Back to Hot Topics

A Primer on Intellectual Property Insurance
By Ronald C. Wanglin, Executive Vice President

In his book The Patent Wars, Fred Warshofsky quotes an address given by John Armstrong, Vice President for science and technology at IBM, on the importance of preserving intellectual property:

"Conventional wisdom in the business world says intellectual property is vital because it is a stimulus to innovation, a vehicle for technology transfers and a magnet for financing. I would push that further. An intellectual property system is a crucial part of a country’s economic infrastructure. It enhances the ability of any country to strengthen and advance its technological base in a sustained way. It helps to build human resources. It conditions priorities in allocating financial resources. It fosters the movement of technical knowledge across borders."

More than ever before, intellectual property claims involving infringement of patent, copyright and trademark are being filed and litigated at a tremendous cost to both parties. While corporate giants like Kimberly Clark and Procter & Gamble have the resources to wage long-term patent litigation for a billion dollar market in the famous "diaper wars," the majority of companies that have developed and maintain valuable intellectual property often lack the financial resources to either defend or enforce it. Yet, preservation of the intellectual property asset is the lifeblood of many of these companies.

The most recent economic survey by the American Intellectual Property Law Association shows that the average cost to litigate a patent infringement lawsuit is in excess of $1 million. While somewhat inflated due to fees developed by large scale patent infringement cases, legal fees associated with preserving intellectual property rights represent a significant financial risk to companies in the $1 million to $500 million revenue range. Emerging companies and non-profit organizations are at a particular disadvantage against a larger and financially stronger adversary.

From an insurance perspective, although there has been limited coverage afforded for copyright, trademark or trade dress infringement under the advertising injury coverage section of the comprehensive general liability insurance policy, claims for patent and trade secrets have for the most part been denied by insurance companies as outside the intended scope of coverage.

With court decisions broadening the insurer’s responsibility for defending and indemnifying claims for intellectual property violations, a trend is growing to add specific endorsements to liability policies excluding intellectual property claims beyond the copyright and trademark infringement associated with the advertising exposure. For example, an endorsement from the Chubb Insurance Companies reads as follows:

"…the following exclusion is added:

Intellectual Property

This insurance does not apply to any liability arising out of or directly or indirectly related to: the actual or alleged publication or utterances of oral or written statements of any type which is claimed as an infringement, violation or defense of any of the following rights or laws:

1. copyright, other than infringement of copyrighted advertising materials;
2. patent;
3. trade dress;
4. trade secrets; or
5. trade mark or service mark or certification mark or collective mark or trade name, other than trademarked or service marked titles or slogans."

As claims for intellectual property infringement grow, an increasing number of insurance companies will add similar language to limit, or exclude altogether, any liability.

Over the past several years, a number of insurance companies have developed specific contracts to provide coverage for intellectual property exposures, with an emphasis in the area of patent infringement. To evaluate them, it is critical to understand that each is unique in concept and design and should be considered based on the client’s needs and objectives, along with the coverage afforded by the policy. There are three basic types of policies:

• Defense and Indemnity: This type of policy will provide defense coverage for the insured in the event of a patent infringement suit and, in the event of liability, will pay damages, including prejudgment interest.

• Defense Only: Referred to as "defense cost reimbursement insurance," this coverage is for defense only and does not pay any damages under the contract.

• Offensive Policy: Known as "infringement abatement insurance" or "enforcement" coverage, this policy is designed to reimburse the insured for legal expenses associated with pursuing an infringement party.

The major underwriter of defense and indemnity coverage is American International Specialty Lines Insurance Company, part of the AIG Group. Available for the last 2-3 years, this policy will defend the insured against patent infringement claims and pay damages in the event of a judgement or settlement. Covered defense expenses include legal fees and costs, declaratory actions, injunctions and appeals costs. Coverage for judgements and settlements includes lost past royalties and lost past profits, interest and costs (if fixed by the court) and attorneys fees (again, if assessed by the court).

Some of the more important policy characteristics include a broad definition of "insured," including the company and subsidiaries (50% or more owned), directors and officers and company employees. Coverage can be written on a blanket basis covering all products (subject to underwriting by AIG), can incorporate newly developed products and newly acquired companies and, if desired, coverage for prior acts is available.

Another key feature to the coverage is the insured’s ability to agree in advance on selection of defense counsel, including the client’s existing intellectual property counsel. If none is specified, AIG has an extensive panel of expert intellectual property counsel and trial panel counsel to represent the insured.

As with most professional liability policies, defense costs are included within the policy limits and the policy is written on a "claims made" basis—i.e., for claims which occur and are reported during the policy period. As noted above, however, coverage can be negotiated to include prior acts of the insured, and a one year discovery period is available at 125% of the expiring premium. Presently the coverage form is designed to insure U.S. patents only and to defend claims brought in the United States.

Policy exclusions include willful or intentional infringement (insurer must show knowing disregard of another’s patent rights), litigation initiated by the insured (except preemptive litigation with insurer’s consent), claims by government entities (except to enforce patent rights they hold), punitive damages and pending or prior litigation.

AIG offers high limits of liability ranging from $1,000,000 to $15,000,000 in its standard form. When combined with a custom program of self-insurance and risk transfer mechanisms, higher limits can be achieved. The policy carries a minimum retention (deductible) of $50,000 per claim and requires a minimum co-insurance participation of 10% by the insured. While not automatically covered, the policy may be endorsed to add coverage for copyright and trademark infringement for an additional premium.

The minimum policy premium begins at $20,000 and underwriting requirements include a completed application, current financial statements (including the annual report and 10-K, where available), a list of all products manufactured, used, sold, distributed and advertised, any catalogs or brochures, and a written description of the insured’s intellectual property risk management practices and past litigation experience. AIG’s target market is companies with annual revenue ranging from $50,000,000 to $500,000,000+.

A defense cost reimbursement coverage form has recently been developed by Intellectual Property Insurance Services Corporation, Inc., and is underwritten by the Evanston Insurance Company. In contrast to the AIG policy, this coverage is designed for smaller companies ($500,000 to $25,000,000 in annual revenue), and offers correspondingly lower limits and smaller premiums. Unlike the AIG contract, there is no coverage for judgement or settlement costs.

The design of the defense cost policy is to reimburse the insured for litigation expenses incurred defending alleged infringement of patents owned by a third party. Invalidity counterclaims are reimbursed as well as re-examination proceedings which are a direct consequence of covered litigation. Coverage is for products manufactured or sold in the United States and suit must be brought in the United States.

The policy is written on a "claims made" basis and offers a one year discovery period at 125% of the policy premium. The company maintains a list of selected patent counsel and if not presently included, will consider adding the insured’s patent counsel (registered only) to their list.

Policy exclusions include: any damages for liability resulting from an unsuccessful defense; pre-existing claims; declaratory judgements; anti-trust counterclaims; costs, expenses and salaries of employees, officers and directors; willful infringement; infringement of which the insured has prior knowledge; and ITC proceedings. The policy also has a "recovery of costs" provision, stating that the insured will reimburse the insurance company pro rata for any award of attorney fees and costs up to the amount contributed by the insurer. This provision directly contributes to keeping the policy premium at a reduced amount.

Underwriting requirements include a search by patent counsel determining that the product or product line to be insured does not infringe on any existing U.S. patent, risk management practices, prior litigation experience, etc.

Standard policy limits are $250,000 and $500,000, although limits to $1,000,000 may be considered on a case-by-case basis. The policy carries a minimum deductible of $2,500 and annual premiums for insuring the product/product lines range from $2,500-$3,500, depending upon policy limits. Co-insurance requirements range from 10%-25% and coverage for copyright/trademark can be considered on a selected basis.

Infringement abatement insurance, also known as "enforcement" or "offensive" coverage, has been offered since 1991 by Intellectual Property Insurance Services Corporation (underwritten by Homestead Insurance Company) and, more recently, by Litigation Risk Management, Inc. (through Lloyds of London). While similar in design, these policies differ in their construction, approach and philosophy and should be considered carefully.

The Homestead policy, like the Evanston defense policy noted above, offers lower coverage limits at premiums that smaller companies ($250,000-$10,000,000+ annual revenue) will find attractive. Standard policy limits range from $100,000 to $250,000 to $500,000 and can develop a minimum premium in the neighborhood of $1,000+ for a $100,000 policy. While there is no deductible, the policy carries a co-insurance provision of 25%, requiring the insured to contribute 25% of the cost of covered litigation. Additional patents can be added for a reduced premium.

Written on a "reimbursement" basis, the duty to enforce the patent remains with the insured. Reimbursement for litigation is authorized upon the insured completing a claim form and submitting a current letter from IP counsel stating that the patent is likely to be found valid based upon a search of the U.S. Patent and Trademark Office and that, more likely than not, a trier of fact would come to a finding that infringement occurred. The insured must pay the cost of providing the opinion letter and may use the counsel of his choice—provided, however, that he does not later choose that counsel as litigation counsel.

Underwriting takes into consideration the profitability of the patented item, the ease of entry into the marketplace and the initial capital investment required. As before, the insured’s previous litigation history, as well as the litigation history for patents in the class and subclass of the patent to be insured, are considered.

Litigation Risk Management (LRM) has taken a somewhat different approach in designing their offensive coverage. Eligibility for the LRM contract involves a specialized investigation, underwriting and valuation process that is unique in the industry. It incorporates an evaluation by LRM of the patent or family of patents in the areas of validity, competing classes of patents, potential venue site in the event of a claim and length of time in the marketplace.

Also included in the underwriting is a financial analysis and valuation by the Big-Six accounting firm of Deloitte and Touche LLP. Their analysis is designed to provide an economic assessment of the industry and market in which the technology competes, including a determination of market participants, the size of the market and potential market barriers to entry.

The cost to perform this evaluation approaches $25,000 and premiums for the actual insurance coverage begin at about $25,000 for a $1,000,000 policy limit for the patent/family of patents.

Higher limits are available on a case-by-case basis and the policy carries a 20% co-insurance provision. LRM’s target client is one that develops $5-$100 million in annual revenue with strong potential for growth.

An important characteristic of both the Homestead and LRM contracts is the ability to recover monies that have been advanced on behalf of the insured. Defined within the contracts as "economic benefit" (Homestead & Lloyds) and "presumed economic benefit" (Lloyds), they allow the insurer specific rights to reimbursement and must be fully discussed with the insured to avoid future misunderstandings.

There are two aspects to the recovery of "economic benefit" that bear review. First, the policies state that if the insured wins a monetary award or settlement, the insurance company will be reimbursed on a pro-rata basis until 100% of monies advanced are recovered. Included is the ability of the insurance company to recover an additional 25% of litigation expenses advanced by the carrier (once they have achieved their 100% reimbursement) to cover current and future administrative costs.

Second, the policy language allows for reimbursement to the insurer based on "presumed economic benefit." Examples would include the insured obtaining an injunction, court order or settlement prohibiting the accused infringer from continuing the infringement; a settlement of the litigation by the enactment of a licensing agreement; a non-monetary commercial agreement between the insured and the infringer; or, the infringing party effectively agreeing to discontinue the infringement. For an additional premium of 50%, the Homestead policy can be endorsed to waive the presumed economic benefit language on their $100,000 and $250,000 policies.

In the future, the marketplace will find other insurance companies wishing to participate in insuring intellectual property exposures and each will have a unique approach to providing coverage. There are presently a handful of companies who can provide copyright and trademark infringement coverage and these may be more appropriate for some clients than the policies reviewed above (where the primary emphasis is on patent infringement).

As companies review their insurance programs and risk management strategies, coverage for intellectual property exposures should be considered as an important component. This is especially critical where a company has outside directors and/or is publicly traded, as a number of suits have been brought against directors and officers personally for intellectual property infringement.

back to top