Legal issues in electronic commerce in the insurance and reinsurance industry.

• Author: Hummer, Paul M.

Electronic commerce may become the dominant method of doing business, so insurers need to take steps to minimize the risks

The insurance and reinsurance industry is in the vanguard of efforts by the business community to embrace the opportunities for electronic commerce (EC) offered by new technologies and forms of electronic communications.

* Robert Flege, a senior market conduct examiner with the Kentucky Insurance Department and President of the Insurance Regulatory Examiners Society, recently predicted that in the near future consumers will be able to apply for, sign and pay for an insurance policy and then have the policy transferred and printed electronically, all from their home computer.(1)

* Marsh & McLennan, Alexander & Alexander, Aon, Johnson & Higgins, Sedgwick, and Willis Corroon, have formed the "World Insurance Network," which will enable parties to close and settle transactions electronically, produce documentation electronically and electronically exchange whatever messages or information they need related to the transaction with the goal of driving down the postplacement cost of producing and delivering commercial and industrial insurance products.(2)

* Electronic claim submissions also are increasing.(3)

In the reinsurance arena, EC is becoming an increasingly important part of the underwriting process. The London Insurance Market Network (LIMNET) handles 800 to 1,000 EC transactions a month. The Continental European market is experimenting with its own Reinsurance and Insurance Network (RINET). In the United States, the Reinsurance Association of America and the Brokers and Reinsurance Markets Association have begun a joint venture with LIMNET and RINET.

One of the principal forums for EC in the insurance industry will be the Internet. A review of trade publications in the insurance industry confirms that there is a tremendous amount of interest in using the Internet to conduct the business of insurance.(4) The reason for the interest is not hard to understand. Within the next three years, the number of Internet users is expected to grow to 200 million.(5) A Data-monitor survey predicts that the sale of personal automobile and homeowners insurance via the Internet will reach $2.4 billion in written premiums by 2000 and that Internet insurers will realize cost savings of about 23 percent over agency insurers and 5.1 percent over insurers selling direct.(6)

There are unresolved legal issues in EC. While the law is evolving, parties interested in EC can take certain steps to minimize the legal risks. Insurers also must address the regulatory issues associated with EC on the Internet.

ELECTRONIC COMMERCE

1. What Is It?

   Electronic commerce may be broadly defined as the automation of commercial transactions through the use of computers and telecommunications to exchange and process information, transactional documents and forms of payment. As defined by the American Law Institute, an "electronic transaction" is "a transaction in which the parties, or their intermediaries, contemplate that an agreement may be formed through the use of electronic messages or responses, whether or not either party anticipates that the information or records exchanged will be reviewed by an individual."(7) In essence, EC is the "paperless transaction" that futurists have been predicting for years.

   An electronic insurance transaction on the Internet has been described by Douglas Simpson, counsel for ITT Hartford Insurance:

   Like mail order and in-person advertising

   and solicitation, use of the Net enables

   prompt, even immediate closure and consummation

   of an insurance sale transaction.

   Given current technology, a customer can

   identify herself, complete a questionnaire/application,

   review disclosures and choose between

   various options while "on line." As

   the customer does this, an insurer's "virtual

   underwriter" software can access databases

   for additional information about the customer,

   confirm (or contradict) the customer's

   statements, and utilize decision support software

   to determine the acceptability of the applicant

   and the proper price and format of the

   product, all while the customer is still online,

   reviewing disclosures. On satisfactory

   completion, the system can generate a

   binder, even an entire policy, that the insured

   can store and print locally, or a firm quote,

   for her consideration and later decision. The

   system can solicit and accept authorization

   for immediate or future payment through a

   credit card or bank fund transfer, or initiate

   an automated billing routine.

   What distinguishes these capabilities from

   current direct mail, telemarketing and in-person

   solicitation is the dramatic cost advantages

   offered by the Net. Using the Net, once

   programmed for the insurer's Web Underwriter,

   the entire transaction can be done by

   unattended machines handling multiple users

   simultaneously and utilizing the insured's

   own data entry.(8)

2. Benefits and Risks

   The principal benefit of EC for the insurance and reinsurance industry is its potential to reduce the administrative and handling costs of preparing, reviewing and transmitting data and documents in the placement, negotiation and documentation of agreements and in the submission and adjustment of claims. EC also offers the prospect of improved customer service by enabling insurers to interact directly with policyholders and by reducing data entry errors. Although EC is still in its infancy, insurers and reinsurers who can master this form of commerce effectively will realize marked competitive advantages.

   Those advantages come at a cost, however. The more automated a transaction becomes, the less time is spent by a human being ensuring both the accuracy and the veracity of the transmitted information. A joke circulating on the Internet observes, "Computers make very fast, very accurate mistakes." This potential for error or fraud can best be met by good technological systems and thoughtful and regularly enforced requirements for system access and quality control.(9) These solutions are more in the realm of a technological adviser than a lawyer.

   The principal legal issues raised by EC relate to the task of adapting existing legal and evidentiary requirements to the new means of contracting and communicating. Decisional and statutory law have evolved to a point that, in cases involving agreements entered into by conventional means, parties can take comfort in their ability to prove and enforce the terms of their agreements. Parties in electronic commerce, however, cannot yet have that certainty.

   EC raises issues both about the formation of contracts and their enforcement. Traditionally, a contract is formed when there is a "meeting of the minds" as evidenced by an offer and an acceptance. In addition, certain formalities, such as a "writing signed by the party to be bound," must be observed for some kinds of contracts. Like the ghosts of old law school exams, EC raises a series of questions for which the common law answers developed over the last 200 years do not neatly fit. For example, if a reinsurance intermediary sends out a request for reinsurance on certain terms and a reinsurer's computer automatically generates an acceptance and issues a cover note, without any human review by the reinsurer, has there been a "meeting of the minds"? Is the result different if, unbeknownst to either party, the computer had garbled the message? If so, who bears the responsibility for the error?

   EC also raises issues of proof. For example, how can one establish the identity of the offeror or offeree in the anonymity of cyberspace? In a widely reported incident, the University of Michigan got an e-mail message from China declining an $18,000 scholarship. The student who allegedly sent the message denies sending it and is suing her roommate for allegedly sending a false message over a shared e-mail account.(10) Is electronic data, which by its nature can be undetectably altered, admissible in evidence?

   Clear legal answers to these questions have not yet been developed. A white paper, Intellectual Property and the National Information Infrastructure (NII), prepared by the U.S. Commerce Department (and available at http://www.uspto.gov/web/ ipnii) notes:

   The law dealing with electronic commerce

   is not clear--especially for totally paperless

   transactions. On-line contracting and licensing

   raise a number of concerns about the validity

   and enforceability of such transactions.

   The NII will not be used to its fullest commercial

   potential if providers and consumers

   cannot be confident that their electronic

   agreements are valid and enforceable.

   The Information Security Committee of the American Bar Association Section of Science and Technology states that "the law has only begun to adapt to advances in technology. The legal and business communities must develop rules and practices which use new technology to achieve and surpass the effects historically expected from paper forms."(11)

   Thus, in an EC transaction, the parties can anticipate that, if they are later forced to litigate over the transaction, they will have to address concerns over: the authenticity and reliability of electronic information; proof that electronic communications were sent, received and accepted; satisfaction of the statute of frauds, where applicable; and compliance with evidentiary rules, such as the best evidence doctrine and the business records exception to the hearsay rule.

   Electronic commerce on the Internet poses additional regulatory issues for insurers. The principal characteristic of the Internet is that it knows no geographical boundaries. By contrast, insurance is regulated state by state. Thus, the question insurers must confront when advertising or otherwise doing business on the Internet is how to avoid running afoul of idiosyncratic laws and regulations in states where they do not normally do business.

   CURRENT APPROACHES TO MINIMIZE LEGAL RISKS

1. Trading Partner Agreements

   Many of...