USA - Hinshaw & Culbertson, LLP
In this chapter of our Annual Insurance Review 2024, we look at the main developments in 2023 and expected issues in 2024 for USA.
Key developments in 2023
Insurers continue to confront social inflation, economic inflation, ESG/sustainability, and artificial intelligence as well as the systemic challenges associated with artificial intelligence and cyberattacks. COVID-19 business interruption, cyber and privacy, PFAS and opioids, construction defect, weather-related claims, D&O/securities, and traditional asbestos and environmental claims dominated claims and litigation activities and court decisions.
Social Inflation
Although economic inflation has dropped from a 40-year-high of 9.1% in 2022 to approximately 3.5%, it remains almost three times the rate of 2020. Social inflation remains unabated in the US, where a world leading 40 million lawsuits a year are filed. The tort system costs per household range from US$2,000 to $5,500 depending upon the state.
Combating social inflation is difficult in an environment fraught with improvident legal and evidentiary rulings by judges giving rise to large liabilities, coupled with nuclear and thermonuclear verdicts rendered by juries. Traditional rules of evidence and jury instructions have been ineffective in tapering proclivities of younger jurors and addressing the challenges presented in this instant information age. The plaintiffs’ bar is rolling in cash, armed with litigation funding, employing reptilian tactics, and spending nearly US$1.5 billion annually in advertising to recruit plaintiffs and pre-condition future jurors to render large verdicts. Meanwhile, defendants and insurers have relinquished their traditional leverage and financial advantages in favor of what at times seems to be a myopic focus on containing their litigation spend.
Except for Florida, little meaningful tort reform has been enacted across the US in recent years. The short-term impact of the Florida reform has been the infusion of 280,000 new cases filed in advance of the effective date of the legislation. By contrast, state legislators have contributed to social inflation by passing privacy statutes such as the Illinois Biometric Information Privacy Act (BIPA) (which allows for recoveries in the absence of plaintiffs sustaining any actual damages), eliminating statutes of limitation for sexual abuse cases, expanding causes of action permitting an award of punitive damages. Public nuisance tort theory has gained traction in some states.
ESG/Sustainability
The Biden administration and many states continue to advance environmental, social, and governance (ESG) criteria on a “whole of government” basis with ESG dominating most decisions and actions of agencies and departments. The Securities and Exchange Commission has proposed an onerous climate-related disclosure rule and is stepping up enforcement activity with respect to ESG.
The momentum remains on the side of ESG, but the pace and depth of ESG have resulted in backlash. The anti-ESG movement has gained momentum on the heels of last year’s US Supreme Court decision in the West Virginia v EPA case, which struck down a rule promulgated by the EPA to address carbon dioxide emissions from existing coal and natural gas-fired power plants, ruling the agency exceeded its authority under the Clean Air Act. The Court’s 2023 decision in Sackett v. EPA narrowed the federal government’s authority to regulate bodies of water and upending a Biden administration rule. Finally, the Court’s decision in Students for Fair Admissions, Inc. v. President and Fellows of Harvard College took a bite out of diversity, inclusion, and equity initiatives in terms of college admissions. The Court struck down affirmative action admissions policies used by both Harvard and UNC, effectively barring the consideration of race as an independent factor in university admissions. Harvard and UNC receive federal funding and are subject to the Equal Protection Clause of the Fourteenth Amendment to the U.S. Constitution and Title VI of the Civil Rights Act of 1964, which bar discrimination based on race. Private companies generally are not subject to the Equal Protection Clause but are subject to Title VII of the Civil Rights Act of 1964, which has language very similar to Title VI. Many companies are at least reevaluating their DEI initiatives. The ultimate impact on private employer diversity initiatives will play out over time.
As the ESG debate roils, some state legislative bodies have enacted or proposed anti-ESG legislation, much of which is directed to investment issues. This past legislative season saw roughly 99 bills nationwide aimed at restricting the use of ESG factors, a marked increase from the 39 bills in 2022.
Artificial Intelligence
Insurers are using artificial intelligence (AI) in a variety of ways with respect to underwriting, pricing, fraud investigation, claims evaluation and handling, and other activities. There are no insurance industry-wide AI standards or regulations, but state insurance regulators, the National Association of Insurance Commissioners, and various organizations are formulating regulations, guidelines, and best practices for the use of AI and algorithms by insurers, and artificial intelligence may be subject to otherwise applicable existing regulatory requirements. In November, the US Cybersecurity and Infrastructure Security Agency and the UK National Cyber Security Centre released their Guidelines for Secure AI System Development. The use of AI and algorithms by insurers is drawing increased scrutiny from regulators and policyholders alike.
Effective use of AI will be an important determinant of insurer success going forward. AI already has produced claims and it is expected to produce and amplify a large volume of claims activity into the future.
COVID-19 Business Interruption Litigation
Almost 2,400 COVID-19 have been filed in state and federal courts across the US since the pandemic. Approximately 476 cases have been filed as putative class actions and 856 cases include allegations of bad faith. At the trial court level, insurers have prevailed in approximately 69 percent of the 236 rulings on motions to dismiss in state courts across the country and in more than 86 percent of the 740 rulings in federal courts. These victories have been predominately obtained on the grounds that the claims do not involve “direct physical loss or damage” to property as required by the language contained in most US first-party policies or based upon the application of virus or other exclusions. Insurers have prevailed in most summary judgment rulings in and 6 of the first 7 trials. Policyholders scored their only jury win to date with a $48.5 million verdict in favor of Baylor College of Medicine against Lloyd’s in Texas.
Insurers have prevailed before every US Courts of Appeals circuit, except for the D.C. Circuit which has yet to rule. Insurers also have prevailed in appeals before State Supreme Courts in Connecticut, Delaware, Iowa, Louisiana, Massachusetts, Nevada, New Hampshire, Ohio, Oklahoma, South Carolina, Washington, and Wisconsin. Policyholders were handed a victory in the Vermont Supreme Court allowing a lawsuit to go forward. Insurers have prevailed in most state intermediate appellate court decisions to date as well.
Cyber
For the past 13 years, the U.S. has had the highest average costs in the world for data breaches at US $9.48 million. Since 2020, the costs of healthcare data breaches have increased by 53.3%. Phishing accounts for 16% of data breaches followed by stolen or lost credentials at 15%. Breaches resulting from the use of stolen or lost credentials had the longest lifecycle at nearly 11 months to detect and contain the breach. Organizations with high levels of incident response planning and testing reduce average data breach costs by US $1.49 million, and extensive security, artificial intelligence, and automation on average lowers data breach costs by US $1.76 million.
Most reported coverage decisions involving cyber issues have been so-called cyber decisions – decisions under traditional general liability, first-party, and crime/fraud policies.
The intermediate New Jersey appeals court affirmed the trial court decision in Merck & Co. v. Ace Am. Ins. Co., holding the 2017 cyberattack from malware known as NotPetya carried out by hackers acting on Russia’s behalf was not barred by the hostile/warlike action exclusion. The New Jersey Supreme Court agreed to review the decision. The decision will be important for legacy cyber insurance contracts, but insurers in the US are moving forward with a new generation of war exclusions. Reportedly, the US Department of Treasury has reached a tentative conclusion that a federal cyber insurance backstop is required for catastrophic cyber risk. At this point, however, no such backstop exists.
On July 26, 2023, the US Securities and Exchange Commission adopted rules requiring registrants to disclose material cybersecurity incidents they experience. Additionally, they must disclose annually material information regarding their cybersecurity risk management, strategy, and governance.
Privacy
The US. lacks an encompassing federal law comparable to the European Union’s General Data Protection Regulations. Data breach notification laws, however, are in place in all 50 states. There are now 9 different comprehensive state privacy laws along with at least 25 different state data security laws in the US. At least 16 states introduced privacy bills in the 2022-2023 legislative cycle.
Privacy acts in Connecticut and Colorado became effective in 2023 and the comprehensive California Privacy Rights Act of 2020 (CPRA) became fully effective. Numerous rulings have been rendered under the Illinois Biometric Privacy Act demonstrating the broad scope of the act. Most of the coverage decisions to date have favored policyholders and hold that various exclusions do not preclude coverage.
PFAS/Forever Chemicals
Per- and polyfluoroalkyl substances (PFAS), often referred to as “forever chemicals,” have been around since at least the 1940s and have been used in so many products they are said to be ubiquitous. Only recently has PFAS became one of the most fervent areas for civil litigation. There are now thousands of cases pending across the US, with numerous eye-opening settlements reached. Governmental regulators arrived late to the scene but are now locked and loaded on regulating PFAS chemicals. Numerous states are suing manufacturers and others for contaminating drinking water and damaging natural resources and are seeking to bar the use of these chemicals. The United States Court of Appeals for the Sixth Circuit vacated a district court order certifying a class of 11 million Ohio residents in a case involving ten defendants.
On October 11, 2023, the EPA issued its final rule under the Toxic Substances Control Act, requiring companies that manufactured or imported PFAS for a commercial purpose since 2011 to report PFAS data to the EPA by the first half of 2025.
PFAS claims present numerous coverage issues. Several decisions have ruled on the applicability of various forms of pollution exclusions with mixed results. Various specific PFAS exclusions may be included in policies of more recent vintage. Many claims potentially implicate legacy policies.
Climate & Weather-Related Claims
The greatest impact that climate change has had on insurance claims to date has been as a phenomenon impacting the frequency and severity of weather events. Despite all the activity surrounding climate change, only one actual climate change coverage decision has been reported. This is the Virginia Court of Appeals decision in AES Corp. v. Steadfast Ins. Co. in which the court affirmed the grant of summary judgment in favor of the insurer on the basis that the underlying complaint did not allege an “occurrence” covered by the policies. The court did not address the pollution exclusion or trigger issues.
In the wake of several insurer insolvencies, Florida enacted two statutes interposing litigation reform impacting first-party claims, particularly with respect to claims involving roof damage and creating a US $2 billion reinsurance program. This year, at least three major insurers announced they would stop or limit writing homeowner’s policies in California due to weather-related claims and the inability to charge adequate premiums.
Traditional Environmental & Asbestos Claims
Notwithstanding the various emerging claim types, traditional asbestos and environmental claims continue to dominate with over 1300 Superfund cleanup sites and 22% of U.S. population residing within 3 miles of them. Approximately US $1 billion from the Infrastructure Investment and Jobs Act was allocated to the cleanup of 49 Superfund sites. Claims-made policies and issues are more dominant in environmental claims today than decades ago. There have been several coverage decisions rendered, but none changing the course of coverage litigation.
Opioids
Opioid epidemic reportedly cost the U.S. approximately US $1 trillion annually. Approximately, 3,000 state and local governmental entities have been seeking to recover costs of public services associated with opioids from drug manufacturers and distributors. Policyholders have not fared well seeking coverage under general liability policies over the past couple of years. However, there was a policyholder victory under a D&O policy in North Carolina federal court in 2023.
Lead Paint
Coverage issues relating to the US $400 million plus lead paint abatement fund resulting from a long-pending case in California against three lead paint manufacturers have been subject to three separate coverage actions, with the insurers prevailing in California, the policyholder prevailing in New York. In the Sherwin-Williams case, the Ohio Supreme Court heard oral argument in October.
Construction Defect
There has been no slow-down in activity in construction defect coverage litigation. Recently, the Illinois Supreme Court ruled that water damage to the interior of the completed townhome units, if proven, could satisfy the definition of “property damage” and “occurrence” requirement, but remanded the case to the trial court to consider whether the business risk exclusions bar coverage. Earlier in the year, the Wisconsin Supreme Court changed the way it analyzed whether there has been “property damage” caused by an “occurrence” under the policies.
Representations & Warranties/Transactions Insurance
Representation and warranties and other forms of transactions insurance have taken root in many transactions, but the claims volume has been manageable and only a few coverage decisions have been reported.
D&O & Securities Law
There has been an uptick in litigation involving greenwashing claims, including shareholder derivative actions against officers and directors for breach of fiduciary duty and violation of securities law. Consumer litigation around alleged ESG misstatements about products and practices continue to be asserted with mixed outcomes. To minimize exposure for greenwashing, some companies have turned to “green hushing,” where companies seek to hide their climate strategies from wider scrutiny.
Although companies with cogent ESG practices may reduce some exposures, corporate activism on ESG issues can have an adverse impact on stock prices and create litigation exposures. Disney found itself in this position, but it prevailed in a records demand action brought by a shareholder. The Delaware Supreme Court ruled that a professional services exclusion in a management liability insurance policy’s professional services exclusion did not preclude coverage for the underlying investigation and claim.
The US Supreme Court granted review in Macquarie Infrastructure Corp. v. Moab Partners, L.P., to determine whether the failure to make the disclosure required by Item 303 of Reg. S-K (requiring disclosure of known trends or uncertainties that have or will have a materially favorable or unfavorable impact on the company) constitutes an actionable omission under Section 10(b) and Rule 10b-5. The Second Circuit has held that Item 303 creates an actionable duty of disclosure, while the Third, Ninth, and Eleventh Circuits have held that it does not.
Wasting Limits Policies & Reimbursement Of Defense Costs
Effective October 1, 2023, Nevada became the first state in the country to preclude issuance or renewal of insurance policies that pay defense costs on a wasting limits basis. The enactment of this legislation generated considerable concern that the abolition of wasting limits policies would result in insurers leaving the Nevada market or liability insurance becoming prohibitively expensive. In response to these concerns, the Nevada Commissioner of Insurance adopted a regulation limiting the application of the law.
Courts across the US are split over the issue of whether insurers may obtain reimbursement for defense costs incurred on non-covered claims by asserting the right to reimbursement in a reservation of rights letter in the absence of a policy provision expressly providing for reimbursement. Policyholders recently prevailed on this issue before the Hawaii Supreme Court and the Eleventh Circuit (under Georgia law). These decisions will not have broad application in view of the number of existing decisions on the issue and the inclusion of provisions expressly allowing for recoupment in policies of recent vintage.
Reinsurance
Several decisions addressed arbitration and panel related issues, but few substantive reinsurance decisions in 2023. The Second Circuit considered allocation under English law in The Ins. Co. of the State of PA. v. Equitas Ins. Ltd. There, the cedent settled environmental claims with its insured applying an “all sums” allocation pursuant to California law. The reinsurer challenged the cession, contending that an “all sums” allocation was improper under English law, which governed the facultative certificate. The Second Circuit determined the issue was not whether English law would have allocated the cedent’s liability based on an “all sums” allocation. The issue was, once the cedant’s liability was property allocated as the parties agreed it was, whether English law would interpret the reinsurance policy as providing co-extensive coverage. The Second Circuit concluded English law would interpret the reinsurance policy as providing co-extensive coverage. The Second Circuit also rejected the reinsurer’s late notice defense.
What To Look Out For In 2024
All the claim types discussed above are expected to be subject to additional decisions in 2024. Social inflation, ESG, and artificial intelligence will continue to impact insurers. Few new COVID-19 business interruption cases are expected to be filed but pending cases will continue to be litigated and generate decisions for the next couple of years before dropping off. Coverage decisions will be rendered under cyber-specific policies with greater frequency.
PFAS losses will present major losses to insurers and their policyholders with the potential to rival asbestos-related losses. This is a rare time where two cases directly impacting insurers are pending before the U.S. Supreme Court. The Supreme Court will render decisions in Great Lakes Ins .SE v. Raiders Retreat Realty Co. LLC, which involves the issue of choice of law under a marine insurance policy and Truck Ins. Exchange v. Kaiser Gypsum Co. Inc., which raises the issue of whether an insurer who will be paying on asbestos claims has standing to object to a plan of reorganization.
Written by Scott M. Seaman & Pedro E. Hernandez - Co-Chairs Global Insurance Service Practice Group.