Year 2000: Implications for financial institutions and their insurers

Introduction

The Year 2000 is drawing ever closer yet the extent of disruption likely to result from the Year 2000 problem continues to be unquantifiable. It is unlikely that our transition into the Twenty First Century will be trouble free however and financial institutions, together with their regulators, are particularly aware of the dangers of complacency (see below). Where disruption occurs, it is anticipated that financial institutions may suffer first party losses and be the subject of third party claims. In these situations, financial institutions are likely to look closely at their portfolio of insurance cover with a view to shifting liability wherever possible, on to their Insurers.

The nature of the Year 2000 problem itself has received extensive coverage in the press for some time now. The following text sets out the key features of the problem and provides a context within which "losses" may be sustained by banks in the form of either first party loss or third party liability.

The Year 2000 problem has arisen as a direct result of computer technology developed in the 1970's which saved valuable memory by using two digits rather than four to designate dates, with the result that such computer systems cannot differentiate between Year 2000 and the Year 1900. It has been recognised that systems programmed in this way can, when dealing with dates shown as "00" onwards, misinterpret them as meaning the Twentieth Century. Alternatively they may be interpreted as the Year when the relevant programme was written. There is also concern as to whether computer software will treat the Year 2000 as a leap year, which it is. This means that 29th February 2000 may also be a problem date along with 9th September 1999, since some programmers are using "9999" as shorthand to prompt the end of the programme or to represent infinity.

Year 2000 problems will impact every sort of computer system. All types of software are affected, from standard off the shelf PC packages to the most complex in-house main frame systems. Computer hardware will also be affected. Additionally, two digit programming has been adopted in the programmed element of embedded computer components which are found in all sorts of appliances including telephones, fax machines, photocopiers, as well as heating, lighting and security systems. Any of these components could be non-compliant.

How will the Year 2000 problem affect financial institutions

Financial institutions are heavily dependent on computer systems in all aspects of their business, including the recording, effecting and settling of transactions, storing customer information, transmitting information within and to markets and in monitoring their own risk exposure. They are also reliant on such systems in controlling security systems and access to premises.

A high level of interdependency exists amongst financial institutions, who deal in exchange information with other firms with whom they have a counterparty relationship. Even if their own system to the Year 2000 is compliant, a financial institution will be at risk from any such other institution whose systems are not Year 2000 compliant.

Financial institutions are also dependent on external organisations, such as exchanges, clearing systems and information providers, all of whom make up the infrastructure that supports financial markets.

Financial institutions are also heavily reliant on the general infrastructure including, in particular, the power and telecommunications industries. Any Year 2000 problems causing a disruption to the services provided by these entities could have a dramatic impact on financial institutions.

The customers of financial institutions (including deposit holders, investors and policy holders) are themselves at risk through discontinuity, disruption of banking services and potential loss of access to cash, delayed settlement of bargains, inaccurate calculations of amounts due (including interest) and a failure to maintain accurate records. Customers may seek to recover any loss suffered from the financial institution at fault and from its Directors and Officers.

Last but by no means least, financial institutions face a potentially huge credit exposure in respect of corporate lending. The risk of corporate failures due to Year 2000 non-compliance will have a direct effect on the solvency of financial institutions.

Timing

The potential impact of what is essentially a date recognition problem is not limited to the change of date from 31st December 1999 to 1st January 2000. Affected systems may begin to operate in an inappropriate manner as soon as they are required to process affected dates, for example in financial projections utilising dates beyond 31.12.1999.

We have already seen examples of losses arising out of system malfunctions in processes relating to date sensitive information, such as the miscalculation of a leap year in 1996, causing the breakdown of an aluminium smelting process in New Zealand causing US$1 million of damage and the destruction of drugs in Europe by a manufacturer where a computer system believed the drugs to be out of date, the computers having interpreted the Year 2000 as 1900.

Level of Year 2000 compliance amongst Financial Institutions

United Kingdom

The industry has been quick to identify the problem and extensive co-operation amongst industry participants has now become the norm. The Bank of England, concerned to maintain the stability of the financial system as a whole and ensure the efficiency and effectiveness of the UK's financial services, has taken an active role in setting guidelines, encouraging testing and in monitoring and publishing progress towards compliance. It has focused in particular on the Compliance Programmes of the payment and settlement systems, the markets and on other infrastructure providers used by the financial sector.

The Financial Services Authority has focused its attention on the preparations of individual regulated firms and markets. Financial institutions will no doubt be well aware that Year 2000 related failures may result in breaches of the FSA Statements of Principle and the applicable Conduct of Business Rules. For example, failure of a computer system to record or process information accurately may result in breaches of the principles dealing with duties to act with due skill, care and diligence to supply information to customers and to organise and control one's internal affairs properly. Year 2000 problems may likewise cause breaches of Conduct Business Rules relating to fitness and properness, record keeping and notifications. The "incentive" to take the necessary steps to ensure compliance are the various regulatory sanctions available to the FSA, including the right to order a review of any firm which cannot satisfy the regulator that they are taking adequate steps and to force the firm to pay for that review and any remedial action which may be necessary. Disciplinary action may be taken against firms that get into difficulty if they cannot demonstrate that they took reasonable steps to deal with the Year 2000 problem. Financial Institutions will be concerned to do all they can to maintain their regulated status.

In order to provide an across the board snap shot of progress amongst related firms, the FSA required those firms categorised as high and medium impact (determined according to an assessment of the potential impact on retail customers, market integrity and stability of the financial system if the firm were to experience the Year 2000 problems) to complete a questionnaire stating the progress they had made on specific aspects of the Year 2000 problem as at 31st December 1998 and their expectations of when in 1999 they would complete the different parts of their programme. It is perhaps interesting to note that of the 8000 firms regulated by the FSA, approximately half are in the "no impact category". Of the remainder, the FSA's focus is on approximately 160 high impact and 350 medium impact groups. Of the high impact groups, 58% were on track, but 35% were behind and 8% were at serious risk of material disruption. Of the medium impact groups about 40% were on track, 45% behind and 15% at serious risk.

International perspective

A number of international initiatives have been put in place under the auspices of the Joint Year 2000 Council (sponsored by the Basle Committee on Banking Supervision, the Committee on Payment and Settlement Systems, the International Organisation of Securities Commissions and the International Association of Insurance Supervisors), Global 2000 (which consists of the various members of the Global Financial Community having joined forces to address the Year 2000 problem - participants in the group includes over 240 institutions and associations representing 53 markets globally) and Custody 2000 which is a securities industry working group established in January 1999.

The Year 2000 problem is quite clearly an international problem and responses will vary from country to country. It would appear that Canada, Australia and the UK are leading other countries in coping with the Millennium problem. However, a survey conducted by "The Banker" magazine concerning the Year 2000 positioning of the world's top 1000 banks indicated that of the 445 banks that responded, 86.74% claimed their business critical systems would be fully compliant by the end of June 1999. 99.2% claimed that their business critical systems would be fully compliant by the end of December 1999. There have been some concerns as to how the Japanese banks are coping with the Year 2000 problem and Western banks have urged the Japanese Government to slow financial market reforms this year to give banks more time to prepare. "The Banker's" survey revealed that 74 of the 118 Japanese Banks listed in the top 1000 responded to the questionnaire - of which 89.2% claim to be fully compliant by the end of June 1999. An important point to note is, however, that even if Banks are fully compliant by the end of this year, no one is entirely sure what will happen and even the most prepared banks cannot possibly cover all unforeseen events. As a result, a large emphasis has been placed on contingency plans to mitigate the risks.

Classes of financial institutions insurance potentially triggered by the Year 2000 losses

Potential exposure may arise for Insurers and indeed their Reinsurers from the Year 2000 claims arising from direct financial institutions insurance including Directors and Officers, Professional Indemnity and Bankers Blanket Bonds ("BBB")/Fidelity covers. Each of these is dealt with below.

Directors and Officers Liability

A survey was conducted by Cameron McKenna in March 1999 of 100 financial services organisations including (amongst others) high street and investment banks regarding their preparations for Year 2000. It is interesting to note that 84% of organisations surveyed had given one person overall responsibility for dealing with the Year 2000 problem. Of those people who had been given responsibility for dealing with the Year 2000 problem, 32% were senior executive officers, 34% were company directors and 7% were company secretaries. The potential claim for claims being made under Directors and Officers Liability should not therefore be ignored.

A typical insuring clause to be found in a London market Directors and Officers Liability insurance policy will provide cover for a "Wrongful Act". A "Wrongful Act" will be defined within the policy wording, and will often include wording such as "breach of duty, neglect, error or omission", encompassing both breach of contract and negligence. If a company suffers financial loss caused by a failure of its own computer systems resulting from the Year 2000 problem, Directors may face liability for breach of fiduciary duty (i.e. failure to act bona fide in the best interests of the company - which has traditionally meant in the best interests of the shareholders of a company) and for breach of duty to exercise reasonable care and such skill as "may reasonably be expected from a person of his knowledge and experience" (City Equitable Fire Assurance Limited (1925) CH 407) arising out of his mis-management of Year 2000 compliance programme.

A number of points arise. First, in any action for mis-management of Year 2000 Compliance Programmes, it is unlikely that a Director could claim that he did not have the requisite level of knowledge of the problem to justify liability. The saturation level press coverage given to this issue, together with the fact that 73% of respondents to the Cameron McKenna Year 2000 survey confirmed that the issue appeared as a minuted Agenda item at Board Meetings supports this assertion. Second, under the rule in Foss -v- Harbottle, the proper plaintiff in an action in respect of a wrong alleged to be done to the company is the company itself. As the company can only act through its Board, it may decide not to sue the Director responsible, and it is therefore likely that claims on D&O policies will emanate from derivative actions brought by shareholders falling within one of the exceptions to the rule (possibly on the grounds of infringement of personal rights where it can be shown that the director breached his fiduciary duties). The loss in each case is likely to be the fall in the Company's share price following Year 2000 failures.

In the event that a claim on a D&O policy is received, Insurers will need to examine closely the exclusion clauses available to them within the policy wording. Reference should be made in particular to any "Closely held clause" whereby Underwriters are entitled to refuse to indemnify loss arising from a claim made by or on behalf of an entity holding more than 15% of the issued share capital of the company - whether the claim is made in the name of the company or not. The "insured -v- insured" exclusion may enable underwriters to refuse a claim made against the Directors' by or on behalf of the company. Further, particular attention will need to be given as to whether the claim could be refused where it is brought about by any circumstances existing prior to the inception date of the policy which the Director and Officer of the company knew or ought reasonably to have known could give rise to a claim. IT managers have certainly known about the Year 2000 problem as far back as the mid-1970's. The date of knowledge attributed to Directors is likely to be much later. This exclusion may provide assistance where a director was aware that the Year 2000 programme was substantially behind schedule and arguments of non-disclosure may arise.

One particular area of concern where claims may arise under D&O Policies is in relation to any regulatory enquiries that may be initiated into a financial institution's failure to be Year 2000 compliant. It is now common for D&O Policies to include coverage for what are commonly described as "Special Proceedings", which are defined as any investigation or enquiry into the business of the Institution by any body legally empowered by regulation to look into its affairs. This would include not only Government inspections but also inspections by regulators and possibly trade associations and trade bodies. The exposure relates principally to the cost of Directors and Officers being represented at such a hearing and these can be very extensive, with the hearings going on for a long time.

Professional Indemnity Insurance

Such policies customarily provide cover for breach of professional duty arising from neglect, error or omission by the Insured. The words "neglect, error or omission" were examined in the case of Wimpey -v- Poole (1984) in which it was found that those words encompassed negligence but additionally some omissions and errors occurring in the absence of negligence, in particular breach of contract.

The nature of claims likely to be seen under professional indemnity covers concern negligent advice relating to Year 2000 issues. Unless there is an effective disclaimer, a lender may be liable under the case of Hedley Byrne -v- Heller [1964] A.C. 465 for any negligent advice it gives the borrower as there will be an implied (or even express) assumption of responsibility on the giving of such advice (such that it would be foreseeable that if the advice was negligently given, it would be likely to cause damage and there would be sufficient proximity between the Bank and the lender as reliance would be intended). For example, a merchant bank might advise its client as to the merits of an investment in a company or the commercial merits of a proposed transaction. If, due to Year 2000 failure on the part of the investee company, the customer suffers loss, he may seek to recover such loss in an action against his advisers for negligent advice. A professional indemnity insurer should have reference to the exclusion clauses made within the wording. As this type of policy is intended to respond to negligent advice claims however, it is likely that Year 2000 "advice" claims will be covered.

Bankers Blanket Bonds ("BBB")

The very description of this type of first party loss cover is likely to mean that commercial entities suffering at the hands of Year 2000 failure will look to it to recover any pecuniary loss suffered. Of the various insuring clauses incorporated in these types of policies, the text below focuses on two which may be particularly exposed to Year 2000 claims. The first concerns cover provided in respect of infidelity of employees.

Such clauses often provide cover for loss caused "by reason of and solely and directly caused by one or more dishonest or fraudulent acts of any of the employees of the insured, which are committed with the manifest intent of making and which result in improper personal financial gain for themselves wherever committed and whether committed alone or in collusion with others ....". One can foresee a situation in which an employee takes advantage of a system malfunction arising from the Year 2000 problem to effect a withdrawal or transfer of funds for his own benefit or by tampering with loan calculations for the benefit of a customer/borrower in return for a bribe, both of which cause loss to the Bank. Although the clause requires the loss to be "solely and directly caused" by the dishonesty of the employee, the mere fact that the Year 2000 disruption "facilitated" that dishonesty would be unlikely to prevent a claim being made. It is the dishonesty of the employee that triggers this clause.

The second insuring clause of interest concerns loss of property from the premises of the bank and will commonly provide cover for loss sustained by reason of "property being lost through theft, larceny, burglary, robbery, false pretences, a hold up ... or being damaged, destroyed or misplaced, howsoever or by whomsoever caused, while such property is in or upon any premises of the Assured or of any other bank, wherever situated". One can envisage a robbery type claim being submitted under this insuring clause in relation to monies taken from a Bank safe following failure of the access/security systems containing embedded chips. It should be noted that BBB policies often exclude "any loss resulting wholly or partially from any act or default of any Director or Directors of the Assured whether or not an employee". If an argument could be established that the Year 2000 failure resulted wholly or partially from the mismanagement by the Directors of the Year 2000 Compliance Programme, liability might be avoided.

Additionally, the Year 2000 problem may cause damage to a Bank's computer equipment (hard, tangible property) as well as its software packages, including corruption of data and loss of computer files/records (soft, intangible property). Might the "Premises" insuring clause respond to such damage? As has already been mentioned, cover is provided in respect of "Property...being damaged, destroyed or misplaced, howsoever or by whomsoever caused,...". "Property" is invariably a defined term and commonly includes "cash (i.e. currency, coins and Bank Notes), bullion, precious metals of all kinds..certificates of title and all other negotiable and non negotiable instruments or contracts representing money or other property ...or interests therein, and other valuable papers, including books of accounts and other records used by the assured in the conduct of their business". Applying the Ejusdem Generis rule of construction, it is likely that "other records" (which is the closest we come to computer records) will be construed to mean tangible papers rather than computer records. It is therefore unlikely the damage described above will be covered and we need not consider whether the Year 2000 damage would be "damage" covered by the policy. By way of information however, if damage is not defined, case law provides some assistance. In Hunter -v- LDDC (1996) 2 WLR 348, damage to property was at common law held to mean physical change to tangible property which renders it less useful or less valuable. In the case of Regina -v- Whiteley [1993] FSR/L168, the Court treated damage to software as damage to the disk on which the software was written. In practice, this form of damage may be covered by another type of property policy procured by the Bank.

Computer Crime

Banks and Financial Institutions have historically always purchased computer crime insurance and it is not necessarily the case that these particular policies will be any more exposed by potential Year 2000 problems. One can imagine that claims might arise under such policies if a Year 2000 failure allows a Third Party dishonestly to access a Bank's computer system to steal money. Equally somebody may dishonestly try to infect the Bank's computer system with a Year 2000 virus to gain access to the system to transfer funds but one would expect that by now most sophisticated Banks will be fully protected against this risk with their own internal systems.

The Year 2000 claims concerning financial institutions; insurance issues.

Fortuity

Are Year 2000 losses in fact insurable events? The broad rule is that insurance responds to risks and not certainties. In view of the fact that the nature of the Year 2000 problem, if not the degree, was and is foreseeable and has been known about (at least by certain IT professionals) for some years, raises the question as to whether losses resulting from such problems are losses to which insurance contracts should respond at all - these being foreseeable and potentially preventable.

In relation to first party losses potentially covered under BBB's, it is within the power of the financial institution to prevent the impact of the Year 2000 or to minimise that impact by replacing or altering non-compliant systems. In practical terms, however, it will be impossible to eradicate the risk of first party Year 2000 losses completely. Even where systems are Year 2000 compliant, it is still not certain how they will react to the date change. Further, even if the financial institution is itself Year 2000 compliant, given its dependency on other entities which may not be compliant, the potential for disruption and loss remains. In such instances, there may be good arguments for saying that any loss was fortuitous.

In Prudential Insurance -v- Inland Revenue Commissioners [1904] 2KB 658 it was said that "there must be either uncertainty that the event will happen or not or, if the event is one which must happen at some time, there must be uncertainty as to the time at which it will happen".

The inevitable result of the use of non-compliant computer systems is disruption of some sort. The timing of the disruption and its consequences will not however be so predictable. This may save claims which might otherwise fail for lack of fortuity.

In relation to the third party claims, where Year 2000 problems give rise to a claim against the Director or Officer or the Financial Institution itself for negligent advice, for example, (rather than a first party loss), it may be easier for an argument to be raised that the ramifications of giving the advice, and in particular the decision of the third party to claim, were entirely unforeseeable and the loss fortuitous. The question of uncertainty will be judged from the perspective of what the Insured knew or should have known (Soya -v- White GmbH (CA) 1982 1 LLR 122).

Although the consideration of the underlying facts will be required in each case, it seems likely that claims under professional liability policies, and particularly third party claims, will have the necessary element of fortuity by virtue of the fact that it cannot be said the claim is bound to arise, and that it is bound to arise at a particular time.

Year 2000 and Trigger of Cover

How and when insurance policies are triggered by Year 2000 claims will effect the year of coverage (and thus the Insurers and Reinsurers at risk), aggregation and the effectiveness of any Year 2000 exclusions.

In certain first party loss policies (such as BBB's), the operative date may be the date of discovery of loss. This raises significant issues in terms of Year 2000 losses. Given the potential scale of technological disruption following a Year 2000 failure, the dishonesty of an employee may not be discovered for some time so that when a claim is eventually made, it is under a subsequent policy which contains a Year 2000 exclusion clause.

An interesting Year 2000 issue arises out of policies written on an "events occurring basis". The time of the "event" is decisive, rather than when the losses arising out of it occurs, as was illustrated in the case of Kelly -v- Norwich Union [1989] 2 ALL ER 888. This case concerned an insurance policy providing cover against loss or damage to buildings from, inter alia, burst water mains and provided that Norwich Union would indemnify Kelly in respect of "events occurring during the period of the insurance". The water mains supplying the house burst prior to the commencement of the policy. Leakage from the burst main however caused the damage to the house during the policy period. The Court of Appeal upheld Norwich Union's denial of liability on the basis that the word "event" did not refer to the damage but rather the peril that gave rise to it.

This could have important ramifications in relation to the Year 2000 issues where it could be argued that the relevant insurance contract to respond is that in place at the date of installation of the defective software or component or hardware, rather than the date of any resulting damage - this being the relevant "event".

Blanket Notifications

It is common to find in professional indemnity policies and D&O policies clauses providing for notification of circumstances, coupled with a "deeming" provision which provides that where a notification of circumstances is made in accordance with the notice provisions under the policy, any subsequent claim arising in relation to that notification will be covered by the policy for the year in which the notification of circumstance is made.

Obviously, if the policy current when the claim is made contains a Year 2000 exclusion, whereas the policy current when the notification of a circumstance was made does not, the issue of which policy year properly responds to the claim will be extremely important. To avoid the application of exclusions, Insureds may attempt to provide notification by way of "laundry lists" of potential claims in order to take advantage of the more generous cover provided by the earlier policy. Given the potential proliferation of Year 2000 claims, Underwriters will need to be clear as to what constitutes a valid notification under their policy.

This will be dependant to a large extent on the facts of any given case. That said, it is clear that a notification of claims in relation to every matter ever handled by the insured not constitute valid notification (Home Insurance Company -v- Cooper and Cooper (1989 - F 2nd 146). In Hamptons Residential Limited -v- Field & Others (CA) 22nd May 1998, the Court of Appeal found that whilst only one potential claimant had been referred to in a notification concerning a dishonest employee the notification was broad enough to encompass a subsequent claim by another claimant. In the more recent case of Rothschild -v- Collyear [1998] AllER 431, Rix J considered the wording of a notification clause contained in a professional indemnity policy requiring notification of "circumstances which may give rise to a claim". The notification concerned potential exposure regarding pension mis-selling. It was held that the notification was valid. The test of materiality for notice was only of circumstances which "may" give rise to a claim not which were "likely to". In Layher v Lowe 1997 58 Con LR 42 the Court of Appeal held that "likely" meant at least 50% chance of a claim. The message is clearly that what constitutes valid notification will be determined by the policy provisions applicable in each case.

Means of minimising Year 2000 exposure

Warranties

Insurers may choose to include warranties within the policy/slip relating to the original Insured's Year 2000 compliance i.e. incorporated into the policy from the proposal form.

Breach of such a warranty discharges the insurer from all liabilities under the contract from the date of the breach and where a breach occurs, it is not necessary for the insurer to demonstrate that the warranty was material to the risk or indeed to the loss.

Accordingly, where an insurer has required a financial institution to complete a questionnaire seeking information relating to the state of their Year 2000 readiness and that information is given the status of a warranty, if untrue at the time given, the insurer will be discharged from liability.

Such warranties have perhaps limited value on the basis that many Insured's simply may not be willing or able to warrant their systems are Year 2000 compliant. Furthermore, after a recent decision in England (Economides -v- Commercial Union [1998] QB 587), warranties are more liberally construed in favour of the Insured if the answers are given only to the best of his "knowledge and belief". In this case, so long as the answer given to the question posed was given honestly, albeit it subsequently turns out to be wrong, then the Court will not allow the Insurers to seek termination of the contract for breach of warranty. The test of "honesty" in this case is both subjective and objective.

Questionnaires

The use of questionnaires has been taken up by those Insurers wishing to attempt to quantify their potential exposure to Year 2000 claims. Questionnaires enable an insurer to selectively underwrite only financial institutions demonstrating satisfactory Year 2000 Compliance programmes, should they choose to do so. The content of the questionnaire may also assist in the decision as to whether to underwrite the risk subject to the inclusion of a blanket exclusion clause (see 8.3 below). Clearly, the more detailed the questions asked, the more useful the information will be. Insurers should be aware however that if they choose to produce questionnaires containing a list of questions but it omits certain issues, they could be said to be waiving production of that information, precluding them from taking any action on the basis of non-disclosure in the future.

Year 2000 Exclusion Clauses

The use of these clauses may be unattractive in the soft market that exists today. It may be the only way of containing Year 2000 exposure where Insurers are not satisfied that the underlying business insured is adequately Year 2000 compliant but they do nevertheless wish to continue to provide cover to their Insured.

The Year 2000 exclusion clause will need to be clear and unambiguous and apply to all direct and indirect losses arising not only from the date change from 31st December 1999 to 1st January 2000 but also out of the fact that Year 2000 is a leap year and in relation to other potentially troublesome dates. Reference should be made to a recommended industry/market wordings [See NMA 2807].

The scope of exclusion clauses is likely to be the subject of much litigation in order to determine the extent of cover. The contra preferentum rule will dictate that such clauses will be construed against the drafter, and it is vital, therefore, for Insurers to use very clear and unambiguous wording.

Year 2000 sub-limits

Where Insurers do not wish to impose blanket exclusions and are prepared to provide some, albeit limited, Year 2000 cover, limits may be employed to restrict indemnity for Year 2000 losses at a significantly lower level than the limit of indemnity otherwise applicable. This clause clearly relies on identification of year 2000 losses at the claims processing stage (see below).

Recognition of the Year 2000 claims; causation issues

In some cases, claims may be readily identifiable as Year 2000 claims and excludable where a Year 2000 exclusion is in force. In other situations, the nature of the claim will be less clear.

Where there is more than one proximate cause of a loss leading to the claim and only one of the causes is covered under the policy, but none is excluded, the claim will be covered (Capel Cure Myers Capital Management Co Limited -v- Richard Justin McCarthy & Others 1995 LRLR 498). However where one of the causes is expressly excluded, the claim may be excluded in its entirety (Wayne Tank & Pump Co. Limited -v- Employers Liability Assurance Corp. Limited (CA) 1974 QB 57).

Arbitration/Mediation

Where a dispute arises between an insurer and an assured in relation to policy coverage issues (or between an Insured and a third party in relation to the underlying issue) involving Year 2000 issues, arbitration and other forms of alternative dispute resolution including mediation can be preferable to litigation. This, of course, is only relevant where the parties to a dispute are willing to agree an alternative to the litigation or where contractual provision is made e.g. the incorporation of Arbitration Clauses. Dealing with disputes in this way will enable the parties to appoint an arbitrator or mediator with the requisite technical expertise, to avoid the potential glut of Year 2000 related litigation in the Courts, to save costs and perhaps most importantly avoid the setting of precedents in relation to Year 2000 issues.

Reinsurance Issues

An insurer of financial institutions faced with a number of Year 2000 losses may wish to aggregate these losses for the purpose of presenting a claim to its Reinsurers. The ability of the reinsured to aggregate will depend on the nature of the reinsuring clause. If "event" based wording is employed for the purpose of aggregation, it is unlikely, following the House of Lords Judgment in Axa Reinsurance (UK) Plc -v- Field [1996] 2 Lloyd's Reports 233, that the Year 2000 problem (in the context of negligent advice claims or mismanagement by Directors of Year 2000 Compliance Programmes) will constitute an event entitling an insurer to aggregate. Lord Mustill stated that "in ordinary speech, an event is something which happens at a particular time, at a particular place, in a particular way". It may however be an "originating cause" in relation to which Lord Mustill said:

• " it can be a continuing state of affairs ... the word originating was in my view consciously chosen to open up the widest search for a unifying factor in the history of losses which it is sought to aggregate".

Other issues which will arise when Insurers propose to make a claim on their reinsurance concern conflicting aggregation provisions, follow the settlements and the ability to recover non indemnity payments i.e. Defence costs where the policy is silent. These issues are beyond the scope of this paper but are likely to be very important once the underlying claims have been identified.

Conclusion

It is clear that the major European Financial Institutions have undergone rigorous testing to seek out any possible risks associated with the Year 2000 problem and all will have significant contingency plans in place to deal with it as and when it arises. It would however be fool hardy for anybody to say that there is no risk to the Insurers of those financial institutions for reasons considered above. The extent of exposure will differ from country to country and institution to institution. Possibly the largest exposure will be the credit risk to a Bank, should its customers run into financial difficulties caused by Year 2000 problems, and there are subsequent business failures.

Mark Elborne
Karen Brymer
May 1999

Mark Elborne is a Partner and Karen Brymer is an assistant solicitor in the Insurance and Reinsurance Group at Cameron McKenna, specialising in claims involving banks and other financial institutions.