A Year for Reflection and Reaction

As the end of 2002 nears, it is the time to look back over the past year and to reflect on the major events in this chaotic year. Any consideration of 2002 must consider the tumultuous reaction to the Sept. 11 terrorist attack. Indeed, even if Sept. 11 had been the only major event affecting the insurance industry in the last year or so, there still would be much to ponder. Alas, the last year has provided little opportunity for cool and sedate reflection on Sept. 11 due to a spate of unexpected developments covering a wide range of insurance issues, many of which will have continuing implications for the insurance industry for years to come. 2002, to say the least, has been an unsettling year.

One point of observation, from a legal perspective, is that the diversity of issues has been striking. For instance, just looking back over the last year’s “Legal Beat” columns by my partner Beth Bradley and myself, the topics vary from the mold crisis, coverage for intentional acts, the effect of Enron and WorldCom on Directors and Officer’s liability insurance, to the rise of asbestos insurance bankruptcies. Now, at years’ end, I would like to take this short space to reflect upon the weightier of those issues and once again look into my murky crystal ball to guess where these insurance issues are going.

Terrorism insurance
No insurance legislation was more closely watched last year than the terrorism insurance bill before Congress. Following Sept. 11, Congress was forced to deal with an industry crisis centering on insurance/reinsurance coverage for terrorist acts. The issue, to simplify, grew from the decision by many state regulators to prohibit carriers from including exclusions for terrorism, even while reinsurers refused to participate in reinsuring such risks. This created a problem for property and casualty carriers who were unwilling or unable to take on this unreinsurable risk. Congress fought bitterly over the insurance issues and a bill blessed by the Bush administration, and attacked by consumer groups, sat waiting for passage up until the fall election. The administration made the Terrorism Insurance Act a campaign issue by focusing on it as a necessary step to spur on the economy. While the bill’s fate seemed unclear, the unexpectedly one-sided results of the election gave the impetus for very quick passage of the bill once the lame duck session of Congress began. Now, with the bill signed into law, the question is whether the law will live up to its advance billing and resolve this dislocation in the insurance industry. Keep an eye on this issue next year.

Corporate corruptions
Recently we witnessed the one-year anniversary of the Enron bankruptcy filing. 2002 was punctuated with bankruptcy filings by Enron, WorldCom and a host of other corporations brought down by inflated books and insider self-dealing, creating significant risks and losses for the Directors and Officers’ liability insurance carriers. Premiums leaped sharply and coverage availability was lessened.

Indeed, a recent article in Insurance Journal, entitled “Brother, Could You Spare Some Coverage?” by Stewart Eisenhart, highlighted the crunch in higher premiums and lower limits for D&O policies issues to non-profits, and discussed how the growing scrutiny of corporate policyholders has resulted in increased premiums and lower available limits. This excellent article highlights the effects on D&O coverage not just for corporate giants, but also for not-for-profit entities such as the American Red Cross or the Boy Scouts of America.

In part this problem is one of pricing for which there is no simple legislative solution. Even so, Congress passed the Sarbanes-Oxley Act of 2002 to place greater responsibility on corporations and their directors and officers to prevent the excesses found in the books of WorldCom, Tyco and others. Reigning in corporate excess is one part of the perceived solution.

The question now is, will this Act, coupled with the public’s revulsion towards the corporate corruption revealed in recent months, create an environment of discipline and responsibility such that further catastrophic D&O losses can be curtailed and the market for D&O coverage regain its equilibrium? While many commentators have argued that D&O coverage has been significantly under-priced in recent years, it seems likely that there will be some over-reaction with consequent over-pricing and non-availability in the near term. As these problems are not likely to dissipate soon, expect to see further legislation fine-tuning the Sarbanes-Oxley Act, as well as an onset of suits and court decisions outlining the scope of the Act and dealing with related D&O coverage issues. We will be watching for this litigation as the new year unfolds.

Homeowners coverage
State Farm Insurance and Farmer’s Insurance rocked the Texas’ homeowner’s insurance market with their respective announcements that they would discontinue writing policies for new customers. Farmers announced its decision to withdraw from the market altogether, for reasons that included the inability to profitably write coverage given the increasing magnitude of losses (from mold, etc.) and the inability to sufficiently raise rates. In addition, the state had asserted claims against Farmers alleging improper underwriting practices and sought large penalties.

For several months a firestorm raged over the implications of the withdrawal and its effect on homeowners’ coverage in the state. The availability of coverage dropped dramatically. Consumers groups cried foul and the Texas Department of Insurance held meetings to resolve the problems. Recently, the state finally reached an agreement with Farmers, one that calls for Farmer’s to pay $100 million in refunds and to provide rate cuts to the relevant holders of Texas homeowner’s insurance policies. The settlement lets Farmer’s continue to offer coverage to Texas homeowners.

However, the underlying problems still remain. Will the explosion of mold and other claims prevent profitability? Will carriers be able to provide the volume of coverage homeowners will require? Stay tuned as the saga continues.

Asbestos bankruptcy
There are over 60 asbestos-related bankruptcies presently pending. Some experts estimate another 200-plus filings in the near future. Yet the full effect of these bankruptcies on carriers has been greatly increased by a recent case, Fuller-Austin Insulation Company vs. Fireman’s Fund Ins. Co., Case No. BC116835 (Cal. Super. Ct.). This California state court case, when coupled with the earlier decision in UNR Industries v. Continental Cas. Co., 942 F.2d 1101 (7th Cir. 1991), supports the proposition that the present value of long-term indemnity coverage for an “estimated” underlying asbestos liability may be due and payable upon confirmation of the bankruptcy plan, rather than after the claims are established through either courtroom verdicts or settlements. Under Fuller-Austin, a bankruptcy confirmation constitutes a final judgment such that the estimations provided for in the plan of reorganization become the underlying liability (i.e., an existing, immediately payable judgment).

Okay, that’s bad enough, but bankruptcy courts are being asked in many cases to refuse to allow the participation of insurance carriers in the bankruptcy process. This is true especially where they were not participants with the insured in negotiations with the asbestos claimants. Indeed, the carrier may be refused participation even though the estimation may ultimately create a liability payable by the insurance carrier. And under UNR, the rule of thumb has become “pay now, litigate later”. This has the effect of making upper level excess carriers run the risk of paying policy limits into a fund or trust now for the benefit of future asbestos claimants for claims that may arise years from now, or never.

The scope of these bankruptcies and the surprising increase of asbestos claims raises a specter for the industry that threatens to last far into the future. Nobel laureate economist, Joseph Stiglitz, authored a study showing that these asbestos-driven bankruptcies have cost workers over $3 billion and about 60,000 jobs. He called for Congress to address the asbestos litigation problem due to its enormous cost on the economy. As these costs are usually borne, directly or indirectly, by the insurance industry, few issues will be more critical in the coming year.

Conclusion
The last year has seen problems arise for the industry which are not likely to be resolved at any time in the near future. Some of them, such as the asbestos bankruptcies, may be with us for many years to come. Unfortunately, the last year is one that the insurance industry would do well to remember, though one it would like to forget.

Brian S. Martin is a partner in the Insurance and Coverage Section of the Houston office of Thompson, Coe, Cousins & Irons, L.L.P. He has extensive experience in insurance coverage and defense matters, specializing in environmental, toxic tort and products cases. Martin is a frequent author and CLE speaker on insurance topics, including coverage and bad faith issues.

Topics Catastrophe Carriers Texas Claims Homeowners Market