There has been no recent shortage of high-profile cyberattacks and data breaches leaving businesses with millions of dollars in losses. Verizon’s 2015 Data Breach Investigations Report counted 79,790 security incidents (including 2,122 confirmed data breaches) in the last year alone. If you’re a business that stores information electronically—that is, if you’re any business at all—you’re probably sufficiently worried about cyber threats just by reading the news. But if you haven’t fully appreciated the seriousness of the problem yet, the insurance industry is happy to help. As one insurer warns in its marketing materials, “many companies don’t realize that whether they experience a data security breach isn’t as much a matter of if it will happen as when.” Sufficiently terrified of cyber threats? Don’t worry—these same insurers will let you know they offer coverage that will help mitigate your risk. As one insurer puts it, “when a security breach happens, you’ll need comprehensive protection from an insurer that specializes in handling cyber risks, offers a full suite of integrated insurance solutions to help minimize gaps in coverage, and understands how to tailor coverage to your business.”
So, you finally bought cyber insurance. Now you’re fully protected, right? Not so fast. So-called “cyber” policies are far from comprehensive – they are sold in separate modules, each of which addresses a different type of loss that arises out of a data breach (e.g., one module covers liability to third parties, another covers crisis management costs, while yet another covers forensic expenses, and so on.) Proving that what’s past is prologue, this “a la carte” approach to selling cyber insurance is just the way liability coverage was sold in the early 20th Century, before the advent of the Comprehensive General Liability policy. And much like the pre-CGL liability insurance market of the early 20th Century, the amount of cyber insurance limits companies can buy is insufficient to cover the losses arising out of data breaches. The CEO of one of the largest players in the cyber insurance market confirmed this recently, telling attendees at an event at New York University that cyber insurance capacity is “very small” compared to coverage companies buy for other property and casualty risks. To complicate matters further, cyber policies are not written on standard forms. Instead, each insurer has drafted its own unique (and confusing) language. The one thing the policies appear to have in common is that all are fraught with conditions and exclusions (some not so obvious) that can leave you vulnerable
All of this suggests there is reason to be skeptical about just how much protection cyber policies provide. A recent lawsuit filed by Columbia Casualty Company seeking to deny coverage to Cottage Health System provides further support that some skepticism is warranted. Cottage, which operates a network of hospitals in California, reached a $4.125 million settlement in a class action suit arising from the disclosure of electronic medical records. The claimants alleged that Cottage or its third-party vendor, INSYNC Computer Solution, Inc., stored medical records on a system that was fully accessible to the internet without installing security measures to protect the patient information. Cottage was insured under Columbia Casualty’s “NetProtect360” liability policy, which purports to provide coverage for data breaches. Columbia initially agreed to cover the cost of Cottage’s settlement under a reservation of rights, but later sued for a declaration that the coverage is void, seeking to recoup the $4.125 million. Specifically, Columbia claims that Cottage triggered an exclusion (disguised in the policy as a condition) by failing to follow “Minimum Required Practices” because it did not “maintain all risk controls identified in the Insured’s Application.” In support of this claim, Columbia contends that when Cottage applied for a NetProtect360 policy, it incorrectly checked the “yes” box in response to such vague questions as “[D]o you . . . contractually require . . . 3rd parties to protect this information with safeguards at least as good as your own?” and “Do you have a way to detect unauthorized access or attempts to access sensitive information?” These questions were part of a “Risk Control Self-Assessment” contained in the application that neither invites the insured to detail its actual risk control policies nor indicates that an incorrect answer can eliminate coverage entirely.
While insurers have touted cyber policies as an essential component of every company’s plan to mitigate the risk of inevitable data breaches, Columbia’s approach essentially renders the coverage illusory. By requiring such yes/no answers to cookie-cutter questions rather than basing underwriting decisions on the specifics of the applicant’s actual security practices, Columbia builds in an escape hatch, laying the groundwork for down-the-road allegations that “minimum required practices” have not been met. Moreover, Columbia deftly attempts to shift its normal burden to prove that an exclusion applies by referring to compliance with these “minimum required practices” as a condition precedent to coverage.
There are lessons to be learned from this. At a macro-level, it appears that we are in the early stages of the evolution of coverage for data security breaches – a risk that barely existed a decade ago but has fast become ubiquitous. If history is a guide, policyholders should expect a market to develop for more standardized cyber policies offering a broader form of coverage to replace the current smorgasbord approach, much the way the market for standardized Commercial General Liability policies developed beginning in the 1940s. At a micro-level, there may be ways to avoid the trap set by Columbia Casualty for Cottage Health. For example, instead of filling out an over-simplified questionnaire about your complicated risk control protocol, insist on submitting a detailed description of your company’s actual cyber security systems and procedures in place to avoid running into allegations of misrepresentation or nondisclosure down the road. Of course, while this may address the particular defense raised by Columbia, insurers no doubt will rely on other language in their policies to seek to avoid their obligation to pay for other data breach losses in the future. As a general matter, companies purchasing cyber coverage should not place blind faith in the insurers’ assurances of “comprehensive protection.” Cyber insurance can be an important protection against the high costs of cyberattacks and data breaches—but you must be very careful in determining which cyber coverage is right for your business, understand what the policy does and does not cover, and not allow an insurer to sell you only the illusion of coverage.