Are Y2K costs covered?

What responsibility, if any, do insurers have to cover the costs that businesses have incurred to "fix" the Y2K computer bug? Several companies -- about a half-dozen at this point -- say insurers ought to pay for at least some of the costs. In general, they're turning to what's known as the "sue-and-labor clause" in making their case. Among the group are GTE Corp., Irving, Tex.; Xerox Corp., Stamford, Conn.; and Unisys Corp., Blue Bell, Pa. The sue-and-labor clause has its roots in the maritime industry, says Dan Zielinski, spokesperson with the American Insurance Assn., Washington. An example of how it might be used: A ship at sea develops a crack in its hull. To prevent the crack from growing and possibly sinking the ship, someone on board patches it. The cost of the repair would be covered under the sue-and-labor clause, which recognizes that this small expense should prevent a much larger disaster. The Y2K suits involve an interpretation of the insurance contracts and a decision as to whether the sue-and-labor clause is relevant. The courts will have to determine whether the policies, which presumably don't specifically address Y2K (none of the companies would comment on the cases), should include -- or exclude -- the costs associated with preventing it. "What's the intent? That's what will be argued," says Lance Ewing, chair of the external-affairs division of the Risk & Insurance Management Society, New York. Ewing also is director of insurance and loss prevention with Las Vegas-based GES Exposition Services, a producer of trade shows. The sue-and-labor clause directly applies with Y2K, say several of the attorneys whose firms are involved in the cases. "Why would major industrial and retail companies have sue-and-labor clauses if they're not meant to do something?" asks Robert L. Carter, a Washington-based partner with McKenna & Cuneo LLP, which is representing Unisys. "The companies have [a responsibility] to mitigate damages. If they fail to do that and a loss occurs, coverage can be denied." In addition, says Carter, insurance contracts routinely provide coverage for risks that are not specifically excluded. It was only about a year ago that exclusions specific to Y2K began appearing in property-insurance policies, although such clauses were in place in liability policies beginning in 1996. "So, the insurance industry knows how to put in exclusions when they want to," says Carter. The insurance companies, not surprisingly, have a different take. They point out that computers were designed to be date-sensitive, and thus what companies are dealing with is planned obsolescence. Upgrading a company's computers to correct for this is general maintenance, not an insurable risk, says Zielinski. The insurers have a strong case, say analysts and academicians. Because the Y2K computer bug wasn't known when the policies likely were written, the premium levels don't reflect the risk. "The companies had to make some back-of-the-envelope calculations as to the array of risks they were buying coverage for," says Clifford W. Smith Jr., professor of finance at the University of Rochester's William F. Simon Graduate School of Business. If Y2K problems are thrown in after the fact, the deal becomes unfairly sweeter for the companies. Although many risk managers are watching the cases, a rush to the courts isn't likely. One reason: Only very large companies generally use the sue-and-labor clause. Even companies that have the clause may decide not to sue, fearing it will hurt their ability to find affordable coverage in the future. The cases currently are making their way through the legal system, making it too early to place bets on the outcomes. "Ultimately, the contracts mean what the judge says they mean," says Smith.