JULY - AUGUST THE COMPUTER LAW AND SECURITY REPORT

connection; the charges for connections; call charges; the provision of an international point of connection; international services; numbering and routing and billing arrangements. All of these elements have an impact on both competition and customer benefit. The two levels of connection are "3L", the connection of a BT exchange line to the Mercury system, and "3J", the connection of the two systems at a BT trunk exchange. Using these two types of connections as and when they become available, customers will be able specifically to choose to route calls over the Mercury system either directly, using Mercury service lines, or indirectly, using the BT system to reach the point of connection where the customers' messages pass into the Mercury system. At the same time Mercury may utilise the points of connection to transfer messages onto the BT system for final delivery where, as yet, Mercury is unable to serve the called party at the distant end. These levels of interconnection are made available through points of connection which are to be provided in accordance with strict time limits. The initial connections had to be made by 30th March 1986. Additional capacity at these connections and different connections at other exchanges can also be requested by Mercury and such connections must be provided within six months of Mercury's notification. Where there are difficulties in meeting these time limits, there is a procedure for a Committee to consider and determine what is a reasonable period in all the circumstances. I shall discuss this shortly. Connection charges, the actual cost Mercury has to pay for physical connection of its system to BT at various points, are based on direct costs and the "consequential incremental" costs of providing capacity at the particular exchange concerned. This cost-based approach, which is required by BT's licence condition 13, is also reflected in the Determination on call charges. These charges appear to be designed to be an incentive for Mercury to extend its system as rapidly as possible and rely as much as possible on its own facilities. One table of charges for example, applies a particular range where only one "segment" of BT's system is utilised whereas another table applies where more than one segment is used. Clearly, the margins for Mercury and its competitiveness vis a vis BT will be greatly influenced by this charging approach and Mercury will be endeavouring, wherever it can, to rely upon not more than one segment of the BT system. These interconnection call charges are geared both to minutes

of call time in the normal way and to the same cheap, standard and peak rates as BT operates for the generality of its customers. Protection is provided for Mercury against BT changing its tariff structure by altering its distance-related rates or time bands in which event the Mercury tariffs under the Determination are also to be adjusted; in such a case if BT and Mercury cannot agree upon this, the Director-General can determine the matter for them With regard to numbering and routing, the background here is the BT and Mercury licence condition on numbering. The Determination provides that BT should make available to Mercury a suitable access code and number groups to facilitate interconnection. BT must make the necessary adjustments within its system to cater for the numbers thus used. This part of the Determination is vital to Mercury in giving it the basis to allocate numbers which will promote freedom of choice. Indeed BT's licence condition shows that the objective is to achieve numbering plans which for example, include as few digits as practicable and do not confer any undue advantage or disadvantage on either party. If the Director-General believes that these objectives are not being achieved, and in particular that numbering plans are not compatible, he can ultimately make a determination to remedy these problems. Prior to April 1990, PTO's are required by their licences to consult Oftel - the Office of Telecommunications about their numbering plans and they must also consult a body approved by the Director-General which is to represent both PTOs and other interested parties. Apparently this representative body is to be set up shortly and it seems likely to be the case that the fall-back of the Director-General's determination on this aspect will become more and more academic as numbering arrangements necessarily have to be worked out in a manner which is ultimately for the benefit of the customer. Finally on the particular aspects of the Determination, the billing arrangements are such that essentially the operator chosen by the calling customer to carry a call will be the party to render a bill to the customer. Where customer choice is not involved and the case is, for example, simply one of a Mercury customer calling a BT customer, it is the originating operator, the operator whose system is first used for the call, who will bill the customer and will therefore be charged for any onward conveyance services provided by the other operator, all at the segment rates set out in the Determination.

Colin Long, Solicitor~ Report Correspondent

RISK MANAGEMENT

PROFESSIONAL INDEMNITY INSURANCE: A NEW NIGHTMARE FOR THE PROFESSIONS At this years annual conference of AIRMIC, the Association of Insurance and Risk Managers in industry and commerce, two major insurance problems were identified: USA product liability and Professional negligence. The common feature of both problems is that insurance cover is only available at such a high cost that many companies' trading viability is seriously affected by the premiums required. Amongst others, accountants, architects and even insurance brokers are having to allocate up to 20% of their fee income to meet premiums, and the cost of funding mandatory excesses within the cover. In this article I shall be looking at the background to the crisis, and at the problems it has produced for insurance buyers and

insurance companies alike. In a future article I will examine the only sure means of long term premium reduction: claims avoidance by risk management.

The background The period beginning in the late 1970's and ending in late 1984/early 1985 was one of the most dramatic, and traumatic, that the insurance industry has ever seen. Attracted by high interest rates on money received as premiums but not paid out as claims until some considerable time later, investment income poured into the insurance industry. Competition for policyholders business increased and throughout the period premium rates fell, insurers offered wider and wider cover to attract business, and scientific underwriting became a thing of the past. One leading insurer had an unofficial directive

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to its underwriters to match any competitive rates in order to hold on to existing business, regardless of how low or suicidal those rates were. In 1984 the results of the ulta soft market became apparent as insurers reported massive underwriting losses and a few insurance companies and Lloyds syndicates were forced to cease or suspend trading. We have now seen the backlash: those underwriters that, 18 months ago, would have accepted almost any risk at any premium are today demanding copious underwriting information, restricted policy wordings and massively increased premiums with almost religious fervour. This scenario is felt particularly acutely with professional indemnity ('errors & omissions') risks. The period between the receipt of premium and claims payment may be an average of six months for a material damage risk. For a professional indemnity policy however the period can be measured in years as it relates to the time lag between the error and the final court settlement. The attraction of all liability risks to cash flow insurers and reinsurers was therefore great. Consequently premiums reduced faster during the soft market and have increased faster during the backlash.

Problem areas: the professions In addition to problems created by the insurance market, there has been a significant increase in the number and size of claims for certain professions, The two mega claims that have received greatest publicity of late come from the accountancy sector, those involving Arthur Young McClelland Moores, facing a claim of £400m from the Bank of England, and Johnson Matthey plc. and Arthur Anderson, facing a £208m writ for alleged negligence and fraud after the De Lorean collapse. Whilst claims have been made against practitioners of the traditional professions for many years, the newer professions are now beginning to receive claims for the first time, a trend assisted by the provisions of the Unfair Contract Terms Act 1977 and a generally increased awareness amongst the public as to the availability of litigation, or threat of litigation, if the product or service does not fulfill expectations. A classic example of this are computer consultants and software houses, who are now the target for claims by their clients because the computer, or the software, or both, does not do what they expected. Because of the comparatively small number of underwriters involved in this area of cover, many companies are finding that there is no longer the market capacity to maintain the high indemnity limits that they have become accustomed to and that even if capacity is available the cost of maintaining those limits has risen beyond their wildest expectations.

The nature of professional indemnity policies I would like to concentrate in this article on the technical aspects of the problem, that is the way in which cover has been affected and some of the problems that have been created by capacity shortfall and a possible need for a change of insurer. However, in order to understand the technical impact of the capacity crisis it is necessary to examine a number of key aspects of a typical professional indemnity policy wording. The object of any professional indemnity policy is to provide an indemnity to the Insured in respect of legal liability for errors and omissions committed during the course of his business. The cover relates to errors and omissions that were committed, and in respect of which a claim is made against the insured, during the period of the policy. The policy period covers any time span during which cover has been maintained

with the same insurer(s). Thus the company taking out a professional indemnity policy for the first time cannot relax from that point onward because if legal action is then made against it in respect of an act or omission committed prior to the policy period it is uninsured. To combat this it has been normal to buy "retro" cover, that is a backdating of cover during the first year for a premium loading the amount of which depends upon the number of years for which backdated cover is purchased. Such a "retro" cover is of course only available if the insured has no knowledge of any possible claim that may be made against them. Similarly, if a policy is cancelled or lapsed there is no cover for claims made against the Insured after that date, even if the error or omission occurred during the period of cover. If the cover is transferred to a new insurer it is normal for the new insurer to provide the extra cover by a "retro" extension. If there is to be no new insurer, for example because the insured cannot obtain a satisfactory quotation, or because the practice is being wound up, it is necessary to buy run off cover from the last insurer so that actions that arise out of acts or omissions that took place prior to the termination of cover will continue to be insured. Again the period of run off is dependent upon the premium that the Insured is willing to pay. Under normal market conditions cover remains with the same insurer for many years and there are few problems encountered because of retro or run off requirements. In the current climate however many companies are forced to change insurer because unacceptable terms have been quoted, or even because the holding insurer has declined to continue with cover, having pulled out of the professional indemnity market altogether. The company most affected under those circumstances is the potential purchaser of run off cover, but even retro cover may be difficult to purchase from a new insurer who is seeking to limit the time span of his liability as much as possible. The second significant aspect of professional indemnity policies is that there is a financial limit which is normally expressed as an aggregate amount, that is the total amount of all claims made against the Insured during any one period of insurance. No one insurance company, or Lloyds syndicate, has the capacity to provide anything other than comparatively modest limits, and cover is therefore purchased by layers up to whatever limit is required. For example, a company seeking a limit of £5,000,000 would purchase an underlying ('primary') cover of perhaps £500,000 from one insurer, followed by layers of perhaps a further £500,000 and four layers of £1,000,000. The higher the cut in point of any particular layer the cheaper the premium as the higher layers are only called upon once the lower layers are exhausted. Naturally all insurers should provide cover on the same policy wording so the insurers writing the layers above the primary (the 'excess insurers') agree to follow the primary wording.

Impact of market changes During the soft insurance market two changes occurred. Firstly there was a redefinition of the indemnity clause, so that the indemnity limit applied to each and every claim rather than to the aggregate of all claims made during the policy year, thus effectively giving the Insured far better cover. Secondly, improved reinsurance meant that individual insurers could write higher indemnity limits. Thus the limit of £5,000,000 could have been provided (with reinsurance assistance) by just one insurer. The hardening market has seen a reversal of this trend with a return to aggregate indemnity limits, and a considerable shrinking of capacity, with the result that more and more

JULY - AUGUST THE COMPUTER LAW AND SECURITY REPORT

insurers have been involved in producing the indemnity limits required. As there are only a limited number of insurers writing this class of business, high indemnity limits may no longer be available, or are only achievable by utilising international and reinsurance markets as well as the UK facilities. The problems of agreeing a common wording, however, can mean that cover is reduced to the lowest common denominator. A wording acceptable to the primary insurer may not be acceptable to one of the excess layer insurers and the cover may have to be restricted throughout the whole indemnity limit to achieve equanimity. Virtually all professional indemnity policies have carried a small degree of self insurance: usually a small excess (deductible in American terminology) which the Insured could elect to increase in return for premium savings. However, whereas in the soft market the mandatory excess could have been £500, insurers are now calling for far higher figures, requiring the Insured to bear a significant proportion of the risk, thus providing a real incentive to improve his professional standards. This co-insurance could take the form of an excess of between £5,000 and £50,000 for small practices; up to ten times those amounts for large companies. Alternatively, it could take the form of a self-insured percentage: usually between 10% and 20% of every claim. It may also be necessary for the Insured to take a higher excess than the minimum imposed by the insurer so as to release capacity for a higher limit at the upper end. Finally, premiums: to renew existing indemnity limits, not necessarily with the same breadth of cover, professional indemnity premiums are more than doubling generally, with increases of up to 1000% for certain professions. Because of the laws of supply and demand there can be significantly greater overall premium increases for high indemnity limits. Companies that bought high limits when they were cheap are having to rethink, and return to the lower limits of earlier years.

Conclusion The manufacturers' equivalent of professional indemnity insurance, product guarantee cover, has been only spasmodically available for many years, partly because whenever an insurance company tries to underwrite the risk it loses money, and partly because it is felt by some that insurance against the quasi-commercial risk of not fulfilling your salesman's promises or your customer's expectations is not a risk for which insurance cover should be available. If the current trend in the professional indemnity market continues there may be some professions that have the same problem with their professional indemnity covers. But having professional indemnity insurance is a requirement of many professional bodies, or imposed as a requirement on the part of some companies. At the end of the day the only solution is to reverse the upward trend in claims. Whilst part of the problem, the advance in consumerism, is outside the Insured's control, there is still much that can be done. Higher standards - quality control for the professions ARE achievable. I will return to this subject in a future article.

David Davies

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C O M P U T E R I N S U R A N C E : P A R T III - C O N S E Q U E N T I A L L O S S

In the eyes of most of the insurance industry the computer is just a valuable asset. Examine a typical computer policy and you will find that a large proportion of the cover concerns

the repair or replacement costs of the computer itself. Other aspects of cover (of which more later) are almost thrown in as nominal extensions. To achieve a more realistic view of the consequential loss risk it is necessary to take a different view: to think not of the computer but of the computing function, and of the risk of interruption to that function. The computing function is not dependent upon the hardware alone: it's component parts are:

• The computer hardware

• The building in which the computer is located

• The environment (air conditioning, temperature and humidity regulation)

• Electricity

• The network of telecommunications lines and modems between the computer and it's terminals

• The software that is needed to run the critical systems

• The data that is accessed by the computer for its critical functions

• The operators, programmers and other key computer personnel

Destruction or corruption of any of the elements listed above could result in interruption to the computing function. The consequences of that interruption will vary from inconvenience to massive profit loss, possibly leading to insolvency. With this in mind I will examine the ways in which companies insure their computer consequential loss risk.

Specified events The first critical aspect of any insurance policy is the specified events, or perils, that will trigger the cover. The second critical aspect is often overlooked: that the policy also specifies, and will only respond to, certain defined consequences. Thus a fire policy does not cover all the consequences of fire, but only the cost of repairing or replacing the damaged property. There is no cover for the secondary consequences, the results of that damage or destruction: for example, the lost production, and thus lost profit, that may follow the destruction of production machinery. This cover is provided by a second policy, usually referred to as loss of profits, or consequential loss. Most companies have a consequential loss policy covering all of their business activities. The specified perils are usually those that are traditionally thought of as being capable of causing massive disruption - fire, lightning, aircraft and explosion. (Usually known as the catastrophe perils). More perils than this are usually insured against for loss or damage policies. The theory is that a non-catastrophe peril may produce significant repair or replacement costs but it could not be serious enough to affect the companies ongoing business activities. The secondary consequences covered are usually confined to lost profit, or revenue, incurred during a specified indemnity period. This period, usually between 12 and 24 months, must be sufficient not only for the replacement of the damaged property, but also for the time required for total recovery: to catch up on the backlog, regain lost customers, etc. The Insured is allowed, indeed required, to incur extra costs to minimise his profit loss, for example by hiring temporary premises, provided the amount spent is less than the amount saved within the indemnity period. To paraphrase Mr. Micawber, "Annual costs incurred £999, annual profit saved £1000, result happiness. Annual costs incurred £1001, annual profit saved £1000, result misery." I will discuss this "economic limit" further later on.

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