By Vito C. Peraino and Deborah A. Pitts
In the Feb. 3 edition of National Underwriter, we wrote an article headlined 'Year 2000 Poses Liability Exposure', in which we outlined the scope of the Year 2000 problem and advocated the need for action on the part of the insurance industry.
Now, approximately 10 months later, we revisit the issue to ask:
- Is American business turning the corner toward a brightening Year 2000 picture? Has the plaintiff's bar begun to awaken to the Year 2000 problem? What impact do developments in the Year 2000 arena potentially have on the insurance industry?
The picture is not brightening.
Hard data regarding the progress of companies in the Year 2000 context remains elusive. Far too much of the data is anecdotal and difficult to verify. The data which does exist, however, is indicative of a problem which is not improving.
By way of example, the U.S. Comptroller of the Currency testified before the Senate Banking Committee on July 30 and revealed the results of a survey undertaken by the Comptroller's office. The results of that survey were disturbing. The Comptroller reported that 85 percent of large banks, representing approximately 85 percent of national bank assets, had Year 2000 mitigation programs in place.
Considered in more detail, however, the results were not reassuring. The survey did not indicate what was meant by a 'program'. Of the banks that had a 'program' in place, the survey revealed several shortcomings, including lack of sufficient prioritization of systems, lack of a formalized budget and insufficiently aggressive timetables.
The survey also considered the condition of smaller community banks. Here the results were worse. Fully 15 percent of community banks were not aware of the Year 2000 problem. Another 20 percent, though aware, had no plans to address the problem.
At that same hearing, Governor Edward Kelley of the Federal Reserve stated that given the complexity of the Year 2000 problem, 'at least a few' bank failures could be expected.
The banking industry results are discouraging both because they are based on rare hard data, and also because the banking industry has been aggressively addressing the Year 2000 problem. Furthermore, unlike most other industries, the banking industry has strong regulatory oversight that has instituted a rigorous plan to assure that banks are compliant.
Significantly, on Nov. 12 the Board of Governors of the Federal Reserve issued its first cease and desist orders against a bank holding company and three subsidiary banks in Georgia for their failure to address their Year 2000 problem with sufficient rigor. (In Re: Putnam-Greene Financial Corp., Docket No. 97-027-B-BHC).
The orders interestingly require that within 60 days of the order the bank 'shall secure a fidelity and indemnity blanket bond that includes all coverages of its present bond and also coverage for errors and omissions of Putnam-Green's data processing services.'
As reported by the National Underwriter in its Nov. 17 edition, action has begun on the legislative front to address the problem. While legislative action is in its early days, it is interesting to see where legislators are heading.
Most significant is the CRASH Protection Act -- the Computer Remediation and Shareholder Protection Act of 1997, S.1518, introduced in the U.S. Senate on Nov. 10 by Sen. Robert Bennett, R-Utah. The CRASH Protection Act essentially calls for mandatory disclosure of Year 2000 problems by publicly-traded entities. Specifically, the act calls for disclosure of:
- The amount of money a company has incurred on its Year 2000 project. What progress the company has made in addressing its Year 2000 project. An estimate of 'litigation costs and liability outlays' associated with the Year 2000 problem. Information relating to the existence of any insurance policies 'that cover specific Year 2000 computer system problems, as well as the defense of legal actions' against the company and its officers and directors in connection with those problems. Information relating to any contingency plans developed by the company to assure continuing operations.
Sen. Bennett's bill gets it about half right. The bill serves the laudable goal of assuring that some basic information regarding a company's Year 2000 progress is reported publicly. This is important both to assure that the consuming and investing public have accurate information upon which to base their decisions, but it also is important for businesses to know the status of their key trading partners.
Equally important, the bill gives Congress a vital tool with which to begin to understand how key industry sectors are addressing the Year 2000 problem.
As it stands, if the Year 2000 problem is even one half as serious as many observers believe it might be, Congress will be flying blind in trying to enact sensible legislation to assist in solving the problem. It is for these reasons that we advocated such legislation in our March 20 testimony before the U.S. House of Representatives.
Sen. Bennett's bill is less well considered when it comes to certain aspects of his proposal.
For example, while the litigation threat is real, mandating that companies disclose information about the possibility of suits may spawn more litigation than it will avoid. Annual reports, 10-Ks and 8-Qs may become required reading at meetings of the American Trial Lawyer's Association as companies would be required to project their litigation exposures.
Additionally, questions arise regarding the maintenance of the attorney-client privilege if a company is required to disclose details regarding anticipated litigation.
Sen. Bennett's proposal to mandate disclosure of insurance coverage for the Year 2000 problem also is troubling. First, it is unclear from the bill whether it seeks disclosure of all potentially applicable insurance coverage or whether it seeks disclosure of Year 2000 policies, such as those being offered by J & H Marsh & McLennan, AIG and others.
Second, it is unclear what the unintended consequences of this requirement might be. For example:
- Will the bill require that companies receive an opinion letter from coverage counsel advising the company of the existence of insurance coverage?
- Will it encourage companies to flood their insurers with precautionary notices on the off chance that coverage might be afforded under their policies?
- Will it begin to polarize insurers and their policyholders with respect to inchoate claims, when the dispute, if there is one at all, is better left to the sharp outlines of an actual claim?
It has been widely reported that the first Year 2000 lawsuit was filed in Warren, Mich. on behalf of Produce Palace for damages allegedly suffered when the grocer's computer crashed due to the use of double-zero credit cards. The eyes of the Year 2000 legal community will be watching the progress of that case with keen interest.
Perhaps more disturbing are the distant beat of the war drums in the plaintiffs, lawyer community. The Wall Street Journal reported on Nov. 6 that Milberg Weiss Bershad Hynes & Lerach has announced formation of a group of lawyers and technicians who are exploring the filing of Year 2000 class action suits arising out of securities violations.
Similarly, several well-known policyholder coverage firms have begun to publish articles outlining theories of recovery for Year 2000 liabilities and announcing that they, too, are forming Year 2000 practice groups.
Leaving aside their analysis of the legal issues, it is becoming apparent that sides are beginning to be chosen and positions staked out. The fact that the storm clouds are forming should be lost on no one.
Where do we stand at the end of 1997?
- We know that from the limited data available, corporate America is not making the progress we would have hoped. The data suggests that companies are lagging behind and that certain sectors seem to be all but ignoring the Year 2000 problem.
- We know that the plaintiffs, bar is becoming active and that its activity is likely to increase rather than wane.
- We know that legislation is on the table that will have a direct impact on the insurance industry as it will force policyholders to begin to consider the availability of their insurance assets.
- We know that policyholder counsel are already articulating theories of coverage -- some even attempting to cast Year 2000 losses as long-tail claims.
What steps might an insurer consider?
- Become compliant. Without question the first order of business for an insurance company should be to address its Y2K problems to maximize the chance that claims will be processed in the ordinary course of business in the new millenium.
- Inquire regarding Year 2000 readiness in applications and renewal. It is time to find out whether your policyholders have a problem, and to assess whether potential liability may be coming their way. This is true for all major property-casualty, directors and officers, errors and omissions and business interruption lines. Time exists to address the problem through prospective underwriting.
- Exclude the risk. In times of soft markets it is difficult to suggest that coverage should be narrowed rather than broadened. However, for exposed lines of coverage or classes of business, a Year 2000 exclusion should be considered.
- Training and awareness. It is not too early to begin to train and advise claims staff regarding the Year 2000 problem. Through the course of 1998 it is likely that the number of lawsuits will increase with the attendant likelihood that the number of claims tendered will increase. Thoughtful prospective planning for this eventuality will pay big dividends should the problem mature into a wave of litigation.
- Legislation. The Year 2000 problem is seeing increasing activity in the halls of Congress and the state legislatures. Close attention to these developments will be essential to ongoing underwriting and claims handling.
Further, it is likely that input will be solicited from the insurance industry -- input that should be formulated sooner rather than later.
The Year 2000 problem is unlike any that the insurance industry -- or the rest of the world -- has ever faced. Unlike the typical incident, we know with certainty the day the problem will arise, the hour the problem will arise, what machinery will be affected by the problem and what business functions will be impacted.
However, the extent of the problem remains anyone's guess. Though time remains for proactive action, the time is running short.
In an editorial in its Feb. 3 edition, National Underwriter warned its readers that 'the clock is ticking. The stakes are huge. The time to act is now.'
Nothing has changed to alter that sound advice. If anything, the picture is worsening. For the insurance industry, four words sum up the state of affairs: act and act now.
Posted with permission from the National Underwriter
Hancock Rothert & Bunshoft has formed a Year 2000 Team to assist companies with related legal problems. If you would like more information on Hancock's Year 2000 Team, or on the firm in general, please contact: Vito C. Peraino on Tel: 213-623-7777 or E-mail: Click Contact Link or visit the Hancock Rothert & Bunshoft website at Click Contact Link
Visit the Year 2000 website at Click Contact Link
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
