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Are You Sure You are Insured?
- the Y2K Commercial Insurance Exclusion
by Peter Kelman, Esq.
This article appeared in substantially the same form in the MetroWest Daily News, July 12, 1999.
You own a business. You've heard about the Y2K computer bug, you've read about the bug and, in fact, you have squashed the bug. You have a new computer system and the latest software. You're Y2K compliant. January 3, 2000 rolls around and you go to work (January 1, 2000 is on a Saturday). You are at work and your employees are at work but your in box is empty because your delivery company could not deliver your raw materials (or your ISP provider is down, or your local telephone company has limited bandwidth). Your business can't operate at normal capacity. For a month, until somebody else works out their Y2K bugs, your business suffers. Finally, after the dust settles, you check with your insurance agent. After all, you have a commercial liability policy and it has "business interruption" insurance. Surely, you say to your agent, my business was interrupted; you generated one-quarter the normal revenues you typically do in one month. So you want to file a claim. Your agent asks for your damage figures and says the check will be in the mail in a week. Then the alarm clock rings and you wake up.
Unfortunately, collecting insurance proceeds to compensate for Y2K business damages will not be as easy as calling your agent and waiting one week for the check. It is often said that the commercial harbingers of misfortune are plaintiff's attorneys and insurance companies. Long before the reality of Y2K has struck, in whatever form it may take, insurance companies have been preparing themselves for the worst. Such is the nature of an insurance company. While most Y2K pundits preface any description of life in the 21st century with "while no one really knows what the Y2K bug will do ", insurance companies assume it will do the worst. And the steps they have taken to protect themselves against worst case scenarios will affect you.
In Massachusetts, the Commissioner of Insurance, Linda Ruthardt, issued a Year 2000 Bulletin on September 28, 1998 (Bulletin 98-15). In that bulletin the Division on Insurance announced its policy with respect to permitting insurance companies to exclude Y2K coverage for insurance policies issued in Massachusetts. The Insurance Division said that it would closely monitor Year 2000 endorsements, and that in general:
· The Division would not permit exclusionary endorsements on personal lines policies (homeowners, auto, etc.); and
· The Division would permit exclusionary endorsements on commercial lines policies, if the exclusion is properly documented by the insurance company.
Proper documentation requires, among other things, that the insurance company must provide adequate notice to its policy holders, if it intends to modify an existing policy to exclude coverage for Y2K caused harm or if it intends not to renew a line of insurance.
Insurance companies have taken liberal advantage of the license permitted by the Insurance Division to write numerous exclusions to commercial lines of insurance. For example, commercial businesses are typically protected by a "package" policy which covers losses arising out of various types of property damage. It is not hard to imagine Y2K induced property damage, for example, where power fails, heat is not produced, pipes freeze and property damage occurs. Many insurers have written a Y2K endorsement to their package policy stating that losses arising out of property damage caused by a Y2K system failure will not be covered under a package policy . Similarly, commercial carriers are writing Y2K exclusions to umbrella packages, director's and officers insurance and general liability policies (which cover liability to third parties).
Even in the absence of an explicit exclusion, industry experts expect insurance companies to deny coverage on the grounds that a Y2K loss is not "fortuitous." The term "fortuitous" is a term of art as used in insurance analysis to mean something which could not be reasonably planned for. Most insurance policies contain language to the effect that if the insured could have anticipated the loss and possibly prevented the loss, but chose not to act, the insurance company will not be liable for the consequences of not acting. This very issue is currently being decided in a case in Iowa, Cincinnati Ins. Co. v. Source Data Systems, where an insurance company is asking a court to declare that it is not liable for the failure of its insured to write a Y2K compliant computer system. The insurance company maintains it was the insured's conscious choice not to make its system Y2K complaint.
What does all this mean to you? First of all, do not assume your business is covered by insurance in the event of a Y2K failure. For example, it is a common misconception that business interruption insurance covers a "slow down" in business. Business interruption typically only applies where some other form of insurable loss has taken place. Talk to your insurance agent and get your agent's opinion about your coverage. Save all communications from your insurance company regarding your policies. If you think a financial safety net is needed, talk to your agent about Y2K insurance. Nature and business abhor a vacuum. Some insurers are now offering Y2K specific insurance to fill the void left by other insurers.
Finally, be prepared. It is better to take steps now to avoid a loss rather than try to receive compensation later. Moreover some insurance companies are willing to waive their Y2K exclusion, on a case-by-case basis, if you can demonstrate that your business has implemented a thorough Y2K compliance plan. A thorough compliance plan includes your key third-party customers and suppliers as well as your internal systems. By undertaking appropriate Y2K corrective action now, you may prevent an insurance nightmare later.
1999, Peter Kelman. All rights reserved.