Insurers seen hit by millennium bug losses

Insurance industry trade groups are quick to downplay the potential for millennium bug losses, saying that most policies will not respond to the problem.

In addition, some insurers, especially in the UK, have begun to add clauses to their policies that specifically exclude coverage for Year 2000 mishaps.

But insurers have already begun to receive Year 2000 claims and insurance and other legal experts say claims may not be so easily denied.

Indeed, insurers may have exposure under directors & officers (D&O), errors & omissions (E&O), commercial general liability and business interruption policies.

And the extent of the potential loss to the insurance industry is hard to gauge.

"It's complex and it depends in many instances on the factual circumstances of the insured and the type of claim that is being filed," said Phil Miller, a consultant with Tillinghast Towers Perrin in New York.

In addition, he said, policies and legal systems differ from one country to the next.

"What's true in the good ol' USA may not be true in the UK," he said.

But, he said, he believes it is naive to believe the insurance industry will get away without paying any claims.

So far, Miller said, he was unaware of any solid actuarial analysis of the insurance industry's potential losses from the millennium bug, although he said his firm was contemplating such a study.

But, the global cost of software changes for the millennium bug has been estimated at $300 billion to $600 billion, by the Gartner Group, a U.S. technology firm.

And if just 10 percent of that $600 billion fell into the laps of insurers, it would eat up about 20 percent of the U.S. insurance industry's $310 billion in policyholder surplus, Merrill Lynch analyst Jay Cohen noted in a recent research report.

In addition, policyholders are expected to challenge their insurers if they are denied coverage, putting the problem in the hands of the courts.

Insurers, therefore, are likely to incur defence costs even if claims are not actually paid.

And, judging from the asbestos and environmental litigation in the United States, those defence costs could also be substantial.

A lawyer from the New York firm LeBoeuf, Lamb, Greene & MacRae has estimated litigation costs arising from millennium bug claims at about $1 trillion in the United States alone.

"Clearly, there is an exposure here and Y2K claims will be paid," according to the report from Merrill analyst Cohen.

The biggest exposure is likely to be under the directors & officers and errors & omissions policies.

D&O policies protect companies and their directors and officers from lawsuits alleging that they were negligent or acted wrongfully.

If the price of a company's stock drops sharply because millennium bug problems disrupt its business, the company and its top officers may face shareholder lawsuits.

As long as the company took steps to make its systems compliant, it is likely to have an argument for D&O coverage, Tillinghast's Miller said.

"That's one of the reasons people buy D&O liability, because people sometimes make mistakes," Miller said.

Companies that have completely ignored the Year 2000 issue, however, are unlikely to have much of a case.

Meanwhile, vendors who sold software with Year 2000 problems or consultants who failed to properly remediate Year 2000 computer systems may submit claims to their insurers if they are sued by the customers.

These policyholders may have coverage under their policies if they made honest mistakes, but may have to contend with issues of timely notice to their insurers and statutes of limitation, Miller said.

Some policyholders also may have coverage under their general liability policies, he said.

If the failure of a company's systems results in bodily injury or property damage and the company took steps to make its systems Year 2000 compliant, it may have coverage, Miller said.

"That's the purpose of liability insurance," he said.

Business interruption insurance also may respond in some cases. However, policyholders must pass several hurdles before qualifying for coverage.

Business interruption coverage usually responds to specific named perils, such as fire or windstorm.

If the failure of a company's system results in a fire that causes a shutdown of a plant, there may be coverage. And if the policy does not name specifically name the perils, then there might be an even stronger case for coverage, he said.

However, a policyholder also must show that the loss was the result of a suspension of operations caused by physical damage to the property.

And in every case, coverage will depend on policy wording, the existence of exclusions and the specific details of the claim.

In the UK insurers have been adding exclusions, clearly stating that their policies do not cover Year 2000 problems, said Rosalind Jones, a solicitor with the London firm Elborne Mitchell.

And Jones said she believes those exclusions will hold up in most cases.

But Aon has written to underwriters in the London market saying that its clients find such exclusions to be unacceptable.

In the United States, most insurers have not yet begun using exclusions, although some are using exclusions on a case-by-case basis.

The Insurance Information Institute in New York said most U.S. insurers are not using exclusions, saying that they are not needed because policies do not cover Year 2000 problems anyway.

But insurers also are reluctant to use exclusions for fear of driving away valued customers.

Insurers may come under more pressure to use them, however, if they find their own reinsurers begin excluding their Year 2000 losses.

But with so much uncertainty about whether policy wording and exclusions will protect the insurance industry from the Year 2000 problem, the only winners are likely to be the lawyers.