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At a Washington press conference this fall, medical researchers showed off a new bionic arm that allows a 26-year-old woman to control her limb as everyone else does--simply by thinking.

The thought-controlled prosthesis, which works by connecting human nerves to the computerized arm, is just the latest and most spectacular of an increasing number of advancements that combine medicine and computer technology.

"Health care is one of the new frontiers for semiconductor companies," says Brenda Shelly, executive vice president of Willis North America.

The health-care market, which at more than $2 trillion already accounts for about a sixth of the U.S. economy, also brings with it a significant amount of new and substantial risks.

"When you're talking about health care, you have a whole new arena of issues that have to do with people getting hurt and mass-tort type of issues," Shelly says.

For semiconductor companies, that means they will have to worry not only about coverage in areas such as business interruption and privacy, but also about managing the risks of medical-products defects and bodily injury where the stakes are much higher.

"It's one thing if the worst-case scenario is a computer system doesn't operate the way it should and you have disgruntled buyers and have to replace that equipment or replace the chips," says Kevin Quinley, senior vice president at Medmarc Insurance Group. "It's another matter if, when it doesn't work the way it should, you have a patient fatality or you have a patient who is permanently brain damaged."

DEEP POCKETS

Among the areas where computer chips are likely to find a home in human medicine are diagnostic tools such as pill-sized digital imaging equipment that can be swallowed, implantable drug-delivery systems that provide time-release dosages, glucose monitors for diabetics and chips implanted in the brain that allow paralyzed people to remotely control electronic devices.

Implantable computer chips got a lot of headlines last year when the Food and Drug Administration approved radio-frequency identification devices the size of a grain of rice that could be injected under the skin to provide emergency workers with a quick way of accessing medical information. Using a scanner that could read the chip, emergency workers could then access a patient's medical records on a remote computer.

While the idea of having a computer chip implanted drew criticism because of privacy concerns, devices such as pacemakers and defibrillators have been implanted in people with heart trouble for decades.

The risks involved in implanted medical devices and the potential liabilities were highlighted last year, when medical device maker Guidant Corp. said that about 50,000 of its implantable defibrillators, which essentially jumpstart failing hearts, were potentially flawed. Nearly 29,000 of the defibrillators, which cost up to $30,000 each, had a wiring problem that could lead to a short circuit, and 21,000 of the devices needed to be reprogrammed to fix a potential computer memory problem.

Guidant, which has since been bought by Boston Scientific Corp., offered to replace the defibrillators at risk of a short circuit, but the recall has sparked a wave of product-liability class-action and individual lawsuits. Boston Scientific said in a recent federal filing that it had set aside $381 million to pay for legal costs related to the Guidant defibrillators.

The Guidant experience highlights the dangers for semiconductor companies whose chips may soon be going into medical devices, especially those which will be implanted in humans.

"When you put them in medical devices and medical equipment, an alleged malfunction could literally become a life-and-death situation," says Quinley.

"The margin for error can be tiny, and the potential for a catastrophic injury or outcome can be significant," Quinley says. "If that occurs, then a plaintiff or an attorney or a litigant is going to look for as many deep pockets as they can. One of those deep pockets might be the provider of the computer chip."

High among the list of potential liabilities for semiconductor companies is, in fact, a situation involving the recall of an implanted device that necessitates surgery. That kind of worst-case scenario is something that chip makers may not think is an issue, but one which is a big concern for insurers. Coverage for product recall is generally excluded in most policies, and companies have to buy a separate policy.

"Product-recall coverage is very expensive. It's kind of like earthquake," says Cristina Varner, life sciences services manager at ABD Insurance & Financial Services. "Clients don't really want to buy it unless they have to or they're forced to by a contract requirement. That's a significant exposure."

SOFT MARKETS

When looking to manage the exposures brought about by the use of their chips in medical products, semiconductor markets need to analyze how and where the end product is going to be used.

"You really have to dial in to what's the product, and what is it being used for, what are the possible side effects and what could go wrong," says Trindl Reeves, a principal in the commercial department of San Diego-based broker Barney and Barney LLC, a partner of Assurex Global. While specialized chips are designed for a particular use, however, general processing chips may be used in any number of devices.

"On the casualty side, a lot of these semiconductor manufacturers don't have control over where the chips are going to end up," says Reeves, "They might just be making a processing chip, and they may not know where the chips are going to end up."

While that may make it harder to trace a problem with a medical device back to the chip maker, plaintiffs' lawyers will still look to bring all the companies involved in the product into the suit.

"What's going to happen is they're going to name everybody," Reeves says. "At the very least, they're going to have to put up some legal fees to get out of the suit."

"That's the big issues that carriers are concerned about and insureds should be worried about--being pulled into some kind of massive action when you have a product that doesn't work the way it's supposed to." Reeves says.

To prevent those kinds of costly surprises, chip makers need to look at the device and how it is going to be used and develop a worst-case scenario.

"If it's a drug-delivery system, the drugs may still be going OK, but there may be some other derivative issue coming out of the chip where the programming isn't right and it's causing a different problem, or it's not interacting well, or the material that it's made from is not being tolerated by 90 percent of the people using it," Shelly says.

"There are a whole host of issues. The concern is that any time you put a foreign body into the human body, you have to deal with the potential for rejection," she adds.

First off, chip makers whose products are used in medical devices need to work to prevent failures by building in redundancies to make the product as safe as possible given the expected use.

"If it goes into an invasive medical device, you look at creating ways to make it as safe as possible, creating redundancies that might be helpful as it pertains to the chip, but if at the end of the day, there's a failure of the product, you're going to be dragged into a suit," says Thomas Whitenight, vice president of technology services for ABD.

To cover that possibility, chip makers may need to add in medical-products liability policies that cover them for bodily injury, which would typically be excluded from a general liability policy.

While the physical chip itself may function properly, there is also a concern that because most chips include some kind of built-in software, programming errors could lead to problems, such as delivering the wrong dosage or delivering doses at the wrong intervals.

"When you look at a semiconductor, a lot of carriers will look at it from a hardware perspective. But so many times there is a software component that drives that chip, that makes it do what it's designed to do. Really, when you're negotiating on the errors and omissions coverage policies, one of the questions you have to ask yourself is what happens if the software fails," Whitenight says.

Along with implanted devices, chip makers also face potential liabilities in external devices that could ultimately stem from a failure to properly operate the machine.

"Often within medical devices, for example, the chip manufacturer is not going to have the capability to influence the training of the people that are using it," says Pam Ferrandino, national casualty practice leader at Willis. "A lot of the liability that comes from that perspective would have to be clearly defined in terms of how we define product failure or negligence."

Reeves also notes the potential for operator error, which is not present in implantable devices that require no actions on the part of the user.

"You've got implantable devices that for years have been working very well, and they've had a lot of experience with it," Reeves says. "Once it's in, it's either working or it's not. A ventilator could be user error, it could be applied incorrectly and cause a loss of life or brain damage. It really depends on what the use is for, what is the worst case."

Because many of the new medical uses for semiconductors may be developed by smaller companies or startups, a significant issue may be obtaining medical-products coverage during clinical trials, which is excluded by standard policies. For a startup, the cost of clinical-trials coverage can be steep.

"It is a big cost for them, but they all expect it," Reeves says. "They look at it as a cost of doing business. Some of the early-stage companies, they're going to run into the minimum premiums, but they understand the benefit."

While the move into medical products may bring new risks for semiconductor companies, coverage is generally available at a reasonable cost, brokers say.

"In casualty itself right now, the market conditions are generally soft. So there's lots of capacity available," says Ferrandino. "If you have a tough exposure, which some of these risks might be deemed as a tough exposure if they are incorporated into a medical device, the market's always a little bit harder, or pricings always a little bit steeper for them. So those clients have to look at maybe a different attachment point."

No matter how much coverage is available at a decent price, however, when it comes to class-action suits, it may never be enough.

"We're talking about potential drug-delivery systems or mass-tort issues. Those things, even if you bought insurance for them, you wouldn't have enough," Shelly says.

MICHAEL FITZPATRICK lives in New Jersey.

December 1, 2006

Copyright 2006© LRP Publications