level, the drug is still rated as a Schedule I illegal substance, alongside the likes of heroin and cocaine.
But Gormley believes that with more than half of states permitting some kind of legal trade and 11 more likely to follow suit in the very near future, the tipping point has been reached, and decriminalization is “inevitable” in the next five to seven years.
Barred from Banking
Until that day comes, cultivators, dispensaries and other marijuana businesses find themselves cut off from the banking system. Funding the production and sale of a Schedule I drug, regardless of its legality in certain states, skirts too dangerously close to money laundering for any mainstream banks to go near the industry.
Credit unions offer one source of finance, while companies like OSL also attract investment from high net worth individuals and other investors with the appetite for high risk, high reward opportunities. But on a day-to-day basis, many marijuana cultivators and dispensaries have little choice but to operate as cash businesses, escalating the risk of theft.
“These operators can be carrying tens of thousands of dollars in cash and product, and the location of facilities is made public by the states, adding to the risk,” said Matt Gunther, an insurance agent at Seattle-based specialist broker Cannarisk.
Gunther noted, however, that recent legislation in some states will now permit third-party vendors to offer armored transportation services, reducing the risk of theft and allowing cultivators to transfer some risk to the security firms.
Gormley said that the absence of banks could also present some operators with problems when it comes to selling their businesses to acquirers after years of self-reporting.
“In a cash-only environment, states in which marijuana is legal have to rely on the retail operators and cultivators to report their own earnings and furnish sales receipts. Underreporting of revenue is common, but some operators who may want to go corporate in the future might not have accurate sales figures to create
stable valuation metrics for their potential acquirers,” he said.
“More savvy operators who have a view on being acquired by a major multinational and developing a brand need to follow the letter of the law and pay their taxes so that they are in a position to present a genuine valuation on their business.”
The risk landscape will improve significantly for marijuana businesses if and when the drug is eventually downgraded to Schedule II.
“Just like the alcohol industry three or four years before prohibition was repealed, there are potentially enormous rewards, but without federal backing there is a higher risk level.” – Steve Gormley, chief business development officer, OSL Holdings
“That’s when banks and institutional money will come off the sidelines in the U.S. and invest directly in retail cultivation, where all the money is,” said Gormley. “The floodgates will open and the banks will be in a mad dash to get involved. It’s a huge business and they are all investigating how to position themselves to capitalize on a nascent industry — a Greenfield, if you pardon the pun.”
But it’s not just banks that have so far steered clear of the sector. While a handful of insurance carriers do service the legal marijuana sector (and the number is slowly growing) the majority of major insurers do not. And industry insurance buyers were dealt a blow in May of this year when the Lloyd’s market — until recently a key provider of specialist coverage for the sector — instructed its underwriters to cease insuring the industry until marijuana is decriminalized at the federal level.
The market’s self-imposed ban is comprehensive, extending to crop, property and liability cover for those who grow, distribute or sell any form of marijuana, as well as cover for banking or related services provided to these operations.
A Lloyd’s spokesperson told Risk & Insurance® that as long as marijuana is listed as a Schedule I drug under U.S. federal law, Lloyd’s is concerned about impeding federal anti-money laundering (AML) laws, adding: “Lloyd’s will continue to monitor developments under U.S. law and will reconsider this position if and when the conflict of laws is resolved.”
Insurers are also wary of the lack of loss data and legal precedents stemming from the marijuana business. “In other industries, insurance agents create risk management strategies to properly indemnify their clients from loss interpreted and measured in case law. Marijuana commerce-related risks are completely unchartered with no precedent,” said Gunther.
“Marijuana commerce-related risks are completely unchartered with no precedent.” — Matt Gunther, insurance agent, Cannarisk
From heightened theft risk to public health concerns, there is little or no loss history in the marijuana industry, and insurance buyers are at the mercy of a small band of wary, first-mover insurers offering limited capacity, low limits, high deductibles and inflated premiums.
The lurking giant of a risk that scares insurers the most, Gunther said, is the public liability risk posed by carcinogens. While both medical and recreational marijuana must undergo extensive testing before being cleared for human consumption in states in which the drug is legal, Gunther said the industry has “all the right variables in place for class-action lawsuits.”
“There don’t seem to be clear studies on whether years of consumption can lead to lung cancer or inhalation diseases of some sort. With legal structures in place, plants are tracked from seed to sale, and it is easy to find where a certain plant was produced.
“Information is public so law firms could easily collect the necessary statistics they need to file a class-action lawsuit — it could be the tobacco industry all over again, but without the hoops of filing subpoenas to do so,” he said.
Gunther noted that some of this risk is transferred from cultivators to the third-party laboratories tasked with carrying out the tests on marijuana products, but the potential for laboratories to make mistakes still exists and the industry as a whole is potentially exposed.
“Getting insurers to provide product liability coverage has been extremely difficult. The policies aren’t priced as accurately as they probably could be, but we don’t expect them to be with uncertainty over what the loss future entails,” he said.
“Marijuana businesses will continue to pay higher premiums until losses and precedents become more established.”
Weed and the Workplace
Workers’ compensation coverage is also proving elusive for many cultivators due to the high perceived risk of explosion at certain facilities.
“Here in Washington State, we have a state-funded workers’ compensation system, but finding private sector carriers in other states who accept workers’ compensation has been one of our biggest challenges,” Gunther said.
While the cultivation of cannabis plants carries no more risk than most manufacturing endeavors, the extraction of chemical concentrates can be dangerous if done with butane-powered machinery, he said. The risk of explosion can, however, be mitigated or reduced by using alternative fuels such as CO2 or solvent-free means, as well as by implementing proper ventilation and safety protocols.
The problem for insurers, said Gunther, once again lies in a lack of loss data.
“[Insurers] may be influenced by what they learn from the hysteria-leaning media, which isn’t always the facts. But there is a big opportunity for workers’ compensation carriers to come into this industry and we wish they would do so more aggressively,” he said, adding that private sector carriers could potentially learn more about these risk exposures through collaboration with state-funded insurers.
Indeed, as more is learned about marijuana risks and more carriers enter the market, conditions should improve for cultivators and dispensaries, but education is vital, and brokers and the marijuana companies themselves both have a role to play.
If Gormley is correct, and federal legalization is an inevitability, it won’t be long before the banks open their doors to the sector, and insurers won’t be far behind.
“Lloyd’s’ exit certainly hasn’t held back other carriers,” said Gunther. “A handful do exist and more are entering the arena. It is just a matter of time.”
Doxing: Are You Prepared?
Cyber insurance experts have warned corporate risk managers to expect more so-called “organizational doxing” attacks, such as those recently suffered by Ashley Madison and Sony.
In a doxing attack, hackers steal sensitive personal or corporate information, then publish the information online.
“Employees are a company’s weakest link.” —Alessandro Lezzi, team leader and underwriter, international technology, media and business service, Beazley
Doxing hacks can be perpetrated by corporations or state-funded organizations seeking to disrupt a company’s business, or by cyber gangs seeking to extort money under the threat of publishing data. In the case of Ashley Madison — an adultery dating website whose members’ details were leaked online — the motive for the doxing attack appears to be based on moral grounds.
Regardless of the reason, the financial and reputation repercussions for victims can be severe. Three Ashley Madison customers whose details were exposed have since committed suicide, and the company now faces a class-action liability suit from scores of clients.
“If someone is motivated to take down a competitor, one way they might do it is hacking that competitor and posting confidential information as a form of corporate warfare or espionage,” said Sarah Stephens, partner and head of cyber, technology, and media E&O at broker JLT.
The methods used by doxing hackers to steal the information are essentially the same as used in phishing or whaling scams, typically relying on employees responding to a fake email infected with malware.
According to Alessandro Lezzi, team leader and underwriter, international technology, media and business service at Lloyd’s underwriter Beazley, senior executives are most at risk of being targeted, as hackers may use embarrassing personal details against them to extort money, as well as potentially hacking sensitive corporate information from their email accounts.
“Our advice to clients is that 100 percent security is unobtainable, so this could happen to anyone,” Lezzi warned. “Companies are coming under attack all the time, and it only takes one to get through. The most important risk management objective is to be ready.”
“Our advice to clients is that 100 percent security is unobtainable, so this could happen to anyone.” — Alessandro Lezzi, team leader and underwriter, international technology, media and business service, Beazley
It is vital, he said, that companies put crisis response plans in place to allow them to minimize the fallout of a potential doxing breach. These plans can often be developed with the help of insurers and brokers, and a response service is usually included in specialist data breach policies.
“The forensic, legal and crisis management services offered under insurance policies in the wake of an attack often mean more to the client than the cover itself,” said Lezzi.
“You need a lot of coordination as fast as possible between the different departments within a company. Lots of people need to be involved — from compliance and legal to IT to crisis management — and the plan needs to have been tested.”
While broadly worded cyber policies should cover the cost of crisis management and forensic investigation, as well as any liability claims that arise from the data breach, Stephens said, it may be hard to quantify the financial impact of the leaking of sensitive corporate data or information that may damage a company’s business or reputation.
The financial impact of a cyber attack is “a very difficult loss to value, and that’s why many insurers shy away from it.” — Sarah Stephens, partner and head of cyber, technology, and media E&O, JLT
“The insurance industry hasn’t done a great job of creating broad coverage for financial losses stemming from this kind of risk, although there are some products out there — primarily in the Lloyd’s market — that do address future lost revenue or immediate loss of attraction in the few months after a data breach,” she said.
This coverage, Stephens said, is often very carefully worded and requires certain triggers to be met within a short indemnity period.
“But it’s a very difficult loss to value, and that’s why many insurers shy away from it,” she added. “You could argue, for example, that Target’s disappointing performance in the quarter immediately following its data breach may have had as much to do with a failed expansion into Canada as the breach itself.”
Stephens and Lezzi both said the frequency of doxing attacks is likely to increase, and while it is virtually impossible to make a company’s network impregnable, the most effective form of defense is to educate staff on the evolving risk of cyber-attack.
“Employees are a company’s weakest link,” Lezzi said. “You’d be surprised how many employees fall for phishing emails — one client was tested with a fake scam and 50 percent of employees responded to the email,” he said.
“It is important to train employees about this type of attack and how to manage confidential information. They also need to be taught what to do and who to speak to in the event of an attack.”