Prison standoff triggers dispute over K&R policy

PHOENIX—Three years after the longest prison hostage standoff in U.S. history, the state of Arizona and its kidnap and ransom insurer are suing each other over coverage of millions of dollars of costs from the two-week siege.

In a suit moved last week to U.S. District Court in Phoenix, the state charges that National Union Fire Insurance Co. of Pittsburgh, Pa., wrongly refused to pay losses that arose in January 2004 when a pair of inmates seized two guards and took over a watch tower at an Arizona state prison complex west of Phoenix.

National Union, a unit of American International Group Inc., counters in a separate suit filed in state court in New York that none of the inmates' actions meet the K&R policy's definitions of "kidnapping" or "wrongful detention."

The separate complaints were filed in state courts last August and have been on hold while the two sides attempt mediation. Although the talks are ongoing, no settlement has been reached. Last week, National Union sought to move Arizona's complaint from state court to federal court in Phoenix.

Representatives for National Union and Arizona declined to comment.

The next step in the litigation is to resolve whether the case will be heard in Arizona or New York, lawyers say.

While K&R coverage typically is bought by corporations--and in some cases universities, to cover traveling students and faculty--"it's quite unusual" for a government entity to purchase it, said Douglas Milne, chief executive officer of Special Contingency Risks Ltd., a London-based unit of Willis Group Holdings P.L.C.

"Government organizations tend not to buy it because their public stance is, 'We do not pay ransom,"' Mr. Milne said. "To buy K&R would give lie to that."

Arizona bought a three-year K&R policy incepting Nov. 4, 2001, covering the state and its "departments, agencies, boards, commissions and universities," court filings show.

The incident at the center of the coverage dispute began Jan. 18, 2004, when Ricky Wassenaar and Steven Coy, inmates of the state prison in Buckeye, Ariz., overpowered a lone guard in a prison kitchen. Wearing the guard's uniform, Mr. Wassenaar was admitted to a guard tower where he attacked the two guards on duty, one male and one female, and took them hostage. The inmates released the male guard after seven days, but held the female guard for another eight days before surrendering.

Over the 15-day period, the two men at various times demanded release, access to the media, cash, a piloted helicopter, transfer to another prison, and meetings with the warden and governor, Arizona court papers say.

Mr. Coy, a convicted rapist, later pleaded guilty to charges of kidnapping, escape and sexually assaulting the female guard and a woman, then 54 years old, who was working in the prison kitchen when the incident began. He was sentenced to seven terms of life in prison.

Mr. Wassenaar was found guilty of similar charges in a 2005 trial and sentenced to 16 consecutive life terms.

The 15-day standoff cost the state $3.6 million, including overtime for state corrections department employees and bills from outside law enforcement agencies, according to The Arizona Republic, a daily newspaper for the Phoenix area, that cited statistics from those entities.

The state also settled a $5 million lawsuit filed by the kitchen worker attacked by Mr. Coy for an undisclosed amount.

Arizona sued National Union in Phoenix, charging breach of contract, bad faith and fraud for failing to cover the losses and for allegedly misrepresenting the policy's terms to exclude coverage for the kitchen worker's suit.

National Union countered with its own declaratory judgment action in New York.

The insurer argues that the hostage standoff was not "kidnapping," which the policy defines as seizure "for the purpose of demanding ransom monies." The policy defines ransom as "cash...or the fair market value of any securities, property or services."

According to National Union, the siege also did not involve "wrongful detention," which the policy defines as involuntary confinement by someone "acting as agent(s) or with the tacit approval of any ...governmental entity, or acting...on behalf of any insurgent party, organization or group."

The insurer's suit rejects Arizona's charges of bad faith and fraud as "unfounded," and contends that the state in fact had already agreed that the kitchen worker's claim was not covered by the K&R policy.