Intellectual property is important to many organizations-and not just to large companies. For many smaller concerns, the knowledge and skills needed to make their products or provide their services are their primary assets. These companies can be particularly vulnerable to attacks on their intellectual property as larger, better-financed competitors seek to eliminate them. For these smaller companies, protecting their intellectual property may be their most important responsibility, and the difference between success and failure. Most carriers in this market focus on small and midsize concerns, except SwissRe, which concentrates on the largest companies, especially those with which it has other relationships.

A company that infringes, or is even alleged to have infringed, on a competitor's intellectual property is likely to be threatened with lawsuits that, even if unsuccessful, are expensive to defend. A successful defense of alleged copyright infringement can cost $150,000 and often more. The cost to defend allegations of patent infringement averages $1.5 million and even higher in jurisdictions like New York, Boston and San Francisco. (Source: American Property Law Association 1999.) A recent patent-infringement lawsuit resulted in a judgment of less than $2 million while costing more than $3 million to defend.

We still hear that "scrubbing" a company's intellectual property (carefully checking it to ensure that it is unlikely to be challenged for infringing on another's rights) is a better solution than protecting it with insurance. We also still disagree. Even a well-scrubbed intellectual property is subject to loss that may need to be insured. A combination of effective scrubbing and competent insurance should be considered.

Even if an uninsured defendant prevails in an intellectual-property lawsuit, it can be put out of business just by litigation costs, and investors' or customers' fears that it may not win. The need to defend an alleged infringement can distract management and dissuade investors. Even a successful defense can result in business failure. Indeed, many well-entrenched companies will attempt to defeat new competitors by challenging their patents, rather than compete in the marketplace.

An alleged infringer has few options:
-Abandon its intellectual property rights.
-Negotiate a license from a position of weakness.
-Defend the suit.

Patent holders are not the only potential targets of patent infringement lawsuits. Retailers, distributors and others that contribute to the alleged infringement can be-and often are-sued as participants in the stream of commerce.

Marketing the product

Intellectual-property insurance can be a tough sell for insurance brokers, as the perceived need for protection is often challenged by intellectual-property lawyers, who may consider the involvement of insurance companies in a previously uninsured realm to be restrictive and possibly intrusive. This is unfortunate, since carriers generally are supportive of their insured's choice of counsel. Intellectual property is an extremely specialized area of the law, and carriers recognize that fact.

Richard P. Reed, vice president and manager of electronic commerce and intellectual property at Chubb Commercial Insurance, provided us with some interesting comments about the challenges insurers face in marketing this product:

"During every discussion I have with our producers, I find lack of understanding to be the biggest hurdle in almost every case. This lends itself to developing specialists, but does little to perpetuate growth in the market.

"Our strategy is to offer enterprise-wide protection and integrate it with other products. Only after the market benefits from adequate spread of risk will intellectual-property insurance become more widely available.

"Convincing buyers starts with educating producers on what's available and then delivering on the promise. It's equally important to also highlight what's not available in terms of (Chubb's) coverage-patents/trade secrets."

These are interesting comments, and show why Chubb is offering intellectual-property insurance as part of its cyber liability product for financial institutions. (See sidebar above.)

Need for specialized coverage

Typical commercial insurance products, even sophisticated ones, do not cover intellectual-property claims. Although some argue that the commercial general liability policy's advertising liability coverage provides protection for this exposure, insurance companies usually disagree. Indeed, most court cases involving the CGL policy's coverage for intellectual-property claims have ended in victory for the carriers. Most advertising liability insurance is written to focus narrowly on advertising activities; even piracy is covered only when it is committed in the course of advertising a product or service. Since allegations of intellectual-property infringement can be made in many contexts not involving advertising, it is apparent that a CGL policy, even with its advertising liability insurance, is an ineffective source of coverage. Another problem with relying on the CGL for coverage is that an infringement can be construed as an intentional act and thus excluded.

State of the market

Although the turmoil in the more traditional property-casualty lines is settling down, the challenges in underwriting intellectual-property insurance still make coverage difficult to acquire.

Significant losses-more severity-driven than frequency-driven-have occurred in this line, prompting underwriters to be cautious.

The intellectual-property insurance market currently offers three types of policies:

-Intellectual-property defense cost (so-called "defense" coverage), which protects a company against allegations that it improperly used the intellectual property of another. This is the most common form of intellectual property insurance.
-Intellectual-property abatement coverage (so-called "offense" or "enforcement" coverage), which funds legal action against a party that improperly uses the insured's intellectual property.

Abatement coverage is available from few markets. While still offered by Intellectual Property Insurance Services and Miller Insurance Services Ltd. (Lloyd's), many insurers may view the product as having narrow application and thus outside their interests. It strikes us that the product requires very specialized underwriting and likely will always remain a niche product, but a useful one.

-First-party intellectual-property coverage (similar to business income insurance), which can cover the insured's direct loss when its revenue is diminished from a violation of its intellectual property rights. This is an interesting product currently offered by only one market (Kiln) participating in our survey.

When considering which carrier to use for intellectual-property insurance, keep in mind that each product is unique, so coverage terms should be the deciding point. However, also keep in mind that this is a very complex product to underwrite, requiring great skill and knowledge of intellectual-property law and business.

Volume

The amount of premium written for intellectual-property insurance is small, although carriers are reluctant to tell us exactly how much they write. In fact, carriers will not even tell us about changes in their volume. We suspect that the market is stable or even shrinking, although increasing rates could be causing limited growth. To the extent the intellectual-property insurance market is growing, it is in defense coverage. This product is likely to be more familiar, and thus easier to underwrite, than enforcement or first-party coverage.

One reason for growth in defense coverage could be the perception by senior management and investors that smaller companies are vulnerable to larger competitors that use the legal system to defeat or cripple them. Without adequate financial and management resources, court battles over intellectual-property rights can tie up and destroy a company. Wise investors, particularly in technology startups, make sure that their companies have the wherewithal to defend against intellectual-property attacks. Intellectual-property insurance is a good instrument to fund such a defense.

Having said that, there is still interest in enforcement coverage, and we expect it will continue to grow. First-party coverage also could be extremely attractive to many companies. If Kiln can continue to grow this product, especially by adding to its capacity, we predict good things for both them and their prospective insureds.

Claims experience

There is little public information available about intellectual-property claims experience, and with relatively small amounts of premium being written, loss ratios are not particularly meaningful.

Most of the claims information we have for defense insurance is anecdotal. There have been a number of insured claims-some for more than $1 million. There also have been a number of claims for enforcement coverage, although we would not expect many, since this is an extremely specialized product.

Policy particulars

Who is covered? Keeping in mind that there are two main types of coverage-enforcement and defense (we will ignore the rare first-party coverage)-most policies cover the usual insureds: corporate entities, directors, officers, stockholders and employees. Other parties, like distributors, can be named in intellectual-property lawsuits, so it is important to identify them if you wish to extend them defense coverage.

What is covered? Enforcement policies typically cover the cost of attacking a third-party infringer. Benefits include:

-Funding for intellectual-property suits an insured brings against third parties for infringement initiated during the policy period.
-Coverage for the cost to defend against counter suits alleging that the insured's patent is invalid.
-Coverage for the cost to re-examine the insured's patent, if the defendant tries to invalidate it.
-Coverage for the costs to reissue the patent, if required to strengthen the claim.
Defense policies respond to allegations that the insured has infringed upon the intellectual property of another.

Among expenses covered are:
-Defense costs.
-Settlements, judgments and like expenses, including prejudgment interest. To cite an example, judgments and settlements could include compensation for a claimant's lost profits or royalties arising out of the insured's manufacture, use, distribution, advertising or sale of an infringed intellectual property.

Limits. Except for Swiss Re, which in rare cases can provide as much as $50 million in excess coverage above a $25 million attachment point, insurers offer relatively low limits for intellectual property (defense) insurance. Among the primary markets responding to this survey, maximum limits range from $2 million to $15 million. Deductibles typically range from $25,000 to $100,000 (higher if requested) or even $2 million in one instance.

Prior-acts coverage. The concept of prior acts is inapplicable to enforcement coverage, which is written more like a property form. Coverage is triggered when an insured's intellectual property is misused by another and the insured wishes to take enforcement action. Prior-acts coverage clearly is an appropriate concern for defense coverage, which is a form of liability insurance. Prior-acts coverage is available from Intellectual Property Insurance Services, Swiss Re and Venture Programs in their standard policy forms. It is available as an option from AIG (both Lexington and National Union) and Chubb. Keep in mind that, even if a carrier provides prior-acts coverage, it may be subject to a retroactive date.

Coverage territory. In regard to defense insurance, all carriers surveyed for this report will cover suits that originate anywhere, as long as they are filed in the United States, its territories, Canada or Puerto Rico. Kiln and Miller automatically provide coverage for lawsuits filed anywhere in the world. Intellectual Property Insurance Services provides coverage for suits brought outside the United States, its territories, Canada or Puerto Rico as long as reimbursement is made to a U.S. entity. AIG/Lexington and Swiss Re can provide true worldwide coverage as an option. AIG/National Union, Chubb and Venture Programs do not offer the option.

Risk management services

Intellectual-property insurers do not commonly offer value-added services, which is regrettable, considering that loss-avoidance measures in this field tend to be quite technical. However, we do note that Chubb is releasing a new risk management guide for insureds, which they can use to measure themselves against industry best practices.

Summary

We remain excited and optimistic about intellectual-property insurance. Although many insureds are still at the "Why do we need this?" stage of analysis, a role for this product clearly exists, particularly for defense insurance. When one considers the value of intellectual property and the high cost of defending infringement allegations, it is clear that many insureds should seriously consider this coverage.

The relatively low limits available for defense insurance are not helping its popularity, although we are sympathetic to the carriers' unwillingness to risk big limits in such an evolving area. Perhaps as intellectual-property litigation settles down, the risk will become easier to underwrite, although that statement may be overly optimistic.

First-party coverage remains an intriguing product, and we hope that Kiln is able to grow this market. How odd that insureds will readily buy business income insurance to respond to loss of profit resulting from damage to physical property, but not even think about a similar exposure arising from the loss of intellectual property rights. Clearly, the brokerage community will have a major education role to play in growing this market, as will intellectual-property counsel. As long as available limits are constrained by lack of capacity, it will be tough to sell this product to larger companies, but small and midsize companies could become takers. We have not seen any interest in this product on the part of the "traditional" intellectual-property insurance markets; but if Kiln can prove a market exists, no doubt they will attract competitors.

(This article was derived from the April 2004 issue of The Betterley Report, which is published five times a year by Betterley Risk Consultants. The complete report, which contains charts showing the responses of individual markets, can be purchased for $65. Annual subscription are available for $347. For more information, contact Richard S. Betterley at (877) 422-3366 or at [email protected], or visit www.betterley.com.)