Insurance Law Alert

January 2024

In This Issue
Ninth Circuit Rules That Insurers Have No Duty To Defend Underlying
Opioid Claims
The Ninth Circuit ruled that opioid-related suits brought by government entities against a
pharmaceutical distributor do not allege a covered “occurrence” and that insurers have no duty
to defend the underlying suit. AIU Ins. Co. v. McKesson Corp., 2024 U.S. App. LEXIS 1806
(9th Cir. Jan. 26, 2024). (Click here for full article)

Fifth Circuit Reverses And Remands Ruling In Favor Of Insurers In
Southwest Airlines Cyber Dispute“Any ‘bet thecompany’ or ‘bet
the issue’ litigation
requires the best and[Simpson Thacher] is the bestof the best.”– The Legal 500(quoting a client)

The Fifth Circuit ruled that a Texas district court erred in dismissing Southwest’s breachof contract and bad faith suit, ruling that the cyber risk policy could potentially provide
coverage for losses related to a computer system failure. Southwest Airlines Co. v. Liberty
Ins. Underwriters, Inc., 2024 U.S. App. LEXIS 996 (5th Cir. Jan. 16, 2024). (Click here forfull article)

California Appellate Court Addresses Whether Extensions Of Policy
Periods Create New Aggregate Limits
A California appellate court ruled that language in two policies created new aggregate limits forpolicy extension periods, whereas language in a third policy maintained a single aggregate limit
notwithstanding a several-month extension of an annual policy. The Pep Boys Manny Moe &Jack of California v. Old Republic Ins. Co., 2023 Cal. App. LEXIS 998 (Cal. Ct. App. Dec. 28,2023). (Click here for full article)

Communications Between Policyholder And Insurance Agent Do Not
Give Rise To “Special Duty” To Offer Specific Coverage, Says California
Appellate Court
A California appellate court ruled that an insurance agent was not negligent in failing to offer
or provide errors and omissions coverage to a policyholder-client despite a longstanding
professional relationship between the parties. Shin v. State Farm General Ins. Co., 2023 Cal.
App. Unpub. LEXIS 7433 (Cal. Ct. App. Dec. 14, 2023). (Click here for full article)

NYSDFS Releases Draft Circular Relating To Insurers’ Use Of Artificial
IntelligenceThis month, the New York State Department of Financial Services issued proposed guidelines
regulating the use of artificial intelligence systems by New York insurance companies. Clickhere to learn more about the proposal. (Click here for full article)

Simpson Thacher News
Click here to learn more about the Firm’s insurance-related honors and publications.
Simpson Thacher & Bartlett LLP

1

Ninth Circuit Rules That Insurers Have No Duty To
Defend Underlying Opioid Claims
HOLDING

The Ninth Circuit ruled that opioid-related suits brought by government entities against a
pharmaceutical distributor do not allege a covered “occurrence” and that insurers have no
duty to defend the underlying suit. AIU Ins. Co. v. McKesson Corp., 2024 U.S. App. LEXIS
1806 (9th Cir. Jan. 26, 2024).

BACKGROUND

McKesson, a distributor of prescription drugs, was named as a defendant in underlying
suits brought by government entities for its alleged role in contributing to the opioid crisis.
The suits alleged that McKesson intentionally flooded the market with opioids,
contravening various industry safeguards and ignoring or concealing risks associated withthe use of opioid medications. McKesson’s insurers sought a declaration of no coverage,
arguing that the underlying claims did not allege an “occurrence” (defined as an accident)
and did not seek damages “for” or “because of” bodily injury. A California district court
ruled that coverage was unavailable because the underlying allegations failed to allege an“occurrence.” The Ninth Circuit affirmed.

DECISION

Under California law, deliberate conduct is not an accident “unless some additional,
unexpected, independent, and unforeseen happening occurs that produces the damage.”
The Ninth Circuit concluded that the claims against McKesson exclusively alleged
deliberate conduct and did not include any allegations relating to independent or
unforeseen happenings.
The court rejected McKesson’s assertion that negligent causes of action in the underlying
suits indicated at least some amount of unintentional conduct. The court emphasized thatthe appropriate focus is on the facts alleged, rather than theories of recovery, stating “[t]hemere fact that such intentional conduct gives rise to causes of action for negligence does nottransform those allegations into allegations of merely accidental conduct.” The court also
rejected McKesson’s contention that the conduct of “downstream actors including doctors,
pharmacists, and opioid addicts” should be deemed additional, unexpected, independentand unforeseen happenings so as to give rise to an“occurrence.” Because the court concluded that theunderlying suits did not allege an accident, it did notreach the issue of whether the claims alleged covered“bodily injury.”

COMMENTS

As the Ninth Circuit noted, a California appellate
court has previously ruled that an insurer had no
duty to defend underlying opioid claims. See
Travelers Prop. Cas. Co. of Am. v. Actavis, Inc., 225
Cal. Rptr.3d 5 (Cal. Ct. App. 2017). McKesson argued
that Actavis was distinguishable because in that case,the insured policyholder was an opioid manufacturer(rather than a distributor) and that complaint allegeda deceptive marketing scheme (whereas the instantcase arose out of distribution activities). However,the court deemed those factual differences
immaterial for the purposes of determining coverage
under California law.

2

Fifth Circuit Reverses And Remands Ruling In Favor Of
Insurers In Southwest Airlines Cyber Dispute
HOLDINGThe Fifth Circuit ruled that a Texas district court erred in dismissing Southwest’s breach ofcontract and bad faith suit, ruling that the cyber risk policy could potentially provide
coverage for losses related to a computer system failure. Southwest Airlines Co. v. Liberty
Ins. Underwriters, Inc., 2024 U.S. App. LEXIS 996 (5th Cir. Jan. 16, 2024).

BACKGROUNDSouthwest suffered a computer failure in 2016, resulting in a three-day suspension of its
flight schedule. Prior to this event, Southwest obtained a cyber risk policy that included“System Failure Coverage,” as well as a tower of follow form excess policies. Southwestsought reimbursement of approximately $77 million it allegedly incurred as a result of thesystem failure. A primary insurer and the excess insurers in the first three tiers of coverage
paid a total of $50 million, but Liberty, the fourth-tier excess insurer, denied coverage.
Liberty argued that coverage under its policy (for losses exceeding $50 million) was not
implicated because five categories of claimed losses—Fare Saver Promo codes, travel
vouchers, Cover Refunds, Rapid Reward Points and advertising costs—were outside thescope of coverage because they were essentially voluntary payments not caused by thecomputer failure.
Southwest sued Liberty, alleging breach of contract and bad faith and seeking a declarationof coverage. The district court granted Liberty’s summary judgment motion, ruling that
Southwest’s expenses were not caused by the system failure, but rather were the resultof “various and purely discretionary customer-related rewards programs, practices
and market promotions.” It further held that coverage was barred under certain policy
exclusions. The Fifth Circuit reversed.

DECISION

The System Failure Coverage provision applied to “all Loss . . . that an Insured incurs . . .
solely as a result of a System Failure.” Liberty argued that the system failure was not the“sole” cause of Southwest’s claimed losses and that the “independent” and “more direct”
causes of those losses were Southwest’s business decisions to incur them. Rejecting thisassertion, the court explained that those business decisions were not the precipitating
cause of the costs, but rather “links in a causal chain that led back to the system failure.”With respect to policy exclusions, the Fifth Circuit ruled that the district court erred inconcluding that coverage was barred as a matter of law. One exclusion applied to “anyLoss . . . alleging, arising out of, based upon or attributable to contractual penalties or3

consequential damages.” The parties disputed interpretation of the term “consequential
damages.” Southwest argued that the phrase referred to harms that flow “naturally, but
not necessarily” from the initial cause and that “are not the usual result of the wrong,” andwould include a customer’s lost business opportunity due to a canceled flight. In contrast,
Liberty argued that consequential damages included any damages that are not direct andimmediate. Siding with Southwest, the Fifth Circuit held that Liberty’s interpretation would
render much of the policy coverage illusory, such as coverage for costs to repair damaged
computer systems or otherwise undertaken to mitigate damage.
The Fifth Circuit also addressed application of an exclusion that applied to “any Loss
. . . arising out of, based upon or attributable to . . . any liability to third-parties forwhatever reason.” The court rejected Liberty’s assertion that the term “third-parties”
included customers and thus encompassed refunds or other payment to customers. The
court reasoned that such an interpretation would effectively eliminate coverage underother provisions relating to “pecuniary obligations” such as fines and employee payroll
obligations.
COMMENTS

The court did not rule that Southwest’s system failure was the sole cause of each of the fivecategories of costs incurred by the airline (and therefore subject to coverage), but rather
remanded the matter for resolution of that and other issues. The Fifth Circuit was not
persuaded by Liberty’s argument that Southwest could “literally dictate the amount of its
own ‘loss’,” but noted that basic insurance principles relating to business interruption
coverage necessarily limited the type of expenses Southwest could recover under the policy
and that Southwest would need to demonstrate, among other things, how its expenses
would not result in a windfall “that would put Southwest in a better position than it would
have occupied without the interruption.”

California Appellate Court Addresses Whether Extensions
Of Policy Periods Create New Aggregate Limits
HOLDINGA California appellate court ruled that language in two policies created new aggregate limits
for policy extension periods, whereas language in a third policy maintained a single
aggregate limit notwithstanding a several-month extension of an annual policy. The Pep
Boys Manny Moe & Jack of California v. Old Republic Ins. Co., 2023 Cal. App. LEXIS 998(Cal. Ct. App. Dec. 28, 2023).

BACKGROUND

After being named as a defendant in asbestos-related bodily injury suits, Pep Boys sought
coverage from its primary and excess insurers. Each of the relevant policies had been
extended beyond its original term, at the request of Pep Boys. Pep Boys paid an additional
prorated portion of the premium for each extension. The insurers took the position that
their respective policies provided only one aggregate annual limit for the underlying claims,
notwithstanding the extensions. In response, Pep Boys sought a declaration that eachpolicy provided two aggregate limits: one for the first 12 months and one for the remaining
extension period. The trial court ruled in the insurers’ favor and the appellate court
reversed in part and affirmed in part.

4

DECISION

A policy issued by Old Republic provided that it was subject to a limit of $10 million “in theaggregate for each annual period during the currency of this policy.” The parties agreed
that Old Republic was obligated to pay up to $10 million for the first 12 months of the term,
but disagreed as to the meaning of the phrase “each annual period” with respect to a
five-month extension of the policy term. Old Republic argued that “annual period” meant
the entire 17-month term of the policy, whereas Pep Boys claimed that the policy term
consisted of two annual periods, each with its own $10 million aggregate limit. Finding
neither interpretation “more reasonable than the other,” the court deemed the policy
ambiguous. Turning to extrinsic evidence, the court noted that Pep Boys chose to extend its
insurance policies for administrative convenience in order to align its insurance programwith its fiscal year end accounting, not to reduce its costs or alter the scope of coverage.
Further, the court noted that under Old Republic’s approach, Pep Boys’ coverage would be“diluted” by spreading the original aggregate limit over 17 months.
The court reached the same conclusion with respect to a policy issued by Fireman’s Fundthat was extended to 15 months and contained similar language. That policy contained a$15 million aggregate limit “for all damages sustained during each annual period of thispolicy.” Employing the same reasoning used in interpreting the Old Republic policy, thecourt deemed the Fireman’s Fund policy ambiguous and construed it as providing two
aggregate limits.
However, the court reached a different conclusion with respect to an American Excess
policy, which stated that the $5 million aggregate limit applied “with respect to loss excessof the Underlying Insurance which occurs during the term of this Certificate.” The court
ruled that this language was unambiguous and established an aggregate limit for the entire
duration of the policy, not based on annual periods within the entire term. In so ruling, thecourt rejected Pep Boys’ assertion that a reference to annual premiums in the extension
endorsement indicated an intent to create an additional annual aggregate limit, finding
such language “insufficient to overcome the policy’s plain definition of its limits as applying
to the entire policy period.”

COMMENTS

Addressing this matter of first impression under California law, the court made several
noteworthy observations. First, the court recognized that its consideration of the aggregate
limit issue was “artificially constrained” because Pep Boys sought only a ruling on thepolicies at issue and the factual record did not reference the presence or absence ofcoverage for the period of time immediately following the policies’ extensions. As the court
noted, if Pep Boys obtained coverage for the period immediately following the partial-year
extensions, then its ruling could result in Pep Boys receiving more coverage than expected
for that calendar year. The court noted the unfairness of that result, but reasoned that theinsurers’ interpretation could lead to a gap in coverage, which would be an equally
unfair result.
Second, the court acknowledged that the “most conceptually satisfying resolution” of thiscase might involve a pro rata calculation of aggregate limits in order to “bridge coverage
between different policies.” However, the court deemed such an approach impossible inpractice, stating: “we interpret insurance policies, not multi-year, multi-layer insurance
policy frameworks, and we must apply each policy’s language as written.” And in any event,no policy explicitly allowed for the proration of aggregate limits.
Finally, the court noted the lack of judicial consensus on this issue and the “even split”
across jurisdictions.

5Communications Between Policyholder And Insurance
Agent Do Not Give Rise To “Special Duty” To Offer
Specific Coverage, Says California Appellate Court
HOLDINGA California appellate court ruled that an insurance agent was not negligent in failing tooffer or provide errors and omissions coverage to a policyholder-client despite alongstanding professional relationship between the parties. Shin v. State Farm GeneralIns. Co., 2023 Cal. App. Unpub. LEXIS 7433 (Cal. Ct. App. Dec. 14, 2023).

BACKGROUND

Stemmler founded a medical billing company in 1998. In or around 2001, he began
working with Johnson, a State Farm insurance agent. Stemmler requested insurance
coverage “for all of his needs,” including home, automobile and “all his business liabilities.”
In 2018, a group of physicians sued Stemmler, alleging negligence, breach of contract,fraud and breach of fiduciary duty. State Farm denied coverage, citing a professional
services exclusion in Stemmler’s business office liability policy. Thereafter, Stemmler sued
Johnson and State Farm, alleging negligence based on Johnson’s failure to exercise
reasonable care, diligence and loyalty in procuring insurance coverage requested by
Stemmler. A trial court granted the defendants’ summary judgment motion and theappellate court affirmed.

DECISION

The appellate court ruled that Stemmler failed to establish a duty necessary to support thenegligence claim. More specifically, the court explained that an insurance agent does nothave a duty to volunteer additional or different coverage unless (1) the agent misrepresents
the scope of the coverage being offered; (2) there is a request or inquiry by the insured for aparticular type of coverage; or (3) the agent assumes an additional duty by express
agreement or by holding him/herself out as having special expertise. The court rejected
Stemmler’s assertion that a duty arose as a result of the second scenario, noting that
Stemmler’s coverage requests were neither “targeted” nor “specific” so as to implicate aheightened duty of care. In this respect, the court emphasized Stemmler’s failure to utilize
the phrase “errors and omissions coverage” in his discussions with Johnson.

COMMENTS

The decision highlights the stringent standard courts utilize when deciding whether
insurance agents should be held to a special duty with respect to the procurement of
insurance coverage. The court acknowledged that Stemmler had purchased insurance fromJohnson for many years and had followed his advice on certain insurance-related issues,
but deemed those factors insufficient to impose a greater duty of care. Further, the court
was not swayed by Stemmler’s assertion that he had no experience in insurance mattersand was unfamiliar with the term “errors and omissions coverage.”

6

NYSDFS Releases Draft Circular Relating To Insurers’
Use Of Artificial IntelligenceThis month, the New York State Department of Financial Services issued proposed
guidelines regulating the use of artificial intelligence systems by New York insurancecompanies. The circular, titled “Use of Artificial Intelligence Systems and External
Consumer Data and Information Sources in Insurance Underwriting and Pricing,” would
apply to any insurer domiciled or licensed to conduct business in New York. The proposed
framework includes requirements relating to numerous areas of concern implicated by
the use of AI systems, including the following: violations of state insurance law, unfair
discrimination, the implementation of sufficient internal controls and oversight, andtransparency to policyholders. The proposed circular requires insurers to engage incomprehensive reviews of AI systems used in the underwriting and pricing contexts
in order to ensure against “disproportionate adverse effects” on protected classes ofpolicyholders. Further, the proposed guidelines include qualitative testing requirementsthat provide justification for the use of AI systems in risk assessment. The proposed
circular also incorporates a list of documentation requirements, such as a the maintenanceof materials describing the operations of the AI system and any monitoring or testingmechanisms, among other things.
Notably, the circular not only requires an insurer to comply with all regulations withrespect to its own direct use of AI, but also as to third-party vendors with whom an insurer
may contract. The guidelines warn that insurers may not “rely solely on a vendor’s claimof non-discrimination” and should institute meaningful oversight of such third-party AI
usage. One important limitation of the proposed circular is that it pertains to the use of AI
in the pricing and underwriting contexts, but does not reference AI systems for marketingor claims management purposes.
The full text of the circular is available here. The deadline for comment is March 17, 2024.

Simpson Thacher News
Simpson Thacher was selected as a Law360 “Practice Group of the Year” in sevencategories, including Insurance, placing it among the publication’s “Firms of the Year” for2023. Law360’s “Practice Group of the Year” awards honor the law firms behind the major
deals and litigation wins that resonated throughout the legal industry in 2023, with an eye
towards landmark matters and general excellence.
Andy Frankel and Summer Craig authored the United States chapter in the sixth editionof In-Depth: Insurance Disputes (formerly The Insurance Disputes Law Review). The
book provides a practical overview of recent developments in insurance disputes across 17
jurisdictions worldwide and examines the key features of the legal framework governing
insurance-related disputes in each jurisdiction, including substantive and procedural issues
and recent litigation trends, among other topics.

7

Simpson Thacher has been an international leader in the practice of insurance and reinsurance law for
more than a quarter of a century. Our insurance litigation team practices worldwide.

Andrew T. Frankel+1-212-455-3073
afrankel@stblaw.com

Lynn K. Neuner+1-212-455-2696
lneuner@stblaw.com

Summer Craig+1-212-455-3881
scraig@stblaw.com

Bryce L. Friedman+1-212-455-2235
bfriedman@stblaw.com

Joshua Polster+1-212-455-2266
joshua.polster@stblaw.com

Matthew C. Penny+1-212-455-2152
matthew.penny@stblaw.com

Michael J. Garvey+1-212-455-7358
mgarvey@stblaw.com

Tyler B. Robinson+44-(0)20-7275-6118
trobinson@stblaw.com

Sarah E. Phillips+1-212-455-2891
sarah.phillips@stblaw.com

Chet A. Kronenberg+1-310-407-7557
ckronenberg@stblaw.com

George S. Wang
+1-212-455-2228
gwang@stblaw.com

Abigail W. Williams+1-202-636-5569
abigail.williams@stblaw.com

Laura Lin
+1-650-251-5160
laura.lin@stblaw.com

This edition of the
Insurance Law Alert was prepared byBryce L. Friedman / +1-212-455-2235
bfriedman@stblaw.com
Joshua Polster / +1-212-455-2266
joshua.polster@stblaw.com andKaren Cestarikcestari@stblaw.com.

The contents of this publication are for informational purposes only. Neither this publication nor the
lawyers who authored it are rendering legal or other professional advice or opinions on specific facts
or matters, nor does the distribution of this publication to any person constitute the establishment of an
attorney-client relationship. Simpson Thacher & Bartlett LLP assumes no liability in connection withthe use of this publication. Please contact your relationship partner if we can be of assistance regardingthese important developments. The names and office locations of all of our partners, as well as ourrecent memoranda, can be obtained from our website, https://www.simpsonthacher.com.
Please click here to subscribe to the Insurance Law Alert.
8SimpsonThacherWorldwide

UNITED STATESEUROPEASIANew York
425 Lexington Avenue
New York, NY 10017+1-212-455-2000

Brussels
Square de Meeus 1, Floor 7
B-1000 Brussels
Belgium+32-472-99-42-26

Beijing
3901 China World Tower A
1 Jian Guo Men Wai Avenue
Beijing 100004
China+86-10-5965-2999

Houston
600 Travis Street, Suite 5400
Houston, TX 77002+1-713-821-5650
Los Angeles
1999 Avenue of the Stars
Los Angeles, CA 90067+1-310-407-7500
Palo Alto
2475 Hanover Street
Palo Alto, CA 94304+1-650-251-5000
Washington, D.C.
900 G Street, NW
Washington, D.C. 20001+1-202-636-5500

LondonCityPoint
One Ropemaker Street
London EC2Y 9HUEngland+44-(0)20-7275-6500

Hong Kong
ICBC Tower
3 Garden Road, Central
Hong Kong+852-2514-7600
Tokyo
Ark Hills Sengokuyama Mori Tower
9-10, Roppongi 1-Chome
Minato-Ku, Tokyo 106-0032
Japan+81-3-5562-6200

SOUTH AMERICA

São Paulo
Av. Presidente Juscelino
Kubitschek, 1455
São Paulo, SP 04543-011
Brazil+55-11-3546-1000

9