Year 2000 exclusion clauses - why the big fuss?

United Kingdom

Insurers and the Year 2000

It is, of course, a well known albeit perhaps somewhat simplistic saying that any insurance risk can be underwritten provided that the risk to insurers can be assessed and the premium rated accordingly.

In circumstances where IT experts hold widely differing views of the likely impact of the Year 2000 problem and where there is no historical data available to assist insurers to project potential Year 2000 losses for specific classes of business, it is unsurprising that so far as certain of the most directly exposed classes of business are concerned insurers simply consider themselves not to be in possession of sufficient information to allow them to rate the risks and therefore to underwrite the business. The inevitable upshot of this is that insurers who are, after all, as much businesses as the buyers of insurance, may feel obliged to apply what are publicly unpopular exclusions to those classes of business.

Factors underlying insurers' decision whether to underwrite or to exclude are:

  • the obligations of their directors and officers and responsibilities to their shareholders, in the case of insurance companies
  • responsibility to their capital providers, in the case of underwriting syndicates
  • obligations to their reinsurers.

It is important to bear in mind that it is unlikely that, taking into account the degree of competition created by the current soft insurance market, insurers faced with what they saw as any real choice, would seek to apply Year 2000 exclusions; indeed we are already seeing an active policy of selective underwriting in certain markets.

Exclusions - only partly the point:

While the application of exclusions has public immediacy and therefore attracts attention to the plight of insureds, there is a real chance that this publicity may have led buyers of insurance to the erroneous conclusion that policies free of Year 2000 exclusions will provide cover for Year 2000 losses.

Whether this is, in fact, the case will of course depend upon:

  • whether the loss was foreseeable by the insured at the time the contract was made
  • the wording of the operative clause
  • the effect of any existing exclusions
  • other relevant conditions of the insurance
  • compliance with warranties and obligations of disclosure
  • other conduct of the insured.

The foreseeability/fortuity issue has already been considered extensively and it is therefore perhaps more useful here to consider the other issues.

The operative clause

By way of example:

the wording of most product liability policies has the effect that insureds are covered for liabilities arising from damage caused by their products but not for damage to the product itself; suppliers of embedded processors insured under a product liability policy who expect to have the benefit of insurance if they are called upon to replace non-compliant kit may have to think again, whether or not a Year 2000 exclusion is imposed

Insureds under policies whose operative clauses provide indemnity in respect of “damage” may not, depending upon the definition of "damage", be indemnified for failure of systems to operate as a result of the Year 2000 problem on the basis that, under English law, damage is usually construed as physical damage to tangible property.

Existing exclusions

Insureds must consider carefully the potential impact of the Year 2000 problem on their particular business and assess whether existing exclusions will act to exclude Year 2000 losses. Consider, for example, a manufacturing company whose waste disposal is controlled by plant containing embedded processors. If, because of the Year 2000 problem, the control equipment malfunctions leading to pollution, an existing pollution exclusion in the company's All Risks policy could result in there being no cover for those losses, irrespective of whether a tailor made Year 2000 exclusion is applied.

Other relevant conditions

Many property policies contain conditions such as the requirement that the insured should have in place, at all times, an active security system and/or functioning fire alarms.

Where such terms are conditions precedent to liability under the insurance contract, and where the Year 2000 problem disrupts such systems so that they do not function properly, there may be no cover for losses sustained - whether as a result of other manifestations of the Year 2000 problem or otherwise. Where such conditions are general conditions, the amount that the insured will be able to recover under the policy may be reduced.

Warranties

The insured may have made statements in relation to its Year 2000 readiness which form part of the basis of the insurance contract and, accordingly, have the status of warranties; for example in the proposal form at inception of the cover. If so, and if any of these statements are untrue, insurers may well be entitled to avoid the policy from the date of the breach - in the case of warranties in the proposal form, from inception.

Obligations of disclosure

It is well known that the parties to an insurance contract have the obligation to disclose to one another all facts material to the formation, or renewal, of the insurance contract. Depending upon the wording of the insurance contract, there may also be obligations to provide disclosure mid-term. Information that the insured has in relation to its Year 2000 readiness may very well constitute material facts. Any studies/projects that the insured commissions voluntarily in relation to its exposure to Year 2000 risks may also constitute material information which should be disclosed. Where there is found to have been a material non-disclosure by the insured, insurers’ remedy is, of course, avoidance of the insured’s policy ab initio.

Conduct of the insured

Where the insured has not taken steps to protect its position in relation to Year 2000 losses, there are some circumstances in which the conduct of the insured could amount to recklessness rather than negligence. If, for example, an insured commissioned the report of a computer consultant into the effect of the Year 2000 problem on its systems and that computer consultant informed the insured that failure to replace a simple, inexpensive, embedded processor in a piece of plant would lead to that plant failing and causing damage to other property, and if the insured, knowing this, failed to replace the embedded processor and the predicted damage occurred, it would be open to insurers to argue that the loss suffered was so obviously the result of reckless conduct that the insurance should not respond.

Conclusion

It is a sobering thought that, in the final analysis, perhaps the greatest potential loss to any business which may arise from the Year 2000 problem is to its cashflow and goodwill as a result of the disruption or failure of the business. There are few insurance policies that offer a remedy for such loss. This, coupled with the fact that many other Year 2000 losses will simply not trigger policy coverage even in the absence of Year 2000 exclusions, means that those who focus continually on exclusion clauses may simply be missing the point.

If buyers of insurance believe that absence of an exclusion means that there is Year 2000 cover, this is leading to expectations which are likely to be dashed. Although, as businesses, insurers should not be blamed for the selective imposition of exclusions, perhaps the industry collectively should now focus on ensuring an understanding, by buyers of insurance, of the bigger picture.

Maxine Cupitt
Anthony Hobkinson