The False Security Blanket: When Cybersecurity Insurance Fails to Protect
When Jason Miller* arrived at his office on that ordinary Tuesday morning, he had no idea his mid-sized accounting firm was about to face an existential crisis. The ransomware attack that had locked his company’s systems overnight wasn’t just devastating because of the immediate business disruption—it was what happened three weeks later that truly threatened everything he had built.
“Your claim has been denied.”
Those five words from his cybersecurity insurance provider sent Jason’s world crashing down. Despite paying premiums for years, his $2 million policy wouldn’t cover a penny of the $750,000 ransom demand or the estimated $1.3 million in business interruption costs. The reason? His firm had failed to implement “reasonable security measures” as required by a clause buried deep in the policy’s fine print.
A story like Jason’s is not unique. It represents a dangerous trend facing businesses across America: the growing gap between what organizations believe their cybersecurity insurance covers and what it actually protects when disaster strikes.
Real-World Cautionary Tales: When Insurance Claims Get Denied
P.F. Chang’s: The $2 Million Coverage Gap
Restaurant chain P.F. Chang’s learned this lesson the hard way in 2014. After suffering a significant data breach that compromised 60,000 customer credit cards, the company expected its cybersecurity insurance policy to cover all related damages. Federal Insurance Company did pay approximately $1.7 million for direct breach costs, but denied coverage for an additional $2 million in fees and assessments imposed by MasterCard.
The U.S. District Court for the District of Arizona upheld the denial in P.F. Chang’s China Bistro, Inc. v. Federal Insurance Company, ruling that the policy’s “Privacy Injury” coverage did not apply because of specific exclusions in the fine print. The restaurant chain was left to absorb these substantial costs on its own, despite believing they were fully covered.
BitPay: The $1.8 Million Phishing Disaster
In 2015, cryptocurrency payment processor BitPay became the victim of a sophisticated phishing attack. The company’s CFO received what appeared to be legitimate emails from a business partner requesting bitcoin transfers. In reality, a hacker had compromised the partner’s email account, and BitPay ended up sending approximately $1.8 million in bitcoin to the attackers.
When BitPay filed a claim with their insurer, Massachusetts Bay Insurance Company, they were shocked to receive a denial letter. As reported by CSO Online, the insurer claimed that “the Policy does not afford coverage for indirect losses caused by a hacking into the computer system of someone other than the insured.” Because the initial compromise wasn’t of BitPay’s own systems but rather their business partner’s email, the claim was rejected—a technical distinction that cost the company $1.8 million.
Merck & Co.: The War Exclusion Battle
Perhaps the most publicized cyber insurance dispute involved pharmaceutical giant Merck & Co., which suffered estimated losses of $1.4 billion when it was hit by the NotPetya malware in 2017. When Merck filed claims with more than 30 different insurers, including Ace American Insurance Company, they were met with denials based on “war exclusion” clauses.
The insurers argued that since the U.S. and UK governments had officially attributed the NotPetya attack to the Russian military, it constituted an “act of war” excluded from coverage. Merck challenged this interpretation, and after five years of litigation, the New Jersey Superior Court ruled in Merck’s favor, finding that the traditional war exclusion language was not applicable to cyber events in this context.
While Merck ultimately prevailed, the case illustrates how insurers will aggressively seek any available policy exclusion to deny cyber claims—and how critical proper legal guidance is before purchasing such policies.
International Control Services: Failure to Implement MFA
In a more recent case, Travelers Property Casualty Company asked a district court to reject International Control Services’ claim for losses stemming from a ransomware attack. The basis for denial? The company had failed to properly implement multi-factor authentication (MFA), which was explicitly required under their policy terms.
This case highlights how technical security requirements embedded in policy language can become the basis for denied claims if not fully implemented and documented.
The Hidden Perils of Cybersecurity Insurance
Cybersecurity insurance has become an essential component of business risk management. As cyber threats escalate in frequency and sophistication, more companies are investing in these policies as protection against potentially catastrophic losses. Yet many discover—often too late—that their policies contain exclusions and requirements that can render coverage void precisely when it’s needed most.
Research from cyber consulting firms suggests that as many as 44% of cyber insurance claims are rejected, primarily due to security deficiencies, policy exclusions, or technical non-compliance with policy requirements.
These high-profile examples illustrate a critical reality: cybersecurity insurance is not a simple financial product but a complex legal document that requires careful scrutiny and negotiation.
The Attorney Advantage: Why Legal Counsel Makes All the Difference
As attorneys who has helped dozens of businesses navigate these treacherous waters, our counsel at Burrell Law, P.C. has witnessed firsthand how proper legal guidance before purchasing cybersecurity insurance can mean the difference between recovery and ruin. Here’s why involving an attorney from the outset is not just advisable—it’s essential:
1. Identifying Coverage Gaps Before They Become Costly
Cybersecurity attorneys specialize in recognizing the gaps between your actual business operations and what your policy covers. We recently represented a healthcare provider who narrowly avoided disaster when we identified that their policy excluded coverage for third-party vendor breaches—despite the fact that they processed 70% of patient data through external partners.
2. Navigating Complex Technical Requirements
Modern cybersecurity policies often contain specific technical requirements that must be maintained for coverage to remain valid. These can include:
- Multi-factor authentication implementation across all systems;
- Data encryption across all systems;
- Regular patching schedules with specific timelines;
- Particular types of endpoint protection;
- Employee training programs meeting certain standards, e.g., where possible, include clear separation of duties between a representative responsible for writing the check and a representative responsible for approving a transaction or service;
- Data backup and restoration protocols with specific configurations;
- Procedures for and logging of actual periodic tests of data backup and restoration protocols.
An attorney with cybersecurity expertise can translate these requirements into actionable steps for your IT team and create compliance documentation that strengthens your position should a claim arise.
3. Negotiating Better Terms Before Signing
Insurance policies are not one-size-fits-all documents. With skilled legal representation, key terms can often be negotiated to better align with your business realities. When a financial services client approached us before renewing their policy, we successfully negotiated removal of a problematic “security audit” clause that would have given the insurer excessive access to sensitive systems.
4. Creating Documentation That Strengthens Claims
Perhaps most importantly, attorneys help establish documentation practices and protocols that create a strong paper trail demonstrating your compliance with policy requirements. This documentation becomes invaluable when responding to an insurer’s inevitable questions following an incident.
The Real Cost of Going Without Legal Counsel
Consider the contrasting experiences of two manufacturing companies hit by similar ransomware attacks last year:
Company A purchased their policy directly, relying on the broker’s assurances about coverage adequacy. When attacked, they discovered their policy contained an exclusion for failures to implement specific security controls—controls they had partially implemented but couldn’t prove had been maintained consistently. Their $3.4 million claim was denied.
Company B engaged legal counsel before purchasing their policy. Their attorney identified problematic exclusions, negotiated clearer terms, and established documentation protocols proving their ongoing compliance. When attacked, their $2.9 million claim was paid within 45 days.
The difference? Company B’s legal fees totaled just under $15,000—a fraction of what Company A lost when their claim was rejected.
A Proactive Approach to Cyber Insurance
The time to consult with an attorney isn’t after a breach has occurred or when your claim has been denied. By then, the legal options available are far more limited and expensive.
Instead, consider your cybersecurity attorney as a strategic partner in your risk management approach:
- Before purchasing or renewing a policy: Have counsel review and negotiate terms that properly align with your actual business operations and risk profile.
- During implementation: Involve legal experts in creating compliance documentation and establishing protocols that demonstrate adherence to policy requirements.
- Throughout the policy period: Schedule regular compliance reviews with your attorney to ensure changing business practices haven’t created new coverage gaps.
Conclusion: An Investment in True Security
In today’s digital landscape, cybersecurity insurance isn’t optional—but neither is proper legal guidance in securing that coverage. The modest investment in legal counsel before purchasing a policy can save millions when disaster strikes.
As we tell our clients: if you think you can’t afford an attorney to review your cybersecurity insurance, ask yourself if you can afford to pay for a major cyber incident entirely out of pocket. Because without proper legal guidance, that may be exactly the position you find yourself in when you need your insurance the most.
* Fictional person and anecdote for illustrative purposes
This blog post was prepared by the Cybersecurity and Privacy Practice Group at Burrell Law, P.C. While based on real experiences, specific case details have been modified to protect client confidentiality. This post is for informational purposes only and does not constitute legal advice.
