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BONN, Germany-German businesses have long benefited from a stable civil justice system under which court battles over liability are infrequent and court awards generally are small.

But there are signs of possible change on the horizon.

New strict liability laws, the increased sale of insurance to cover plaintiffs' legal expenses and a disproportionate rise in the size of awards indicate the calm may be coming to an end, which could mean an eventual increase in German businesses' liability exposures.

When contemplating his company's liability exposure, Klaus-Wolfgang Schulze-Weslarn, risk manager of Henkel KGaA, a German consumer products manufacturer based in Dusseldorf, applauds three key features of the German legal system: no jury trials, no lawyer contingency fees and no punitive damages.

"With little to gain in court, most problems can be settled behind closed doors," said Mr. Schulze-Weslarn. "In fact we've very rarely had a liability claim go to court."

That view is relatively common among German corporations. Even large pharmaceutical companies such as Bayer A.G., or chemical manufacturer BASF A.G., confront nothing in Germany akin to their U.S. or British litigation exposure.

"In Germany, a judge decides the amount of an award, not a jury, and lawyers' fees are fixed," explains Karl-Heinz Jaeger, risk manager and head of the insurance division for Ludwigshafen-based manufacturer BASF. "And if plaintiffs lose a case, they not only pay their own costs but also the costs of the defense," he added.

Such judicial constraints and the financial consequences for unsuccessful plaintiffs have made corporate liability a less volatile exposure than for companies in some other nations, said Mr. Jaeger. "Should a claim occur and it's our fault, we pay quickly, and insurance is sufficient to cover the exposure," he said.

"In Germany, court awards are nowhere near those of the U.S.," said Friedrich Graf von Westphalen, a defense attorney in Cologne. "An extreme case of pain and suffering might get a plaintiff 100,000 DM ($60,300). By American standards that's nothing."

Mr. von Westphalen says court awards for personal injury are almost negligible in Germany because of generous social security benefits. "Since social insurance pays for workers compensation and rehabilitation, people have little reason to go to court, where awards are restricted."

Court awards for personal injury are generally limited to a fixed amount above social security benefits, and there also is a schedule of compensation for various injuries.

On the other hand, commercial disputes are quite common, he added. "Most claims occur between a manufacturer and supplier. But these disputes seldom go to court because companies don't want to hurt their image."

Henkel, for example, "aggressively" challenges product liability claims brought by suppliers, said Mr. Schulze-Weslarn.

"When a product liability claim is made, I put our best people on it. We investigate the cause with those making the claim and use all our know-how to find the fault. If it's not our fault, we help our clients pinpoint their weakness and help them fix the problem. It's something our clients welcome."

It's Henkel's policy to investigate and settle some claims without the involvement of its insurers, said Mr. Schulze-Weslarn. He added, however, that he welcomes the expertise of Henkel's insurers, especially as mediators with claimants.

"An insurer is a wonderful catalyst in restoring trust. Often an insurer can convince an irate customer we are not as wrong as he thinks," he said.

Under normal circumstance, Mr. Schulze-Weslarn said, risk managers might have perfected the art of staying out of court if not for what he calls "a lot of criminal energy."

Thanks to the availability of legal cost insurance, which covers a plaintiff's legal fees, some consumers now can afford "to sue us without cause. It's a useless exercise that wastes expertise and money," he said.

In addition to the availability of such financing for litigation, Mr. Schulze-Weslarn also partly blames the media for whipping up the legal fervor of German consumers. "The media has pushed some extreme cases to the point that we're concerned," he said.

"While essentially no product liability or impairment liability claim has come of it, I still can't get over a queasy feeling that someday we could get hurt by an environmental claim," he speculated.

Unpredictable exposures

That "queasy feeling" has been circulating in the board rooms of German liability insurers since 1990, when lawmakers started slapping German companies with strict liability for pharmaceutical development risks, which are health risks for consumers that can emerge years after a drug is introduced, and for pollution that companies generate in the course of normal operations and that builds up over many years.

"The long-tail nature of these liability risks is explosive," said Herbert Schilling, a retired Gerling-Konzern A.G. executive and former committee leader of the German Assn. of Property & Casualty Insurers. "It will take 20 to 30 years before we know if we're making a profit or loss."

As technology and science advance, casualty insurers also will meet new unpredictable risks in medicine, foodstuffs and the environment, says Mr. Schilling, who estimates many liability risks are underwritten today at rates as much as 65% below what they should be.

A classic example of an unpredictable risk is AIDS. In 1993, German insurers paid claims totaling 120 million DM ($72.4 million) to hemophiliacs who had contracted acquired immune deficiency syndrome from tainted blood products.

"What then occurred could be a forbearer of things to come" in other liability cases, said Mr. Schilling. "Politicians also wanted pain and suffering compensation for these AIDS victims, which has no legal basis in civil law and only a basis in criminal law if negligence can be proved," he said. "Both the government and parliament demanded that insurers pay into a fund that would have had a volume of 700 million DM ($422.1 million). Liability insurers refused because it would have set a precedent."

As a result of the tainted-blood incident, German lawmakers raised a cap on damages that can be awarded for personal injury from pharmaceuticals. The cap was raised to 1 million DM ($603,000) per person, from 500,000 DM ($301,500).

Changing liability laws

Other changes in Germany's liability laws have been proposed by lawmakers.

Germany has one of the most far-reaching pharmaceutical liability laws in the world, which in addition to strict liability for so-called development risks also includes liability for research and development risks. One major exclusion, however, is that only directly affected victims may sue.

Following the tainted blood products case, the German Justice Ministry began drafting legislation that would extend liability for "contagiousness," so that the victims of secondary infections can also sue.

Liability insurers have rebuked the plan as "uninsurable."

Further changes to Germany's liability laws include what Mr. Schilling calls a "revolutionary" mitigation of the burden of proof for plaintiffs. Under reform proposals, "pharmaceutical manufacturers would be liable when there is a 'reasonable suspicion' and 'high probability.' It could lead to a liability of companies that had nothing to do with the case," he warned.

In addition, lawmakers plan to introduce a proposal to compensate pain and suffering into German drug liability laws.

Mr. Schilling said he fears that could set a precedent for allowing such damages in environmental and product liability cases, as well. "We can expect a great increase in court awards," he said. "Courts would consider not only bodily injury, but also emotional pain."

Other legal changes that worry businesses and insurers include a proposed expansion of liability under Germany's environmental impairment law. Currently businesses categorized under the law as "dangerous facilities" are required to buy environmental impairment liability insurance. German lawmakers, however, are considering following a suggestion of the E.U. Commission that could make EIL coverage mandatory for all businesses.

German lawmakers are also considering proposals to change product recall laws. In addition to businesses' voluntary recalls of allegedly defective products, the proposals call for giving the government the authority to recall products.

Such a move would upset an already difficult situation for insurers, said Mr. Schilling. "German underwriters are courageous to write coverage for product recalls at all. Despite selective underwriting, recall insurance is catastrophically bad business," he said.

The reason for the poor underwriting experience is a growing consumer rights movement in Germany and the practice of many manufacturers to recall products at the slightest suspicion of a defect. "It used to be that recalls were done with as little publicity as possible. Today it's seen as an improvement of corporate image," Mr. Schilling said.

Insurers' response

Given current exposures and the proposed expansion of liabilities, Mr. Schilling said casualty insurance rates for medical and commercial liability insurance must rise. He also favors an increase of rates for environmental impairment liability risks.

However, under Germany's soft market, rate increases are not likely to occur.

"Employers already had to accept great increases in premium in connection with the environment liability law," said Mr. Schulze-Weslarn of Henkel. "Besides, there have been essentially no claims. As a result, rates are falling and that is good," he said.

Whether falling rates is good depends on one's perspective, said Richard Hinchcliff, director of liability for Cologne-based Cologne Reinsurance Co.

As former head of international business at General Re Corp., he was able to compare the German and U.S. liability systems and sees a danger in what he calls "rear-view mirror" underwriting.

"What I see is loss cost underwriting. Companies are looking at what happened to them last year and predicting what will happen to them next year. But as changes (in the legal situation) come about, it is not as easy to predict what next year will be," he cautioned.

Mr. Hinchcliff said many German businesses and insurers are not prepared for the liability exposures they could confront. "You have to make some decisions and evaluations about what could happen. Exposure underwriting as opposed to loss cost. Only recently have I been able to find companies that recognize the world is changing," he said.

In many ways, the German system is more volatile and more difficult to accurately project than the U.S. system, Mr. Hinchcliff said. "Claims of 15,000 DM ($9,045) that were noteworthy five years ago are now 50-, 100-, 200,000, even a million deutsche marks. . . .Something that is worth X in Germany is probably five or 10 or 12 times that in the U.S., but that value of X is growing dramatically faster in Europe," he said.

Another dilemma for German insurers is that coverage is much broader, he said. "A company in Germany can get coverage for product liability he can't get in the U.S.," said Mr. Hinchcliff. "Germany has not had the losses, and insurers have been willing to grant some broad coverage that would have been difficult, even impossible, to purchase in the U.S."

In Germany, for example, the risk that a product will cause damage to or the failure of another product can be insured, he said. Product recall coverage also is more widely available.

"The question is, what do you do if things don't develop as you expect," says Mr. Hinchcliff.

Despite the risk of the unknown, Mr. Hinchcliff said he cannot predict whether liability insurance rates will rise for German companies.

"For all the years that I have been in this business, there are any number of reasons why rates should have moved in directions they never moved. We have legislative changes or tax changes or result changes that should drive rates in one direction or the other. But they tend not to go that way," he said.

One important factor keeping the market soft is the resistance of corporate buyers to pay higher rates, said Mr. von Westphalen, the defense attorney. "Companies can get along nicely with the insurance coverage and rates they have," he said. "There have been no claims of substance."

As a result, insurers that think rates are too low for incalculable exposures may become more selective in the future, said Mr. Hinchcliff of Cologne Re.

"As rates continue to drop, assuming they

do continue to drop, one of the things insurers and reinsurers should be thinking about is what risk transfer is appropriate. With a declining rate base, the risk taken obviously has to be adjusted accordingly," he said.

Focus on loss control

In that respect, insurers and their policyholders are in complete agreement.

"Several factors come to the aid of German industry" facing new liability exposures, said Mr. Schulze-Weslarn. "One is better risk management and a commitment to sustained development and responsible care."

Companies like Henkel, BASF, Bayer A.G. and steel manufacturer Thyssen A.G. all have stepped up their quality control and environmental management not only to remain competitive, but also to stem growing liabilities.

"To eliminate the risk of faulty parts leaving the factory, Thyssen has a system of quality checks in place, which it examines on a regular basis," said Franz Bartscherer, risk manager of the steel manufacturer, which is a major supplier to the German auto industry.

"Today, German manufacturers won't work with a supplier that lacks quality control. They'll come to the factory and look at what kind of system we have installed." Mr. Bartscherer said.

The checks and balances keep claims from happening, says Mr. Bartscherer. Thyssen, like most other German companies, adheres to quality management protocols set by the ISO 9000 standard.

Mr. Von Westphalen said German scrutiny of quality also is due in part to growing liabilities. "A number of court decisions have expanded the responsibility of manufacturers to control quality," he said.

The German Supreme Court ruled in a recent case of an exploding water bottle that the burden of proof for liability claims falls on companies that cannot show they had adequate quality control procedures in place. The court award of 650,000 DM ($391,950) to the victim for pain and suffering was the largest in German history.

"Great efforts are being made to contain risk," said Herman Joerisson, a member of the executive board and director of industrial casualty business for Gerling-Konzern A.G. "It is a key factor in keeping claims out of court."

Gerling sees big savings from keeping claims out of court. "We save on lawyers' fees and costs for additional personnel and it saves time. It can take up to five to 10 years for a case to reach the German Supreme Court. By reducing the time, we also reduce costs. This is a critical factor."

Mr. Joerisson said a vast majority of liability claims in Germany, in fact, never leave claims departments of German insurers. "Only 1% of liability claims ever reach the courts," he said. "A fraction of those cases go to the German Supreme Court. More justice is served in the claims department of German liability insurers than in the courts."