Corporations and insurers are squaring off in a potentially ugly, and costly, battle over Y2K reimbursement.


Only two months to go, and already the "trial of the next century" is taking shape. Forget O.J. Simpson or Microsoft Corp.'s antitrust squabbles. Xerox Corp., GTE Corp., and Unisys Corp. are squaring off against the insurance industry to recoup their mounting Y2K remediation costs. If they win and the rest of Corporate America follows suit, the insurance industry could face $100 billion to $150 billion in losses--the estimated cost of Y2K fixes in the United States alone.

Such losses would dwarf the industry's litigation costs from asbestos and pollution liability combined and ultimately bankrupt many insurers. Little wonder that "insurers will fight these suits with everything they've got," says Walter Andrews, a partner in the Washington, D.C.-based law firm Wiley, Rein & Fielding, as well as counsel to the Insurers' Year 2000 Roundtable, an organization representing dozens of insurers on Y2K issues. "It's do or die," he adds.

At issue is whether the property insurance policies bought by GTE, Xerox, and Unisys cover the hundreds of millions of dollars the companies have spent collectively to help their computers decipher the date "2000." The plaintiffs say they do, and argue in separate lawsuits that under a little-known clause in insurance contracts--the "sue-and-labor" clause--the companies should be reimbursed for money they spend that helps their insurers avoid loss.

While a verdict is at least three to five years away, the companies are committing internal and external legal resources and their risk management departments to plead their cases in court. And they contend it is in the interests of shareholders to pursue such claims. Says Robert H. Brust, CFO of Unisys, a Blue Bell, Pennsylvania-based information-services and -technology firm, "This action is consistent with our diligence in pursuing all avenues to optimize the value of our assets for Unisys stakeholders."

But if the companies fail to win--and legal observers say they have a steep uphill climb-- they will have a lot of explaining to do to their boards, shareholders, and the Securities and Exchange Commission. "If I were a board member of one of these companies, and I was told by the risk manager and general counsel that these costs may be covered by insurance and should be litigated--and it turns out they're not covered -- I would wonder why so much money and time was devoted to it," says attorney Ann Longmore, vice president at Willis, a London-based insurance broker.

Longmore insists she has no ax to grind. "As brokers, we are continually asked by our corporate clients for advice and counsel on this subject," she says. "We're in a delicate position here. We point out the insurers' arguments insofar as what they can expect in court. Ultimately, we tell them it's up to them [whether or not to sue]. Who's to say our client won't be the one that wins the jackpot?"

Walking the Plank

As in other high-profile insurance litigation cases, the courts will be asked to interpret the meaning of sometimes ambiguous insurance- policy language. In the case of the sue-and- labor clause, they have their work cut out for them.

The clause originated in British maritime insurance policies from the 1600s, well before today's property-and-casualty lines of insurance. Its intent was to encourage the owners of ships and cargo to prevent or minimize potential loss or damage covered by the policy. "One example would be reasonable costs incurred to salvage sunken goods from the bottom of the sea," explains Bob Hartwig, vice president and chief economist at the New York­based Insurance Information Institute. "These costs would be recoverable under the sue-and-labor clause. A more modern example would be the cost of tarp to protect insured merchandise from rain and wind damage after the roof of the insured's warehouse was blown off in a storm. In this case, the policyholder would be covered for the cost of the tarp under the sue-and-labor clause."

While not part of standard property-insurance policies, sue-and-labor clauses are routinely inserted by brokers. And GTE, Unisys, and Xerox contend that the clause requires them to undertake expenses to prevent or minimize the damage wreaked by Y2K problems. "GTE has spent tens of millions of dollars in premiums over the years for insurance policies that specifically cover data corruption and that require us to take measures to protect our data from damage," says Bobbi Hennessey, media- relations director at GTE, an Irving, Texas- based telecommunications company with $25 billion in 1998 revenues.

And now that the disaster of the Y2K remediation costs has struck full-force, says Hennessey, GTE's insurers are obliged to reimburse it for all or part of the estimated $400 million it will have spent on Y2K remediation. "We have met our obligations under our policies to protect our data from corruption," she insists, "and our insurance carriers are now obligated to honor our claims for these clearly covered expenses."

Other plaintiffs agree they are simply doing what their insurance policy requires as far as mitigating insurer losses. "We are making this claim because we believe there is coverage for some or all of our year 2000 expenses," says CFO Brust of Unisys, which has sued insurers Royal Indemnity, Sun Insurance Office of America, Allendale Mutual Insurance, and Insurance Co. of North America for an undisclosed amount. That belief is based on specific language in the policies. Royal's policy, for example, insures against "all risks of physical loss or damage... [which] shall include any destruction, distortion, or corruption to any computer data, coding, program, or software." Sun's policy reads almost the same, while the remaining two do not include reference to actual data corruption, but refer instead to the insured's "property."

The Insurers' Side

The insurance industry, however, argues that it is not subject to any exposures emanating from Y2K problems, simply because it never intended coverage for this risk. "Property insurance, by definition, covers only fortuitous or inherently unforeseen events, such as damage resulting from tornadoes or lightning strikes," Hartwig says. "It's hard to call Y2K an unexpected event. Unless you've been hiding in the basement the last five or six years, there is no way you haven't heard something about the problem."

Attorney Andrews agrees. "The claims will be denied because the loss is not fortuitous--an unexpected, unforeseen, unplanned event," he says. "Therefore, if the loss is not fortuitous, any expenses to correct it are normal business costs the companies incurred to prevent something they knew would happen. Otherwise, what's to prevent every homeowner from putting in a sprinkler system and charging the cost to homeowners insurance because there might be a fire someday? Or people in California retrofitting their houses to be earthquake-proof because, you know, someday the big one will strike?"

Even if the plaintiffs were to meet the standard of fortuity, Hartwig says the losses they incur from Y2K are purely economic and, therefore, not covered. "We're looking at things like loss of market share, loss of consumer and investor confidence, or regulatory sanctions if they fail to fix their Y2K problems," he says. "The fact remains that losses arising from an inability or diminished ability to compete in the marketplace or on Wall Street are not insured."

But if the courts can jump this hurdle as well, and agree insurance coverage is applicable, could they be convinced the insureds acted in their insurers' best interests by spending millions of dollars to fix their computer systems? In other words, were the policyholders acting within the guidelines of the sue-and-labor clause to prevent or minimize an insured loss? That, says Hartwig, will depend on how the courts interpret specific insurers' clauses, all of which basically state that in case of an "actual or imminent loss or damage," expenses incurred by the insured in taking reasonable and necessary actions to protect the insured property are recoverable.

And all the courts have to do is reasonably define "imminent," insists Hartwig, to dismiss the plaintiffs' arguments. After all, he says, actions taken many months or years before January 1, 2000, cannot be categorized as imminent, because there was no immediate threat of a loss. To bolster his argument, he points to GTE's and Xerox's annual reports, in which GTE states it had "an active Year 2000 program in place since 1995" and Xerox states that Y2K remediation efforts have been under way since early 1997. Both GTE and Xerox confirmed the report, although Xerox declined to be interviewed for this article.

"The plaintiffs' arguments that they acted to avoid 'imminent' loss collapses quickly under the weight of its own absurdity," Hartwig says. "The cost of maintaining and upgrading the operating systems of a business, whether it's air conditioning, electrical wiring, or computers, has always been assumed by the business, not its insurer. Insurance companies do not pay the costs of replacing old electrical wiring that threatens to short- circuit and cause a fire, just as they do not pay to replace worn-out brakes with new systems on automobiles."

Slugging It Out

Still, legal observers are hesitant about predicting the outcome of the cases. For one thing, there isn't much precedent to go on. Andrews says he has searched the law books for a sue-and-labor award in a nonmaritime, pure property insurance context, and, "frankly, I can't find any, with respect to future-looking losses. It will be hard for the plaintiffs to come up with examples where this makes sense."

And James E. Forde, an attorney with Thacher Proffitt & Wood, a New York­based law firm, points out that even in maritime cases there are barriers to success. "You need to prove a fortuitous loss, an event that happens purely by chance," Forde says. "The second thing is to prove the reasonableness of the actions taken, which typically means you need to prove an imminent threat. If they're pushing the envelope on reasonableness, they're going to raise some eyebrows."

Finally, says Longmore, "No one can predict how the courts will find. As with any new matter facing the courts, you can get different decisions from different courts. Even the most reasonable people can reach different conclusions on what 'imminent' is or what constitutes the appropriate timing of a claims notice."

What is certain is that the case will be closely followed by Corporate America. Already, hundreds of companies, including pharmacy chain CVS Corp. and Equitable Cos., a financial services firm, have filed a "notice of claim" to their insurers for their own Y2K remediation costs.

And if the plaintiffs win, says Longmore, it will be "blood in the water to every other company out there. Everybody, and I mean everybody, has a policy in the property/casualty market that didn't have a Y2K exposure five years ago. That means that every property/casualty insurance company is exposed."

At least one plaintiff's external counsel is counting on that outcome. An individual close to the litigation says the law firm representing one of the plaintiffs has taken the case on a contingency basis. "They're looking to make their name with this case, knowing full well that if they win, they'll have every other Fortune 500 company knocking on their door," the source says, on condition of anonymity.

But if the insurers win the day--and Longmore says they'll go all the way to the Supreme Court if they have to--one wonders what the shareholders of GTE, Unisys, and Xerox will think about the companies' decision to carry the ball while other corporations sat in the grandstands. "The insurance industry will fight this tooth and nail," Longmore says. "They've got to. They can't afford to lose this one."

----------------------------------------------- --------------------------------- Looming Price Tag
It's not surprising that corporations would like their insurers to reimburse them for Y2K expenditures.

(Chart omitted)

A Question of Semantics

Deciding whether insurance companies should pay for Y2K remediation will be a two-step process for the courts. Step one will be to decide if coverage exists in the first place. Then they will have to see if the sue-and- labor clauses cover costs already spent. In each case, however, the courts will have to navigate through some complicated language.

The lawsuit filed in August by Unisys Corp. against four of its insurers--Royal Indemnity, Sun Insurance Office of America, Allendale Mutual Insurance, and Insurance Co. of North America (INA) -- offers a glimpse into just how complicated.

Most of the policies, for example, insure against "all risks of physical loss or damage." In the INA policy, however, it reads "all risk" of "direct physical loss or damage to insured property...." And in the Royal and Sun policies, the possibility of computer damage is raised. In fact, both policies state: "This policy insures against all risks of physical loss or damage, except as hereinafter excluded, including general average, salvage, and all other charges on shipments covered hereunder. Physical loss or damage shall include any destruction or corruption to any computer data, coding, program or software, including computer virus...."

Because Y2K problems are not specifically addressed, the insurers contend they are not covered--a position Unisys and the other suing companies obviously take issue with. GTE Corp., in fact, alleges that Allendale sought to exclude Y2K exposures in its property insurance policy upon renewal, an attempt GTE rebuffed. "We have not signed any Y2K exclusions, even though we were asked to do so retroactively," says Bobbi Hennessey, a GTE spokeswoman. "I find it interesting that they now want to exclude a coverage they say never existed in the first place." (The insurer's response: It was the first time anyone raised the issue.)

The sue-and-labor clauses offer another challenge. According to the Unisys lawsuit, each clause has subtle differences, but all basically state that in case of an "actual or imminent loss or damage," any expenses incurred by the insured in taking reasonable actions to protect insured property are recoverable. The INA policies, for example, state that "the acts of the Insured or of this Company in recovering, saving, and preserving the property insured in case of loss or damage [shall not] be considered a waiver or an acceptance of an abandonment; underwriters shall pay for charges and expenses incurred as a result of the Insured's compliance with this Clause."

The insurance companies take issue mostly with the idea that the Y2K threat was "imminent." But there are other points the insurers are expected to assert as the cases come to trial, including the argument that the sue-and-labor complaints were lodged well after the companies' Y2K remediation efforts were under way--a violation of the policy that the insurer be notified immediately or as soon as practicable.

Asked to respond to the insurers' likely defense strategies, the plaintiffs politely declined. "We're not going to argue the merits of this in the press," says a Unisys spokesperson. Ditto GTE's Hennessey: "Our lawsuit is a private dispute."


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