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Vol. 71, No. 11, November 1998
Year 2000 Insurance Coverage Issues
By Douglas P. Dehler
As businesses work to fix the Year 2000 problem,1
more attention has focused on the potential for insurance coverage. Because
it is difficult to know what losses may result from what some predict may
be an unprecedented, global computer failure, it is also difficult to anticipate
all of the insurance coverage issues that will arise. It is safe to say,
however, that many types of insurance policies will be involved. This article
addresses some of the coverage issues that may arise, and considers what
steps insurance companies and policyholders may take to deal with those
issues.
| The coming months will set the state for much of the coverage litigation
over year 2000 losses, as insurance companies seek to add new exclusions
when insurance policies are renewed. |
Year 2000 claims almost certainly will be made on first party property policies,
which often include business interruption coverage. These policies cover
damage to the policyholder's own "covered property." When they
include business interruption coverage, these policies also cover lost profits
sustained while the policyholder's business operations are shut down because
of the damage to covered property. In many policies, "covered property"
is defined to include, among other things, "personal property owned
by you and used in your business."2 Often,
these policies specifically exclude coverage for "the cost to research,
replace, or restore the information on valuable papers and records, including
those which exist on electronic or magnetic media," unless such coverage
is added by endorsement.3
 Whether there is damage to "covered property"
will depend upon the unique facts of each claim. For example, if only computer
data is damaged, there may be questions about whether the data is "personal
property." Similarly, if coverage is sought only for the cost of restoring
or replacing computer data, there may be questions about whether the data
relates to "valuable papers and records."
In addition to computer data, a Year 2000 problem may damage computer
software and hardware, a computer network, manufacturing equipment, inventory,
and products. Even if the cost of restoring lost computer data is not covered,
there may be coverage for other property damage caused by a computer malfunction.
Determining where damage to data ends and where damage to computer software
or hardware begins may be a difficult question requiring expert testimony.
In addition, first party property policies generally require that damage
to covered property be caused by a "covered peril" or "covered
cause of loss." Many policies define "covered cause of loss"
broadly to include all "risks of direct physical loss," unless
specifically excluded or limited.4 Under these
policies, unless excluded, computer malfunctions probably are included as
a "risk of direct physical loss." Other policies may more narrowly
define "covered cause of loss" to include only specified perils.
Some Year 2000 claims also may implicate general liability policies.
Unlike first party property policies, which cover the policyholder's own
property, third party liability policies protect the policyholder from liability
for damage caused to others. In some cases, a Year 2000 problem may harm
not only the policyholder's own computer equipment but also damage a third
party's property or even cause bodily injury. For example, if a computer
chip failure causes a medical device to malfunction on Jan. 1, 2000, resulting
in bodily harm to a patient, a claim might be brought against the medical
device's manufacturer. Because most liability policies do not exclude coverage
for bodily injuries caused by computer failures, coverage may be available
under the manufacturer's general liability policy, subject to any exclusions
or limitations for products liability claims.
Claims also might arise under directors and officers (D&O) liability
policies. In the example above, if the medical device manufacturer's shareholders
allege that corporate directors failed to take proper Year 2000 remedial
measures, coverage likely would be available for the claim under the corporation's
D&O policy. Similarly, claims on professional liability policies may flow
from Year 2000 problems. If the patient in the example above alleges that
the medical provider failed to take proper steps when responding to the
computer failure, a claim likely will be made under the provider's professional
liability policy.
Most insurance policies do not exclude coverage for Year 2000-type problems.
But this may change soon. The insurance industry has drafted new policy
exclusions aimed at reducing or eliminating coverage for Year 2000 losses.
These exclusions are being submitted now to state insurance regulators for
approval.5 In the coming months, many insurance
companies will propose adding these new exclusions to insurance policies
as they come up for renewal. To the extent possible, policyholders may attempt
to resist an insurance company's efforts to add new Year 2000 exclusions.
Whether these efforts are successful will depend upon whether the policyholder
has any significant bargaining power and the level of competition in the
insurance market.
In addition to the new exclusions, the insurance industry has hinted
at another strategy for limiting its exposure for Year 2000 claims. Some
insurance companies may take the position that these claims are not covered
under any insurance policy (regardless of the type of coverage it affords)
based upon principles of fortuity and under the known loss doctrine.6 The theory is that Year 2000 losses are known and
foreseeable, and therefore are not the type of fortuitous losses intended
to be covered by insurance policies.
In response to these types of arguments, policyholders probably will
argue that the denial of coverage on such grounds cannot be supported by
the language of the policies themselves. With the exception of "claims-made"
policies, most insurance policies do not contain "known loss"
exclusions. Even where such exclusions exist, it may be difficult to show
that a policyholder predicted or knew about any particular Year 2000 loss
at the time it purchased insurance coverage. Furthermore, what a policyholder
knew (or didn't know) about Year 2000 problems when it purchased an insurance
policy is likely to be a fact-intensive question.
 |
Douglas P. Dehler, U.W. 1991, is a partner at Michael Best
& Friedrich LLP, Milwaukee, where he practices litigation and represents
clients in insurance coverage disputes. |
Late notice also may be an issue. Most insurance policies require notice
once a policyholder knows that a loss or accident has occurred. If a policyholder
fails to notify its insurer promptly after it experiences a Year 2000 loss,
it may later be precluded from obtaining coverage for that loss, particularly
if the insurance company is prejudiced by the late notice. Although much
of the attention has focused on what will happen at midnight on Jan. 1,
2000, in some cases Year 2000 losses may take place earlier. For example,
in a Michigan case filed in 1997, a retailer alleged that its cash register
system already had begun malfunctioning because it would not accept credit
cards with expiration dates after the Year 2000.7
A policyholder should notify its insurer as soon as it learns of a computer
malfunction, even if the extent of the damage is not fully known or the
loss has not yet resulted in a third party claim or lawsuit.
While the magnitude of the Year 2000 problem is debatable, some amount
of litigation is certain. As with most other litigation, insurance policies
will play an important role. The coming months will set the stage for much
of the coverage litigation over Year 2000 losses, as insurance companies
seek to add new exclusions as insurance policies are renewed. Only time
will tell whether this strategy for limiting the insurance industry's liability
for Year 2000 losses has been successful.
Endnotes
1 Additional background on this subject is
available in Craig Fieschko's article, "The
Great Computer Crash of 2000," in the May 1998 Wisconsin Lawyer.
2 See, Insurance Services Office Inc.'s
Building and Personal Property Coverage Form, CP 00 10 06 95 (1994).
(This insurance form is available from Insurance Services Office, 7 World
Trade Center FL 17, New York, NY 10048.)
3 Id.
4 See, Insurance Services Office Inc.'s
Causes of Loss Special Form, CP 10 30 06 95 (1994). (This insurance
form is available from Insurance Services Office, 7 World Trade Center FL
17, New York, NY 10048.)
5 ISO Circulating Exclusions for Y2K Liabilities,
Mealey's Year 2000 Report (February 1998).
6 Anne Colden, "Insurers Differ Over
Paying Y2K Claims," Journal of Commerce, May 22, 1998, at 5A.
7 Produce Palace Int'l v. TEC-America Corp.
and All American Cash Register Inc., No. 97-3330-CK, Macomb County Circuit
Court, Mich., filed June 12, 1997.
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