A nightmare scenario for any business: you've been hacked. The hackers have gained access to countless client records including credit card and other financial data. The expense of dealing with the breach, and the damage to business reputation could be crippling. How best can businesses insure themselves against this and other cyber risks, and what are the legal issues involved?
Types of cyber risks
Cyber risks faced by businesses today take many different forms. In addition to hardware and/or software failure, or the loss of portable devices such as laptops or smart phones, companies face increasingly sophisticated attacks from hackers. Any of these events could disable access to company websites, corrupt databases, or result in the theft of large volumes of confidential customer information. Hackers may attempt to commit fraud with the stolen data, or extort companies anxious to restore access to electronic resources. Hacking attempts, even if only partially successful, could result in the installation of viruses or Trojan horses that cause further damage to company systems or the theft of more data. Company employees or agents may inadvertently or purposefully defame competitors on company websites, blogs or social networking sites like Facebook and Twitter. The list goes on.
Despite these risks, many businesses do not yet possess coverage for electronic and cyber risks. Only 31% of respondents in a 2013 study by the Ponemon Institute indicated that their organizations had some form of cyber insurance coverage, though 57% of those without coverage indicated that their organization had some plan to purchase coverage in the future.1
Insurance issues: A look back in time
Significant changes with respect to insurance available to cover cyber risks took place in the late 1990s and early 2000s, as the volume of electronic data collected and stored by businesses worldwide increased dramatically, and the number and extent of cyber losses began to grow. Questions arose as to whether cyber-related loses ought to fall within the scope of traditional Commercial General Liability policies.
In particular, U.S. Courts began to consider the issue of whether electronic data fell within the definition of tangible property in the context of commercial liability insurance.2 While some state courts in this early period found that electronic data was tangible property for the purposes of insurance coverage,3 other courts were unwilling to extend coverage on this basis. In 2001, in State Auto Property and Casualty Insurance Company v. Midwest Computers & More, in the course of deciding whether an insurer was required to defend and indemnify a policyholder where the policyholder faced a suit over negligently performed computer service work which resulted in the loss of its customer's data, the court held that "computer data cannot be touched, held, or sensed by the human mind; it has no physical substance. It is not tangible property."4
In conformance with this trend in jurisprudence, in 2001, the standard CGL form published by the Insurance Standards Office in the United States was revised to exclude "electronic data" from the definition of "property damage". In Canada, a similar exclusion was introduced in the Insurance Bureau of Canada's standard CGL form starting in 2005.5
The resulting gap in coverage gave rise to an obvious need for a new insurance product, designed to address emerging cyber risks.
What insurance coverage is available to cover cyber risks?
Many insurers now offer comprehensive cyber risk policies, providing both first- and third-party coverages. Perils covered under cyber policies include expenses incurred as a direct result of the breach, such as legal, investigation and public relations expenses, as well as indirect costs, such as business interruption and loss of goodwill. Third party coverages available include losses suffered by customers as a result of the theft and use of their personal financial data. Insurers also offer value-added services, such as network security testing, designed to help companies avoid and mitigate the effects of a data breach, and crisis management services.
Notwithstanding the electronic data exclusion discussed above, litigation continues with respect to whether and to what extent cyber losses may be covered under CGL policies.
For example, in Zurich American Insurance Company v. Sony Corporation of America et al,6 Sony sought coverage under a CGL policy in connection with an on-line breach leading to theft of customer personal information. Rather than seeking to recover under the Bodily Injury and Property Damage coverages, Sony instead argued that the breach of its systems by hackers, which resulted in the information of millions of its users being compromised, constituted a disclosure of information so to trigger coverage under the Personal and Advertising Injury Liability coverages in the CGL policy, as publication of material "in any manner." Sony's CGL policy included coverage for "oral or written publication, in any manner, of material that violates a person's right of privacy."7
Sony's insurers argued that the policy did not afford coverage, first, because "publication" required an intentional act on the part of the insured, and second, because "in any manner" referred to the medium of publication, rather than the source of publication.8 The Court agreed with the insurers, and held that Sony was not entitled to coverage; though the hacking incident did result in a "publication" of the user data, the general liability policy required that publication come as a result of Sony's intentional act.9 The Court ruled on a motion for summary judgment that Sony was not covered under its CGL policy for the breach of Sony's PlayStation Network and other online systems. As a result, Sony's insurers did not owe a duty to defend in class action lawsuits arising out of the breach.
Though the case is likely to be appealed, the decision may well be indicative that future attempts may be made to find coverage for cyber related losses under CGL policies.
Cyber risk insurance products and the legal issues surrounding them are in an emerging and developmental phase. However, as the number and extent of cyber losses is steadily increasing, and regulatory disclosure and reporting obligations are evolving, it is critically important that businesses take steps to insure and protect themselves against cyber losses.
1 Ponemon Institute, "Managing Cyber Security as a Business Risk: Cyber Insurance in the Digital Age" (Ponemon Institute LLC, August 2013) at 19-20.
2 See Magnetic Data Inc v St Paul Fire and Marine Insurance Company, 442 NW (2d) 153 (Minn Sup Ct 1989) (The insured had tendered the defence of a suit to its insurer where it had mistakenly erased magnetic tapes containing its customer's data while performing work on them. The court held that it "need not determine... whether the computer information is tangible or intangible property" because the situation was covered by an exclusion in the policy for property damage that occurred while property was on the insured's premises for the purpose of being worked on).
3 See Retail Systems Inc v CNA Insurance Companies, 469 NW (2d) 735 (Minn App Ct 1991) (The insured had tendered the defence of a suit to its insurer where it had lost a magnetic tape containing its customer's data, and the court held that "[t]he data on the tape was of permanent value and was integrated completely with the physical property of the tape"); American Guarantee & Liability Insurance Company v Ingram Micro Inc, 2000 WL 1094761 (D Ariz) (The insured claimed for property damage under its insurance policy when a power outage caused programming information to disappear from the RAM of its mainframe computers, and the court held that "[a]t a time when computer technology dominates our professional as well as personal lives, the Court must side with Ingram's broader definition of ‘physical damage'" which included the loss of use and functionality of the mainframes).
4 State Auto Property and Casualty Insurance Company v Midwest Computers & More, 147 F Supp (2d) 1113 (WD Okla 2001) ("Ordinary meanings of ‘tangible,' according to a commonly used English dictionary, include: capable of being perceived esp. by the sense of touch: PALPABLE; ... capable of bring precisely identified or realized by the mind; ... capable of being appraised at an actual or approximate value... None of these definitions fits data stored on a computer disk or tape. Although the medium that holds the information can be perceived, identified or valued, the information itself cannot be. Alone, computer data cannot be touched, held, or sensed by the human mind; it has no physical substance. It is not tangible property").
5 The electronic data exclusion introduced in the IBC Form 2100 CGL policy in 2005 reads: "For the purposes of this insurance, electronic data is not tangible property. As used in this definition, electronic data means information, facts or programs stored as or on, created or used on, or transmitted to or from computer software, including systems and applications software, hard or floppy disks, CD-ROMS, tapes, drives, cells, data processing devices or any other media which are used with electronically controlled equipment": Mark G Lichty & Marcus B Snowden, Annotated Commercial General Liability Policy (loose-leaf updated December 2013) (Toronto: Carswell, 1997) at § 20.00 (cited to online version from Carswell's e-Reference Library). See also Richard J Bortnick & Abby J Sher, "Cyber Liability Insurance: The Value of an Educated Broker in the Age of E-Commerce" (2011) 24:12 PLUS Journal at 3.
6 Index No. 651982/2011 (NY Sup Ct, Feb. 21 2014).
9 Zurich, supra at 75-80.