Saturday morning. January 1, 2000.

Imagine you are the owner of a small- to medium-sized manufacturing firm. You take a ride over to the plant just to "check things out." At the front entrance the security keypad doesn't seem to recognize the usual access code so you walk to the side loading dock and use your key to enter the building.

The furnace, part of a computerized air handling system, has unexpectedly shut down. Your building is almost as cold inside as outside. All of the elevator doors are open in the first floor lobby. None are responsive. Walking through the plant you go from one computer terminal to the next noticing that some seem to have locked up.

A few hours later, after summoning your administrative and manufacturing supervisors, you're informed that your company's electronically stored account receivables, payables and contract records are gone. The computer-controlled manufacturing process is turning out rejects, and processing machines are frozen in a stop mode.

In short, the contracts your company depends on cannot possibly be fulfilled, and there is a good possibility that you will end up being sued for failure to perform and willful negligence. To make matters worse, you call your insurance broker to find that policy language from your carrier puts all Y2K direct losses outside coverage that you thought you had.

Do you hire a lawyer to fight the insurance companies in court over a very uncertain outcome and years of delay? You don't have years. And then it hits you - a desperate thought in the midst of a desperate situation.

Set a fire in the trash or storage room? You wouldn't have to destroy the place - just create enough smoke and water damage from sprinklers and the fire department to ruin the old equipment. Or maybe you can stage a "burglary" and trash what's already broken? What about manually shutting off the furnace over the long weekend and letting the sprinkler system freeze before turning the heat back on? Desperate measures? Maybe. But your business is at stake.

While insurers may be shoring up policy language in anticipation of Y2k-related claims - founded or unfounded - they may not be prepared for an increase in the incidence of fraud related to the Year 2000 problems. True, a large scale failure like the one described may not accurately describe most insureds. But it's likely that some insureds looking for ways to avoid years of litigation with uncertain outcomes and costly legal expenses may turn to fraud. Carriers should be aware of this situation and do the kind of planning necessary to avoid getting caught short.

Are You Prepared?
Despite the complexity and technical nature of the problem, there are a number of ways carriers can prepare themselves for dealing with possible fraudulent claims.

q Require each insured to certify that all mission critical systems, including process control devices containing embedded logic, are Y2K compliant.

q Assemble specialized Y2K fraud teams staffed by skilled claims handlers, underwriters and Special Investigative Unit investigators who will screen suspicious losses where computers or process systems are the apparent target. Focus on fire, vandalism or water losses occurring in small- to medium sized- firms that are heavily computerized or automated. These teams should have skilled software engineers available to diagnose and/or test computer controlled equipment and process control devices containing embedded logic.

q Obtain financial reports for companies suspected of making fraudulent claims. SEC guidelines require most public companies to disclose Y2K readiness plans in the MD&A sections of their annual and quarterly reports. Obtaining prior financials in these cases may help establish motive.

q Watch for claims where a computer or system is the subject of a direct "hit" and flag those for specialized investigation.

q Gather detailed make & model numbers for all Y2K susceptible equipment at a loss. Obtain information through disclosure laws from the equipment manufacturer or from industry contacts about Year 2000 problems with the same category of equipment elsewhere.

q Obtain records detailing the insured's efforts to bring the firm to Y2K compliance and verify each entry. Firms making a good faith effort to bring EDP and process control devices to Y2K compliance standards will have already established an historic audit trail with software engineers, software and hardware suppliers and process equipment manufacturers.

q Interview production personnel, shift supervisors and equipment operators as part of any suspected Y2K fraud investigation. Shift supervisors and equipment operators will usually be familiar with modifications to, or failures of, their equipment. Production personnel will also be among the first to know if a critical supplier has had a production failure affecting their own productivity.

q Remember - the potential for fraud starts now, not on Jan. 1, 2000. As insureds begin testing systems and processes they become aware of Y2K-related problems, some will consider fraud.

It's All in the Numbers
Fortunately, many businesses are investing a considerable amount of money and effort to make their operations Y2K compliant. The top 250 corporations in the United States alone will spend at least $37 billion before the year 2000 to make sure that their computers will work in the next century.

Even with this effort, experts agree that is unlikely a company can identify and remedy every glitch. Embedded chip technology, some of which is date-dependent, can be difficult to identify in today's automated manufacturing processes. And even if individual components can be made Y2K compliant, there is no guarantee that they will all work together if even one glitch is overlooked. Add to this scenario some 23 million small businesses not intending to do anything to prepare themselves, their systems, and their process for the Year 2000¹, and there will almost certainly be losses.

Just how many of these losses will become fraudulent claims is impossible to tell. But insurers who are prepared will be in the best position to minimize the consequences.

¹ "Small Business and the Year 2000 Problem," 1998, Wells Fargo Bank

Robert Corry is a Fire Investigation Specialist in the Claims department at American Re. He served on the Massachusetts State Police from 1974 until his retirement in 1997. There he was assigned to the Massachusetts State Fire Marshal's Office (SFMO) from 1982 until 1997. Bob was a fire and arson investigator assigned to Hampden County for 10 years, and was Detective Lieutenant and Commanding Officer of statewide SFMO Fire, Arson and Explosion Investigation Unit - the largest unit in the state police - from 1992 until 1997.

Have a comment on this column or a suggestion for a topic? Please send e-mail to rcorry@amre.com.

Many computer programs with operating systems that use two digits to keep track of the date will, on January 1, 2000, recognize "00" not as 2000 but as 1900. This seemingly minor programming error could cause affected computers to stop running, start generating erroneous data or, in the worst cases, lose all of their data.

With 100 million computers linked together in a global network an inability to electronically communicate may result in failures within a single network or failures within major systems threatening some things we take for granted like delivery of electric power and other utilities, stock markets and even national defense systems.

• Failure of the US or foreign stock markets or banks to operate
• Equipment or machinery regulated by date-sensitive chips in computers or process control devices
• Interruption of power grids or other utility supplies
• Miscalculation of rates or benefits
• Dislocations in traffic control, manufacturing, security systems, HVAC

Any of these failures could impact professional liability, business interruption, or could increase the risk of various types of accidents resulting in personal injury, property damage, business interruption and liability.

Q.Our policies already exclude Y2K-related perils. Why should I be concerned?
Carriers should be aware that uninsured losses resulting in personal injury, property damage, business interruption and liability could become insured losses if damage is created by a named peril such as fire, smoke, burglary or water. You can expect a percentage of your insureds will try to use fraud to cover uninsured losses stemming from Y2K failures.

Q.What can P/C insurers do?
Enforcing strict underwriting & claims handling standards along with getting anti-fraud teams ready are steps all P/C carriers should consider.

Insurers should seriously consider organizing Y2K investigative and adjustment teams soon to prevent an unscrupulous insured from trying to turn an avoidable problem into a windfall for themselves and a crisis for your company.

1 - 888 - USA - 4 - Y2K
Federal Year 2000 Information Telephone Hotline.

Small Business Administration
http://www.sba.gov/y2k

CIO Council Committee on Year 2000
http://www.itpolicy.gsa.gov/
mks/yr2000/cioy2k.htm

Independant Insurance Agents of America
http://www.iiaa.org/

Factory Mutual Insurance Company
http://www.fmglobal.com/

Common Indicators of Fraud

In addition to taking precautions specific to Y2K-related losses, insurers should be alert to the common indicators of potential insurance fraud such as:

• The cause of the loss is suspicious or a felony crime.
• A previous history of questionable or fraudulent claims.
• The loss occurs shortly after the inception or lapse of a policy or immediately following a notice of cancellation.
• Business interruption insurance, floaters, riders or lowering of the deductible were added shortly before the loss.
• The insured's alibi for his/her whereabouts at the time the loss occurred is very vague or extremely detailed.
• A recent request for coverage increase is not justified by betterments.
• Marginal financial condition, health problems, recent or impending divorce or other adverse legal situation affecting a principal in the company who stands to gain from the loss.
• Property of professional or sentimental value is missing from the insured site after the loss has occurred. Key examples are professional licenses, business accounting ledgers, pets, personal trophies, the insurance policy and family photos.
• Excessively high value placed on equipment along with vague or no documentation proving ownership, sale price or origin.
• The insured wants to handle all business in person avoiding use of the mail.
• The insured is very aggressive and pushes for a quick settlement or, on the other hand, takes an extremely passive posture and is willing to accept a small settlement.
• Failure in automated sprinklers, intrusion or fire detection systems.
• Building was entered with a key or there is evidence of a staged burglary.
• The insured has listed his property for sale without success.