The Y2K bug: will insurance carriers be stung by a swarm of claims?

AuthorBrady, Michael J.

It's a safe bet that many insurance claims will be forthcoming after January 1, 2000, but will insureds be able to collect?

WHAT IF you woke up on January 1, 2000, and learned that you owed millions of dollars in interest on an outstanding debt of ten dollars? What if you or a family member needed emergency health care but couldn't get it because the computers had crashed at all the hospitals? What if you tried to withdraw money from your bank account and found that your savings balance had been erased? What if millions of businesses and governments worldwide that rely on computers were forced to suspend operations indefinitely because the computers had all malfunctioned on New Year's Day 2000?

How about another frightening scenario. What if all the losses resulting from computer malfunction on January 1, 2000, were submitted as insurance claims? Could any insurance carrier survive the onslaught?

THE FIX WE'RE IN, AND HOW TO FIX IT

If you haven't before given much thought to the potentially catastrophic computer problem--known variously as the "millennium bug," the "Y2K problem" or the "Year 2000 problem," your days of apathy are numbered. The Y2K/millennium bug, in a nutshell, is the result of the inability of most computer systems in operation today, if they haven't been fixed, to distinguish between the year 2000 and the year 1900.

That deceptively trivial problem has its genesis in the original programming of computers in the 1970s. In those days, computer memory was so precious that programmers elected to use only two digits, instead of three or four, to designate a year. A majority of computer programs and thousands of electronic consumer products in use today still have this programming glitch in their software. Because most computer system memories are date-dependent, those uncorrected systems, when faced with the anomaly of a year with three zeroes, will become confused. They then could come crashing down like the big ball on Times Square at the stroke of midnight December 31, 1999.

The fix for these systems is not as simple as one might think. The programming for the date is invariably buried in millions of lines of computer code requiring huge numbers of hours to locate and fix. Because of the enormous number of man-hours required to make most of the computer systems in the country compliant, it has been estimated that nationwide repair costs will reach $227 billion, with about $100 billion of that representing litigation expenses.(1) Worldwide costs to correct the Y2K Bug could reach $400 to $600 billion(2)--not just in business, but also for, among others, problems in government, healthcare, transportation, and communications. Legal costs could easily exceed $1 trillion, with liability arising from the failures of mainframe computers, personal computers and thousands of products containing embedded microchips with the Y2K bug.(3)

Skilled programmers fluent in the antiquated programming languages in which most computer code was written are already scarce because these languages are no longer routinely taught. Organizations that have begun seeking a fix for their systems have already snapped up the services of the dwindling number of skilled programmers. It is estimated that many companies, however, even with the specter of catastrophe looming over them, have not even begun to address the problem.

As the year 2000 approaches and more information about the Y2K bug is disseminated, only then will many businesses begin to seek a fix. The increasing scarcity of competent programmers, however, will likely result in many companies not being able to obtain a fix for their systems before January 1, 2000. The result? The doomsday scenarios only envisioned now could become a reality.

The gamut of damages that could conceivably be attributed to the Y2K problem is virtually limitless in view of the pervasive usage of computers in all aspects of the global society. Although we may not be aware of it, computers are used in governments, in most large industries, in many small businesses, by financial institutions, by transportation systems, in military and intelligence systems, in public safety systems, by medical providers, by factories, by telecommunications systems, by power generators, and by educational institutions. Not one of these entities is immune from the Y2K bug because of the complex interrelationships among them. Even if, for example, a business managed to completely implement a fix, it still must deal with suppliers or lenders who may not have had the foresight or the wherewithal to resolve their own computer problems.

If thousands or millions of businesses begin failing and losses begin mounting, the inevitable finger-pointing will begin. Those most at risk for liability will be businesses who should have known of the dangers of not correcting their computer systems but did not do so, or did not do so adequately. Also at risk are the many companies involved in the supply of computer systems and software, from the computer manufacturers, designers, and programmers to the vendors and end suppliers. The snowball effect of litigation no doubt will draw in as defendants anyone who might possibly be blamed.

When the full force of the Y2K problem is felt, will insurance carriers be on the hook for the inevitable swarm of claims? There are various types of first- and third-party insurance carried by most businesses and organizations in the United States. First, the comprehensive general liability (CGL) policy is the type of third-party, or liability, coverage most commonly used by businesses. Second, many also carry directors and officers (D&O) liability insurance and errors and omissions (E&O) policies. Third, most businesses and organizations also have first-party property insurance, and some also carry business interruption coverage.

INSURERS PREPARE

More than a year ago, the insurance industry requested the Insurance Services Office (ISO) to draft Y2K exclusions. It has prepared exclusions tailor-made for each state. In late 1998, the exclusions had been approved generally in 48 states, Maine and Massachusetts being the exceptions.

These exclusions, depending on which are used by the insurer, can be employed to preclude coverage for third-party claims, first-party claims, D&O claims, E&O claims, and products/completed operations. In other words, an all-inclusive set of the ISO Y2K exclusions would preclude coverage for any exposure associated with the Y2K phenomenon.

One economic question that arises is whether the insurance industry will utilize these exclusions on an extensive basis. The American insurance market in the late 1990s is "soft," otherwise known as a buyers' market. Many traditional customers of the industry are looking for other forms of protection besides traditional insurance. This makes traditional insurance very competitive and customer-orientated. Many insurers may choose not to engraft the Y2K exclusions onto their policies, especially when their customers are large corporations and businesses. If the insurer is insistent, the customer may simply leave, go to another insurer, or exit the traditional insurance market altogether. Negotiating power is probably with the large policyholder, not with the insurer.

Legally, the Y2K exclusions raise other intriguing issues. The ISO announced that the exclusions are simply "clarifications" of the existing coverage, meaning that coverage never existed under current policies. Insureds undoubtedly will argue that if existing policies needed to be clarified, then existing policies were ambiguous, and therefore any claims falling within existing policies (that is, arising before the Y2K exclusions were issued) would be covered. Or insureds will argue that the fact that the Y2K exclusions were issued suggests that there was coverage under existing policies. Otherwise, why would an exclusion be necessary?

Nonetheless, it is the opinion of these authors that if the damages at issue happen after the proper issuance of a Y2K exclusion, the exclusion will probably be enforced so as to preclude coverage for Y2K-related damages.

But, with the stakes so enormous, the insurance industry would be naive to believe that large sophisticated businesses will give in on this issue, and complicated litigation can be expected.

Regardless of the new exclusions, this article examines all these types of insurance policies in the context of probable Y2K-related claims.

CGL POLICIES

  1. Policy Form

    A typical CGL policy (Form CG 00 01 10 93 of the Insurance Services Office) has the following insuring agreement:

    COVERAGE A. BODILY INJURY AND PROPERTY DAMAGE LIABILITY

    1. Insuring Agreement

    1. We will pay those sums that the insured becomes legally obligated to pay as damages because of "bodily injury" or "property damage" to which this insurance applies....

    2. This insurance applies to "bodily injury" or "property damage" only if:

    (1) The "bodily injury" or "property damage" is caused by an "occurrence" that takes place in the "coverage territory;" and

    (2) The "bodily injury" or "property damage" occurs during the policy period....

  2. No Coverage for Breach of Contract

    It is a widely accepted principle of insurance law that liability policies generally provide coverage only for tort liability, and not for contract liability. Therefore, a liability insurance policy would not provide coverage for an insured's liability for failing to perform a contractual obligation.(4) Likewise, many jurisdictions, like California, have consistently interpreted the phrase "legally obligated to pay as damages," as used in the insuring agreement of CGL policies, to cover only tort liability and not liabilities arising in contract.(5) Liability is said to be purely contractual where it depends on the existence of a contract.(6)

    Although some liability policies include an endorsement for "blanket contractual liability," that endorsement does not cover breach of contract liability...

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