claims

BOP MAY INCLUDE HIDDEN GAP IN ELECTRONIC DATA COVERAGE

by: Gene Riemenschneider and Paul Lipman

For many businesses and risk managers, the proliferation of electronic data storage and communication tools is a mixed blessing. While relatively new technology such as the Internet can substantially increase efficiency and reduce paperwork, it also increases a company's exposure to losses of vital electronic data. Defining the nature of this data, and determining how it is or is not covered under the business owners policy (BOP), is an increasing commercial claims problem that adjusters, risk managers and business owners will have to face in coming years.
Many people dismiss the risk to electronic data by noting that the information is easily backed up. There are several problems with this thinking, however. Many people do not back up as they should or intend to (the author included), and backups that are made are often corrupted due to a problem with the information that is being backed up or with the backup or compression program itself. The backup, along with the original software, installation disk or CD, can also be easily damaged or destroyed by the same hazard that damages the original information. Even if the information can be recovered from the backup or the original storage device, restoration and reconfiguration of the system can be very costly.
Once a loss does occur, the initial response that most adjusters have to a claim for electronic data is that it is excluded or limited by the policy. However, a review of the exact wording in the BOP indicates a gap lurking in the coverage.

The BOP is very confusing, with respect to electronic date coverage, and there are some differences between the various versions. For the purposes of this article, we have looked at the BP 00 01 01 97.
There is no wording in the BOP policy that would exclude electronic  data from the personal property coverage, and any on-site computers used to store maintenance records on a property would also appear to be covered under the real property coverage as "service equipment" (as well as the software and electronic data utilized for that purpose).
This raises some questions: Is electronic data legally "personal property" and therefore covered? What if the data is not proprietary, copyrighted or otherwise intellectual property, but just run of the mill electronic data and information necessary to the running of the computer system or the business?

Courts leave questions unanswered
There is little law on these questions. Many states broadly define personal property in civil codes to include intangibles, so it is not a likely avenue of defense to say that data is not really property simply because it is intangible. And it must be further assumed that the ordinary data loss claim does not have to involve copyrighted work or other intellectual property, but just ordinary data.
Assuming that the ordinary data is property", the value is likely to be the replacement cost of the data, rather that the mere cost of the tangible equipment and media, such as disks destroyed in a fire. It has been commented in a California telephone "hacking" case involving charges that theft of telephone access codes amounted to conversion or trespass to personal property that "the value of the information on (a computer) disk, not the de minimus price of the disk" is the true liability of one who steals a disk (Thrifty-Tel, Inc. v. Bezenek (1996) 46 Cal App.4th 1559, 1565). It would follow that if ordinary electronic data (rather than just the disk) is "property" capable of being stolen or trespassed, that coverage for "property" would encompass such ordinary data in the amount of "the value of the information on the disk, not the de minimus price of the disk." Fortunately, the quoted material is dicta, i.e. not a binding part of the opinion. It has persuasive authority only. Further, the case involved the theft of truly proprietary information (access codes) rather than ordinary electronic data. Unfortunately, to the extent that such language even creates an ambiguity as to whether electronic data is "property," or as to whether the data's replacement value is covered, the insured will be favored.

The U.S. District Court for the District of Kansas addressed a business interruption claim for a meat packer's loss of electronic data, allegedly due to quirks in the computer system. In The Home Indemnity Company v. Hyplains Beef 893 F Supp. 987 (D. Kan. 1995), the court held that there is no coverage for a slowdown or reduction in operations caused by the loss of electronic data where the Business Income Coverage Form only provides coverage for the "suspension" of operations during the restoration period since "suspension" means total cessation, rather than a slowdown or reduction in efficiency. The provision defined the loss period as commencing at the time of "direct physical loss of or damage to property." The court made a specific point of saying that it found it unnecessary to answer the question of whether there could, in fact, be "direct physical loss" to electronic data that was never reduced to hard copy or tangible form, because the court found as a threshold matter that there was never a complete "suspension" of business, anyway.
So, again, a court has left basic questions unanswered, such as whether loss of ordinary electronic data will be considered a true property loss. This area of law will have to await further development, but it appears that (a) loss of such an intangible will eventually be found to be a property loss, independently of the loss of the disk or other media; and that (b) the loss will be the replacement value of the data rather than just the value of the equipment.

Is there a limit?
The BOP provides a coverage extension for "valuable papers & records," in the amount of $5,000 ($2,500 for off site records). Higher limits to this extension can be purchased. The policy then goes on to exclude coverage for many perils faced under this extension. However, these are exclusions only to the coverage extension, not to the policy as a whole.
The only limitation on coverage
is to business income caused by direct physical loss of, or damage to, electronic records, which limits coverage to 60 days or the time to repair. As the term "direct physical loss" is not well defined, it could apply to a loss of electronic data only.
In the "loss payment" section, coverage for "valuable papers & records, including those which exist on electronic or magnetic media" is limited 11 to the cost of blank material and transcribing or copying the records." However, this limitation does not apply if the valuable papers and records are actually replaced or restored. Essentially, there is no limit on coverage, other than the policy limits, if an insured elects to restore or replace the records.

It should be noted that the commercial property policy, CP 00 10 06 95 (which is an older form than the BOP quoted above) specifically states, "covered property does not include: The cost to research, replace or restore the information on valuable papers and records, including those which exist on electronic or magnetic media, except as provided in the coverage extensions." Why is this exclusion omitted from the BOP if coverage is not intended?
This appears to be a glaring error in the BOP policy that ISO and the insurance carriers need to address. The policy provides a coverage extension without limiting the exposure in the first place. The value of the BOP's unintended extra coverage can be immense. Fortunately, the loophole that provides the coverage can also limit the exposure by creat ing a co-insurance penalty.
Under loss payment, the BOP provides an 80 percent co-insurance clause if the lost or damaged items are repaired or replaced. If an actual cash value (ACV) payment is made, no coinsurance limit applies. If co-insurance is applicable, the policy states the insured is entitled to the larger of the ACV or replacement and repair cost. However, the loss payment limit on valuable papers and records does not allow for an ACV payment for valuable papers and records. Some carriers use a manuscript form that imposes a blanket 90 percent coinsurance clause on older BOPs that do not have the co-insurance limit.

Determining value
An insured may fail to keep current in putting an accurate value on personal property covered under the policy. Furthermore, it is very unusual for an insured to consider the value of electronic data when setting the limits of coverage on a BOP policy. Most would be upset if the agent, underwriter or company wanted to charge premium on the value of electronic data - after all, "they back it up." The assumption of most insurance professionals is that it's not covered so why consider it.
Determining the value of the electronic data for co-insurance and possible settlement of the claim can be a subjective matter. Getting a good statement from the insured is the best way to start. Find out what information and software are on the system; how this information is used in the business; what the impact of the loss of the information is on the business. An inquiry into the general finances of the company will also help to place a value on the data. A key issue to cover with insureds is, what do the insureds think is the value of the loss? Make sure to have insureds discuss their reasoning. More important than the value of the data is how much it would cost to reproduce all the insureds' electronic data, as this portion cannot be paid on an ACV basis, per the loss payment section. Other assets of the business should be reviewed to get the big picture for co-insurance. If the size of the claim warrants, the adjuster should consider having an accountant or data recovery specialist help evaluate the value of the loss.
Stolen or damaged commercial software will often be replaced free of charge by the software company. Although this is a valuable too] to use in adjusting computer losses, the cost of the software, absent any exclusions, should still be included in the coinsurance calculation. The cost of reconfiguring the replacement computer system should be included in the personal property coverage limit for co-insurancei remember to apply the reconfiguration cost to all systems, not just the lost or damaged system, when figuring the co-insurance penalty.
Experts can recover electronic data either from the damaged storage device or from a corrupted backup. However, the full cost of recovering or replacing all insured electronic data, not just the damaged portion, should be considered for co-insurance purposes.
Most insureds will not be happy with a co-insurance penalty. However, if the adjuster conducts a proper investigation and documents the file, there will be no trouble justifying it. The interesting issue is what should be done for losses that do not involve electronic data, but where the insured has an exposure (no matter how well it is backed up and protected). Technically, a co-insurance penalty, as described above, should be applied to the loss anyway. In all probability, this would not go over well with the Department of Insurance, the courts, or the consumers. What really needs to happen is for the policy to be fixed. In the meantime, adjusters should use the above procedures to limit the loss.