Insurance Industry Guidance to Consider When Negotiating a SaaS Indemnification Clause

As a software attorney advising SaaS companies in contract negotiations, I am frequently asked for advice on negotiating indemnification clauses. While clients all have different risk tolerances when it comes to the issue of indemnification, it is always challenging to advise parties on either side of the negotiating table, as it is difficult to provide clients with any concrete guidance of what their actual risk may be.

The San Francisco Business Times recently published an article shedding some light on what the actual risk may be to parties on both sides of a data breach, which as any attorney in the software industry knows, is often the concern that prompts the most contentious indemnification negotiations in any SaaS contract discussion.

According to the San Francisco Business Times, the insurance brokerage Aon estimates that 80% of commercial privacy breaches around the world result in $1 million or less in direct costs and damages.  On the other hand, the San Francisco Business Times reported that Aon estimates that  approximately 15% of privacy breaches cost approximately between $1 million and $20 million, with the average cost of those larger breaches running about $7 million.

So what are the significance of these liability estimates to parties negotiating an indemnification clause in a SaaS contract negotiation?

The significance is that a particular group of industry experts are estimating the liability risk for parties on either side of the transaction to generally be at $1 million or less per transaction, with only a small portion of the cases rising significantly above this, and that where the breaches result in greater than $1 million in damages, the loss averages about $7 million.  Thus, for indemnification negotiation purposes, this information suggests that most customers of SaaS services are not going to incur more than $1 million of damages in a privacy breach, and that on the flip side, most SaaS providers will not suffer more than $1 million of damages on a privacy breach affecting a particular customer.

Of course, insurance companies such as Aon do offer cyberinsurance which will provide some insurance against such risk, which is why Aon is in the business of making predictions about the cyber-liability risk to businesses: to sell cyberinsurance and evaluate its own risks as an insurer.

For my purposes, however, as a software transactions attorney, these numbers provide some helpful guidance as to how parties on either side of a deal should be evaluating their real risks for the purpose of indemnification clause negotiations.  While as a customer, an unlimited liability indemnification for a privacy breach might be nice, these numbers suggest that something far less would likely be sufficient to protect your company.  On the flip side, as a SaaS provider, these numbers suggest that your actual risk in the case of an unlimited liability indemnification on a particular customer contract will probably not exceed $1 million, which is far less than the numbers might be envisioned by the phrase “unlimited liability.”   All in all, this data is useful to consider in the context of any SaaS contract negotiation, regardless of whether you are negotiating on the side of customer or the service provider.