Blockchain: Mechanics and Magic

Stephen J. Mildenhall | Aon

The Blockchain cures all ails. It is an immutable (unchangeable) and unhackable database. It lowers transaction costs and enables trust between strangers. It unshackles us from authority. It will revolutionize insurance: Executives everywhere must pay attention. Blockchain is the new plastic. Or so the myth goes.

Numerous articles have explained how using a blockchain will lower costs, increase profitability, and produce a clear competitive advantage for insurers. Fewer articles cover blockchain mechanics and magic—yes, it contains some magic. Executives need to have a basic understanding of the mechanics and an appreciation of the magic in order to assess the applicability of blockchains to their insurance business problems. This article will step back from the hype and explain how a blockchain works. It will highlight some surprising capabilities and debunk some confusing myths and inaccuracies.

Blockchain is a Database

A blockchain is a database. Blockchain databases are generally distributed, that is, stored on multiple machines rather than held by a single authority.

Blockchain databases store records that can be thought of as transactions because they have a temporal order: later transactions can depend on earlier ones. The importance of transactional databases to insurance is obvious.

Individual records are stored in blocks that are chained together through an index, hence the name. The data in each block is called the payload. The payload can be structured data, such as details of a financial transaction or an insurance policy, or unstructured data, such as an image, video, or a PDF file of an insurance contract. Each block is given an index that is used to locate it. (SQL databases work this way. Even though data is presented as a table it is stored in indexed blocks.) The chain arises by including the index of the preceding block as part of data payload on each block. Chaining enforces the temporal order of the database. Given the index of the latest block a user can pull out an ordered list of blocks from the database by following the index chain.

Database users have three concerns: does the data have integrity, is the data valid, and is the data secure? Blockchains offer innovative solutions to these three concerns.

Integrity and Hashes

Does an extract from a database faithfully match the original? That is, does it have integrity. Blockchains use hash functions, a magical mathematical construct, to ensure database integrity.

hash function is a deterministic algorithm that will reduce an input of arbitrary length (e.g. the data on a block) to a fixed length output. A familiar example of a hash function is to concatenate the first five letters of your last name (padded if necessary) and the first letter of your first name, a hash beloved of IT departments creating user names. However, as every J. Smith knows, this hash has a problem: many different names can map to the same hash, giving a hash collision. Here’s our first magical ingredient: there exist hash functions where the probability of a hash collision is extremely low. Given two different inputs the probability the hash produces the same output is negligible. Negligible not as-in not in one hundred, but as-in the chances of a collision within one billion messages is less than the probability of picking a particular atom in the universe. The SHA256 algorithm is an example of such a hash function. It produces a 64 digit hexadecimal output, equivalent to a 77 digit decimal number.

How does a blockchain use the SHA256 hash function to ensure integrity? It is surprisingly simple. It uses the hash of the block payload as the index. Remember the payload includes the index of the previous block, as well as whatever data is stored in the block. The integrity of data download from the database is easy to check: hash the payload and compare the answer to the index of the block. If the two match you can be very confident (not quite mathematically certain, but certain enough) your extract matches the original, that is, your copy has integrity. If you know the hash-index of the most recent card in the database you can determine the integrity of a copy of the entire database by recursively computing hashes. One 77 digit decimal number is sufficient to determine if a copy of the entire 184 gigabyte Bitcoin blockchain has integrity!

Validity and Nonces

Database integrity is important, but an accurate copy of invalid data is useless. Users are also concerned their data is valid: that it is legally or officially binding and acceptable. Data validity is usually enforced by a trusted authority such as a bank, employer, insurer, or government agency. The second magical capability of a blockchain is to enable validity without an authority: to enable distributed validation of new database records.

Given a blockchain it is easy to make an invalid copy with integrity: change a block, for example to credit your bank account, and then recompute all the block index hashes. The SHA256 function is very fast to evaluate so this is a quick and easy change. There are now two different copies of the database which both have integrity. Which is valid?

Validity is an incremental problem: given a copy of the database which all users agree is valid, how should the next block of transactions be confirmed and appended? The new block needs to be consistent with the existing transactions and then “locked-in” somehow, so it becomes immutable, or at least very hard to change.

The Bitcoin network enforces validity through a proof-of-work consensus mechanism. The process has several steps. First, a so-called miner checks new transactions to ensure each is valid by looking at the existing database, which provides a record of who owns what. This stage forestalls double-spending because a miner will only allow a Bitcoin to be spent once. The miner knows that others will independently check their work, so cheating will be detected and their mining in vain. Next the miner combines a number of valid transactions into a block payload. Third, the miner computes the hash-index for the block. This is done hashing the payload concatenated with an additional number, called a nonce (number used once). The nonce is selected so that the resulting hash is smaller than a certain threshold (the block difficulty). Bitcoin miners try to find these nonces through brute-force, by trying different nonces until they chance upon one which produces a small enough hash. The brute-force mining process consumes a massive amount of electricity—another popular fact in Bitcoin press coverage! Fourth, the proposed block is transmitted to other users. If they agree it is valid it can be added to the chain and the process starts over. Checking if a block is valid is very quick—once you have been given the nonce. Miners are rewarded with newly created Bitcoins for their mining efforts.

Why does this process create an (almost) immutable record? Suppose I want to change an old block. I can do that but it takes time, the time to find the nonce for each block I want to change. As this time is elapsing, new blocks are being created. Unless I control the majority of the mining computing power (hence: 51 percent attack) I can never catch up with the current block. Thus it is practically impossible for me to go back and alter the blockchain.

Security and Encryption

A distributed database, where everyone has access to all the underlying records, appears inconsistent with good security. Blockchains use encryption to ensure security. The data payloads on each block are public but encrypted. Without a key issued by the owner of the data it is impossible (again, not mathematically impossible, but practically impossible) to extract the underlying information.

Given the purported security of a blockchain why are there so many news reports of Bitcoin hacks and thefts? Encryption is an unbreakable lock—but all locks have a key. For Bitcoin the key is simply a number. And that number must be stored. Steal the number and you control the Bitcoin. All reported blockchain hacks involve the theft of keys, not a breaking of the underlying encryption. If individuals hold their own keys and there are no extensive databases of keys exposed to hackers then mass data breaches cannot occur. Security has been distributed.

Encrypted security technology offers some magical possibilities. It is feasible to issue security keys that allow one-time access to data. And keys that expire. To grant a third party access to check my credit record using a blockchain credit bureau I would issue a one-time, read-only key. The party would access my record at a point in time but would not be able to use the same key twice. Today, of course, I have to reveal my social security number and other sensitive information and to trust the recipient only looks at my record once. There is enormous potential for using blockchain technology to return ownership and control of private information to individuals.

Applications

Commentators often tout blockchains as a solution to the insurance industry’s processing and back-office inefficiencies. But this is a rather narrow view, and one which completely misses its true potential for insurers.

The internet, which has delivered free access to vast troves of information, has paradoxically created a Trust Vacuum. Alleged instances of election hacking highlight the need for identity verification. The Equifax cyber hack reveals the weaknesses of centrally controlled repositories of private information. Blockchain technology allows us to re-democratize data and reassert the individual’s control over their private data. To enable this will require infrastructure and an alternative revenue model. Insurers are well positioned to provide these services and to profit from the Trust Vacuum, stepping in to replace outmoded and insecure centralized networks with distributed blockchain solutions. This revolutionary model represents the true potential of the blockchain for our industry.

Additional Insured Coverage and Primary/Excess Priority Disputes, Oh My

James W. Bryan | Nexsen Pruet | July 19, 2018

Additional insured coverage in construction projects is one of the most vexing issues facing insurance coverage lawyers. Add to the complexity a priority dispute between primary and excess insurers and you have a recipe for complex coverage litigation. Recently, the Fourth Circuit tackled these issues in the North Carolina case, Continental Casualty Company v. Amerisure Insurance Company, 886 F.3d 366 (4th Cir. 2018). The end result was not a good one for Amerisure. Amerisure, with its primary policy, got it wrong on the duty to defend additional insureds and with its excess policy, also got it wrong on the duty to indemnify. Continental obtained a judgment for over $2.3 million.

Background

In Continental, the general contractor building a hospital near Charlotte, North Carolina entered into a subcontract with a supplier/builder of the steel infrastructure. This first-tier subcontractor in turn entered into a subcontract with an erector of the steel structure, a second-tier subcontractor. During his work on the project, Dustin Miller, an employee of the second-tier subcontractor, suffered severe injuries when he tripped and fell 30 feet to the ground after his safety cable broke. At the time of the accident, the second-tier subcontractor held both commercial general liability (“CGL”) and umbrella insurance policies issued by Amerisure (the “Amerisure policies”). As required by the subcontract between first-tier and second-tier subcontractors, the Amerisure policies included the general contractor and first-tier subcontractor as “additional insureds” and provided minimum coverage limits of $2.0 million. The CGL policy provided a limit of liability of $1,000,000 per occurrence and the umbrella policy provided an additional $5,000,000 per occurrence. Additionally, the subcontract between first-tier and second-tier subcontractor stated “the insurance required of [second-tier subcontractor] must be primary and noncontributory with [first-tier subcontractor’s] Insurance program.” (Emphasis added).

In addition to its “additional insured” status under Amerisure’s policies, first-tier subcontractor held its own CGL policy issued by Continental, which included an “additional insured” endorsement covering the general contractor. The general contractor also was insured under the hospital’s “rolling owner controlled insurance program” (“ROCIP”), which provided coverage under policies issued by a separate provider. Although the terms of the ROCIP required participation by all tiers of contractors, participation was not automatic, and the general contractor did not enroll either the first-tier or second-tier subcontractor in the ROCIP. Instead, as required by an additional provision of the ROCIP, these unenrolled subcontractors maintained their own insurance coverage as previously described.

Underlying Action

As a result of the accident, Miller sued the general contractor and first-tier subcontractor for: failure to provide a safe work environment; failure to ensure that their subcontractors followed certain safety measures; failure to properly inspect certain safety features; failure to control and supervise the workplace; and failure to warn subcontractors about the lack of safety measures. Continental agreed to provide a defense to the first-tier subcontractor and the general contractor under a reservation of rights, but Amerisure declined to provide a defense, asserting coverage was barred pursuant to a controlled insurance program exclusion (“CIP exclusion”) in the Amerisure policies.

Declaratory Judgment Action

After settling the action for $1.7 million, Continental filed this declaratory judgment action in the United States District Court for the Western District of North Carolina, seeking a declaration that Amerisure be required to reimburse Continental for the entire settlement and for all of Continental’s defense costs. On motions for summary judgment, the district court held that Amerisure had breached its duty to defend the underlying action and that, under the terms of Amerisure’s policies, Amerisure was liable to reimburse Continental for the $1.7 million settlement. Finding “[e]quity dictates that the defense costs be shared equally among the two insurers,” the court ordered Amerisure to reimburse Continental for half the associated costs and fees.

Issue #1: Controlled Insurance Program Exclusion

On appeal, the first issue addressed by the Fourth Circuit was whether the CIP exclusion in the Amerisure policies excused it from defending the underlying action. The exclusion states, “This insurance does not apply to ‘bodily injury’ … arising out of … [second-tier subcontractor’s] ongoing operations … if such operations were at any time included within a ‘controlled insurance program’ for a construction project in which [second-tier subcontractor] [is] or [was] involved.” The Fourth Circuit focused on whether the “arising out of” condition was met. Under North Carolina law, courts must strictly construe the phrase “arising out of” when that phrase appears in a policy exclusion. Thus, coverage will not be denied where there is more than one cause of an injury and only one cause is excluded. Under the plain language of the CIP exclusion, only injuries arising from second-tier subcontractor’s operations were excluded, but injuries allegedly arising out of the operations of the general contractor or first-tier subcontractor were not excluded. At the time of Miller’s accident, he unquestionably was performing work for his employer while installing metal decking. However, Miller’s complaint alleged more than one potential cause of his injuries. Numerous allegations in his complaint rested on the failures of general contractor and first-tier subcontractor with respect to their supervisory role over second-tier subcontactor’s operations and safety procedures. Miller also alleged that general contractor and first-tier subcontractor, independently from second-tier subcontactor, failed to provide adequate safety equipment and procedures, causing Miller’s injuries. Regardless of the actual cause of those injuries, at the time Amerisure refused to defend the action, the allegations presented a distinct possibility that Miller’s injuries arose from the operations of the other contractors. Because Miller’s injuries arguably “arose out of” operations other than those conducted exclusively by second-tier subcontactor, the condition of the CIP exclusion was not satisfied. Therefore, the district court did not err in concluding Amerisure breached its duty to defend against the underlying personal injury action.

Issue #2: Priority and Additional Insureds

Given Amerisure’s breach of the duty to defend, the second issue before the Fourth Circuit was whether Amerisure was liable to reimburse Continental for the full $1.7 million settlement. Amerisure argued its coverage was capped at the $1.0 million limit of the CGL policy and did not reach the umbrella layer. The court disagreed.

For starters, the court rejected the argument that the second-tier subcontractor did not agree to extend the umbrella coverage to the additional insureds (i.e. general contractor and first-tier subcontractor). Simply put, the Amerisure CGL policy provided that any “additional insured” under the policy, namely, the general contractor and first-tier subcontractor, were “automatically” insureds under the umbrella policy. Plus, the Amerisure umbrella policy stated: “We will have the right and duty to defend the insured against any ‘suit’ seeking damages for such ‘bodily injury’ … when the ‘underlying insurance’ does not provide coverage or the limits of the ‘underlying insurance’ have been exhausted.” This language plainly meant (1) coverage was triggered when the Amerisure CGL policy limit had been exhausted and (2) because the settlement amount of the action exceeded the $1,000,000 limit in the Amerisure CGL policy, the umbrella coverage necessarily was triggered. The court further rejected Amerisure’s argument that its coverage was capped at the CGL policy’s $1.0 million limit. The court pointed to the umbrella policy language that “the most we will pay on behalf of the additional insured is the amount of insurance required by the contract, less any amounts payable by the underlying insurance.” In support of this rejection, the court focused on the subcontract between the first-tier and second-tier subcontractors, which plainly required the second-tier subcontractor to obtain $1.0 million in CGL coverage and an additional $1.0 million in umbrella coverage. The subcontract also stated that first-tier and second-tier subcontractors “shall be named as additional insureds on” the CGL policy of second-tier subcontractor and plainly required that second-tier subcontractor obtain $2.0 million in “minimum” CGL and umbrella coverage “with additional insured endorsement.”

The court also rejected Amerisure’s argument that Continential’s CGL policy took priority over the umbrella policy of Amerisure based on the “other insurance” provisions of both policies. In other words, Amerisure believed the Continental CGL policy should be triggered before the Amerisure umbrella policy was triggered. The “other insurance” provision of the Continental CGL policy stated: “If other valid [ ] insurance is available to [first-tier and second-tier subcontractor] for a loss we cover … our obligations are limited as follows: [ ] Primary Insurance—This insurance is primary except when … [t]his insurance is excess over: [a]ny other primary insurance available to you.” On the other hand, the Amerisure umbrella policy’s “other insurance” provision stated that the policy was “excess over … any other insurance whether primary [or] excess.” The court noted that the Amerisure umbrella policy coverage was triggered when the limit of the “underlying insurance” was exhausted and only the Amerisure CGL policy was listed as “underlying insurance” in the policy declarations. Moreover, any ambiguity arising from consideration of the “other insurance” provisions is resolved by the terms of the subcontract between first-tier and second-tier subcontractor, which required Amerisure’s policies to be “primary and non-contributory” to all other insurance provided to first-tier subcontractor, including the Continental CGL policy. The court noted that the Amerisure policies plainly refer to and incorporate the terms of the subcontract in several respects. Thus, the court held that the Amerisure umbrella policy coverage was triggered immediately upon the exhaustion of the Amerisure CGL policy and that the Continental CGL policy did not take priority over that umbrella policy.

Issue #3: Defense Costs

The third and final issue addressed by the Fourth Circuit again arose because of Amerisure’s breach of the duty to defend, namely, whether Amerisure was required to reimburse Continental for the full amount of the costs and fees incurred by Continental ($660,700) in defending the Miller action. The court held yes, reversing the district court. Key to the Fourth Circuit’s holding was the Amerisure CGL policy language that coverage afforded to an additional insured shall be “primary and without contribution” from the additional insured’s own insurance. Further, under Continental’s CGL policy, “[w]hen this insurance is excess, we will have no duty … to defend the insured against any ‘suit’ if any other insurer has a duty to defend the insured against that ‘suit.’” Thus, Continental’s CGL policy establishes that Amerisure’s CGL policy was “primary” to Continental’s “excess” CGL policy. In other words, Continental did not have an independent duty to defend.

Conclusion

There are three takeaways from this decision. First, North Carolina strictly construes the “arising out of” wording in policy exclusions, which tends to weaken the exclusions. Not many other states follow such a rule. Second, where a contract requires one party to provide additional insured coverage for the other party, courts give great weight to the terms of that contract when assessing the extent and scope of additional insured coverage provided by the insurance policy itself. This clearly applies to a contract that requires such coverage to be “primary and non-contributory” in relation to coverage under another policy. Third, where one insurer provides a defense to an insured that another insurer should have provided, there is a risk the court will require the latter to pay all legal costs and expenses incurred by the former in the defense of the insured. This can happen particularly when, as in this Continental case, the latter insurer was required to provide “primary and non-contributory” coverage for additional insureds.

Federal Court Says Subpoena Is a “Claim” Triggering Insurance Coverage

Jared Zola | Policyholder Informer | July 12, 2018

An issue frequently raised in coverage disputes involving claims-made liability insurance policies is determining whether certain pre-lawsuit events or disputes constitute a “claim” sufficient to trigger coverage.

Unlike occurrence-based liability policies that respond in the policy year or years during which the coverage-triggering event occurred (e.g., the years in which a person sustained injury in an asbestos bodily injury claim), a claims-made liability insurance policy is triggered upon the insured’s receipt of a claim. Upon an insured providing notice of a claim, its insurers may dispute whether the notice-triggering event constitutes a “claim” at all.

Given variations in policy “claim” definitions and the lack of defined terms in some instances, the point at which a dispute ripens into a “claim” that triggers coverage is frequently disputed. A recent Illinois federal district court decision rejected the insurer’s motions to dismiss and held that a Department of Justice (“DOJ”) subpoena was a “claim” when, as was the case there, the insured sought coverage for defense costs incurred responding to the subpoena.

While issued in the context of a motion to dismiss and not on the merits, the decision deftly rebukes the insurer’s assertions that a government subpoena fails to assert a “claim” against the insured for “wrongful acts” triggering coverage.

Astellas US Holding, Inc. v. Starr Indemnity and Liability Company

In a May 30, 2018 decision, an Illinois federal district court refused to dismiss three insurers from insured Astellas US Holding, Inc.’s suit seeking coverage for the costs it incurred responding to a U.S. Department of Justice subpoena.

The DOJ issued a subpoena to Astellas demanding certain documents relating to the DOJ’s industrywide investigation of pharmaceutical companies for alleged federal healthcare offenses. The subpoena directed Astellas to appear before government officials and produce documents about Astellas’ payments to charitable organizations that provided financial assistance to patients taking its drugs. It advised Astellas that failure to comply exposed it to liability in judicial enforcement proceedings and punishment for disobedience.

Astellas incurred defense costs responding to the subpoena that exceeded the self-insured retention stated in its primary D&O insurance policy. The primary insurer refused to provide coverage—as did several excess insurers—and a coverage lawsuit followed. The insurer filed a motion to dismiss Astellas’ complaint asserting, amongst other purported grounds for dismissal, that (1) the subpoena did not rise to the level of a “claim” that triggers coverage, and (2) the subpoena did not allege a “wrongful act.”

The insurance policy defined a “claim,” in pertinent part, to include a “written demand for non-monetary relief.” It also defined “wrongful act” to include “any actual or alleged breach of duty, neglect, error, misstatement, misleading statement, omission or act by the Company.”

The insurer asserted that the production of documents in response to a subpoena does not rise to the level of a “demand for relief.” In its motion papers, the insurer sought to define “relief” as “legal remedy or redress,” or as “the redress or benefit, especially equitable in nature (such as an injunction or specific performance), that a party asks of a court.” Of course, these so-called definitions that the insurer sought to impose on its insured do not appear in the insurance policy.

Because the subpoena only sought information and did not make a request of the court, the insurer concluded that it did not fit within the plain meaning of a demand for relief. It asserted that the threatened enforcement proceedings are discrete from the informational investigation.

The court rejected the insurer’s position. The court refused to conclude that the subpoena merely requested, as opposed to demanded, information. It reasoned that courts have the power to compel parties to give testimony or to produce documents as demanded in the subpoena. Accordingly, the court held that the subpoena demanded a form of non-monetary relief and that the subpoena was not distinct from the potential enforcement proceedings—“it defined the scope of the judicial enforcement.”

The insurer also argued that Astellas’ interpretation would lead to an absurd result because the insurance policy is only meant to protect insureds from potential liability due to allegations of wrongdoing, which the subpoena lacked.

The court disagreed with the insurer’s characterization of the subpoena. It held that the insurance policy’s broad definition of a “claim” indicated that the policy was designed to cover something like the subpoena—which is a demand for relief in response to an accusation of wrongdoing. Accordingly, the court held that the “result” in this insistence—that the insurer may have to cover Astellas’ defense costs incurred responding to the subpoena—“is not absurd, it is precisely what the policy intended.”

Conclusion

Inherent in coverage cases addressing whether subpoenas constitute “claims” is the recognition that insurers frequently argue both sides of this issue in an effort to avoid their coverage obligations to the insureds. If an insured provides notice of a pre-lawsuit event, its insurer frequently contends that the event does not constitute a “claim.” However, if an insured determined that the same pre-lawsuit event did not yet rise to the level of a “claim” under the policy and later gives notice of a lawsuit arising from the same factual nexus, for example, its insurer frequently contends that coverage does not exist for the subsequent lawsuit because the insured should have provided notice of the earlier event; a “claim.”

If insurers truly want to preclude coverage for costs incurred responding to government subpoenas, there is an easy solution—explicitly and unambiguously exclude coverage for such defense costs. Unwilling to risk losing market share by excluding this valuable coverage, insurers do not use exclusionary language and then seek to impose onerous interpretations not found in the insurance policy.

Perhaps recognizing this tactic, the Astellas case is an example of courts across the country accepting the insured’s business judgment of what event constitutes a “claim” to maximize coverage. The insureds involved in everyday business disagreements and disputes are better positioned than an insurer in determining when such a matter rises to the level of a “claim” for which the insured will seek coverage.

Policyholder Attorneys: Be Careful Playing the Odds During Trial on First-Party Coverage Disputes – It Could Land You Right Back in Front of a Jury

Erin Dunnavant | Property Insurance Coverage Law Blog | July 7, 2018

On July 5, 2018, the Fourth District Court of Appeals, (“Fourth DCA”) reversed a jury’s verdict for Homeowner Sanjay Kuwas based on his counsel’s improper arguments and examination of his insurance company’s litigation manager during trial.1

Kuwas’ home suffered property damage due to water losses that occurred in 2011 and 2015. He was insured by Homeowners Choice Property & Casualty Insurance Company (“Homeowners Choice”) during both losses and made claims on both losses that were ultimately denied. In response, Kuwas hired attorneys who sued Homeowner’s Choice for breach of contract. Among Homeowners Choice’s affirmative defenses filed in response to the lawsuit were:

  • The loss was excluded due to sewer backups;
  • Neglect of the insured to use all reasonable means to save and preserve the property after the loss;
  • Constant or repeated seepage or leakage; and
  • Inadequate maintenance.

Prior to trial, Homeowners Choice dropped the defense of sewer backups and proceeded on the other above-listed defenses.

During trial, counsel for Kuwas argued that Homeowners Choice was “playing the odds” when it denies a claim “in the hopes that the party who is seeking to be paid under a policy will not sue them.” Apparently Kuwas’s counsel argued these points on multiple occasions: during opening statement, while examining Homeowners Choice’s litigation manager, and during closing. For example, during closing, Kuwas’s counsel argued that,

Everything that one needed to know was stuff that [Homeowners Choice] knew from day one. And what they did was, they decided to play the odds. Right? We’ll talk a little bit about that. They decided, we’re going to play the odds. And we’re just going to disregard responsibilities that they have, personal responsibility.

Homeowner’s Choice objected to these comments as improper and during the opening and examination, some objections were sustained while others were overruled. The objections made during closing were overruled by the trial court.

Throughout trial Kuwas’ counsel also emphasized Kuwas’s payment of premiums. For example, Kuwas’s counsel argued during opening, “[s]o my client paid X [amount] year, after year, after year, after year from back in the ‘90s…” and then he segued into another comment about the insurance company having “played the odds.” Kuwas’s counsel also argued that Kuwas “deserves his house back because he paid not to be in this position.”

Finally, Kuwas made comments during trial that undermined, or as the court put it “disparaged” Homeowners Choice’s affirmative defenses. Among the comments by Kuwas’s counsel objected to by Homeowners Choice were, that the parties were “fighting like the dickens over whether or not a sewer backup is excluded. And then we come to court after all this litigation, after all of this depositions and motions, and whatnot… and [Homeowners’ Choice] comes in and says, oh, by the way, we just were kidding about that one…You know the plaintiff’s right, that doesn’t apply, okay, but let’s try something else, right?”

At the close of trial, the jury found for Kuwas and against Homeowners Choice, granting Kuwas a significant award. Afterwards, Homeowners Choice filed motions for new trial and to set aside the verdict, which were both denied.

Homeowners Choice appealed the jury’s verdict, arguing that the trial court erred in several ways, only one of which was analyzed by the Fourth DCA: whether the trial court had properly denied Homeowner’s Choice motion for new trial based on the improper arguments of Kuwas’s counsel and improper questioning of Homeowners Choice’s litigation manager. The Fourth DCA reversed on that issue and remanded the case for new trial.2

In its reversal, the court analyzed the lower court’s denial of Homeowner’s Choice’s motion for new trial using an “abuse of discretion” standard, which is a difficult standard to meet on appeal because the trial court—i.e., the judge with the front row seat—is usually given broad deference. The appellate court also looked at the standard that governs preserved issues of improper argument, which is “whether the comment was highly prejudicial and inflammatory”3 in performing its analysis.

Regarding counsel’s arguments regarding “playing the odds,” in light of Homeowners Choice’s arguments that such comments implied bad faith, or implied that Homeowners Choice denied policyholder claims for any or no reason, the Fourth DCA agreed with Homeowners Choice and found those comments were grounds for reversal. With respect to plaintiff counsel’s arguments regarding the payment of premiums, the Fourth DCA did not believe that the comments rose to a level requiring reversal, at least not on their own (although the appellate court acknowledged that such comments could be grounds for reversal, as Homeowners’ Choice argued and cited case law to support.4) Finally, with Kuwas’ counsel’s argument on disparaging Homeowners Choice’s affirmative defenses, the Fourth DCA also took Homeowners Choice’s side. Homeowners Choice argued that Kuwas’s comments implied that the jury should punish Homeowners Choice for defending itself against Kuwas’s claims. They also argued that Kuwas’ counsel made these arguments to attract the jury’s attention to irrelevant pretrial conduct, implying that Homeowners Choice should be penalized for requiring Kuwas to prove his case. Although Kuwas advanced rebuttal that these arguments were actually made to point out the differences between the denial letters and the affirmative defenses, that argument did not hold water with the Fourth DCA, who ultimately agreed with Homeowners Choice finding these comments were “so highly prejudicial and inflammatory such that [Homeowners Choice] was denied its right to a fair trial.”

As an advocate for policyholders, I typically prefer writing blogs about when an insured (and not an insurance company) prevails. However, after reviewing this case, I thought it was important to point out that it appears courts are holding insureds and their counsel accountable for making sure that even issues that could be construed as implying bad faith should be reserved for after battles over coverage are decided.
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1 Homeowners Choice Prop. & Cas. Ins. Co. v. Kuwas, 4D17-2383, 2018 WL 3301890, at *1 (Fla. 4th DCA July 5, 2018).
2 The other issues on appeal were either affirmed without discussion or were not addressed, as they were rendered moot by the reversal.
3 Murphy v. Int’l Robotic Sys., Inc., 766 So. 2d 1010, 1012 n.2 (Fla. 2000).
4 Government Employees Ins. Co. v. Kisha, 160 So. 3d 549, 552-53 (Fla. 5th DCA 2015)(where a discussion of the length of an insureds’ relationship with her insurer was found to be an impermissible plea for sympathy that impeded the jury’s ability to fulfill its duty of impartiality, and warranted a new trial).

California Supreme Court Rules Broadly in Favor of Insureds

David E. Weiss and Kerry Roberson | ReedSmith | June 11, 2018

On Monday, June 4, 2018, the California Supreme Court ruled that an insurance company must provide liability coverage to its corporate insured against claims of negligent hiring, retention, and supervision of its employee, who allegedly sexually assaulted a 13-year-old child. The case is Liberty Surplus Ins. Corp. v. Ledesma & Meyer Construction Co., Inc., Case No. S236765 (June 4, 2018). This decision is “of exceptional importance to injured parties, employers, and insurance companies doing business in California,” wrote the U.S. Court of Appeals for the Ninth Circuit, in an order certifying the issue to the California Supreme Court.

In 2002, Ledesma & Meyer Construction Co. (L&M) entered into a contract with the San Bernadino School District for a construction project at a local middle school. L&M hired Darold Hecht to work on the project. In 2010, a 13-year-old student at the school (Jane Doe), filed suit asserting numerous claims against L&M, alleging that she was sexually abused by Hecht. One of Doe’s claims against L&M alleged negligent hiring, retention, and supervision of Hecht. L&M’s insurer, Liberty Surplus Insurance Corporation, agreed to defend L&M under a reservation of rights.

Liberty sought declaratory judgment in federal court that Liberty was not obligated to defend or indemnify L&M against Doe’s lawsuit, arguing that L&M’s negligence did not constitute an “occurrence” under the commercial general liability policy. The policy provided L&M coverage for liabilities arising from “bodily injury” caused by an “occurrence.” The policy defined “occurrence” as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” The District Court held that Liberty was not obligated to defend or indemnify L&M in the underlying action because L&M’s negligent hiring, retention, and supervision of Hecht was “too attenuated from the injury-causing conduct” of Hecht to fit the policy definition of “occurrence.”

L&M appealed to the United States Court of Appeals for the Ninth Circuit, which then issued an order certifying the issue to the Supreme Court of California. The Ninth Circuit sought guidance because “California law [wa]s unsettled in this area,” and because of the “significant precedential and public policy importance” of the outcome. The Supreme Court of California agreed to answer the following question: “When a third party sues an employer for the negligent hiring, retention, and supervision of an employee who intentionally injured that third party, does the suit allege an ‘occurrence’ under the employer’s commercial general liability policy?”

The Court explained that the term “accident” in liability insurance policies in California is a settled matter. “[A]n accident is ‘an unexpected, unforeseen, or undersigned happening or consequence from either a known or unknown cause” and refers to the conduct of the insured. Additionally, the term “includes negligence,” which indicates that a policy that provides coverage to the insured for injuries caused by an “accident” includes coverage for injuries resulting from the insured’s negligent actions.

The Court also analyzed the District Court’s decision and determined that the court engaged in faulty reasoning both in terms of causation and its reading of the relevant case law. The District Court determined that L&M’s alleged negligent actions were “too attenuated” from Hecht’s actions to be considered the “cause” of Doe’s injuries. However, this line of reasoning runs contrary to California cases that have recognized that negligent hiring, retention, or supervision can be a substantial factor in causing the harm to a third party due to the actions of an employee.

Additionally, the District Court misplaced reliance on a number of cases to support its proposition that L&M’s allegedly negligent actions do not qualify as “accidents” simply because they did not anticipate the injury to occur. However, the cases that the District Court cited were distinguishable from the case at hand in various critical ways and thus did not support the District Court’s proposition.

Minkler v. Safeco Ins. Co. of America is the controlling authority on this issue (Minkler v. Safeco Ins. Co. of America (2010) 49 Cal.4th 315.) In Minkler, a Little League coach was sued by a player for sexual molestation. The player also sued the coach’s mother for negligent supervision and failure to prevent the molestations in her home. The coach and the mother committed independent torts, but the coach’s intentional actions did not preclude the mother from coverage. Although insurance does not usually cover intentional injuries, the Court stated, “[t]here is no overriding policy reason why a person injured by sexual abuse should be denied compensation for the harm from insurance coverage purchased by the negligent facilitator.”

If the Court had decided in Liberty’s favor, employers would not be covered for claims of negligent hiring, retention, or supervision in situations where employees engage in intentional actions, a result that would be fundamentally inconsistent with existing California case law. For that reason, the court ruled in favor of L&M, stating that, “absent an applicable exclusion, employers may legitimately expect coverage for [claims of negligent hiring, retention, or supervision whenever the employee’s conduct is deliberate] under comprehensive general liability insurance policies, just as they do for other claims of negligence.” This holding protects the reasonable expectations of policyholders and makes clear that the coverage analysis should be focused on the conduct alleged against the particular insured seeking coverage. Thus, if there are claims against multiple actors, the specific claims against each individual actor need to be analyzed separately.

The California Supreme Court’s decision will have implications beyond the employment situation dealt with in the case; for instance, the Court ordered briefing deferred in Travelers Property Casualty Co. of America v. Actavis, Inc., Case No. S245867, pending this decision. In that case, the Court will consider whether Travelers owed its pharmaceutical company insured a duty to defend or indemnify in an action involving underlying claims involving liabilities arising from the sale and marketing of opioids. We will report on that decision as soon as it comes down.