At a minimum, D&O claims are expected; Countrywide’s Balboa insurance operations under review
The subprime mortgage lending blame game is in full swing — with people arguing about who’s at fault for mortgage defaults, bond losses and lender failures. But it’s only the “very top of the first inning” in terms of assessing the impact on the insurance industry, according to one industry expert.
“Already general litigation in the subprime arena is pointing in about every possible direction. Borrowers have sued lenders. Lenders have sued financial institutions. Financial institutions have sued lenders. Regulators have sued just about everybody,” noted Kevin M. LaCroix, an attorney and a director of OakBridge Insurance Services, a specialized insurance intermediary that focuses on executive liability coverages.
American Home Mortgage Investment Corp. (which filed for bankruptcy), Countrywide Financial Corp. (which has begun laying off staff), Fremont General Corp., IndyMac Financial Group, New Century Financial and Radian Group Inc. are among the financial entities that have been hit with class action lawsuits stemming from the subprime mortgage lending crisis. (For a more extensive list of filed litigation visit LaCroix’s “D&O Diary” at www.dandodiary.blogspot.com.
Most likely claims
If the crisis fosters insurance claims, they will most likely be under financial institutions’ directors and officers (D&O) liability and errors and omissions (E&O). LaCroix says there have already been D&O claims, which could affect underwriting and perhaps even pricing for financial institutions going forward.
“[C]ertainly I think it’s something that the heads of the D&O underwriting facilities can’t ignore, and it’s clearly a concern for them. I think it will lead to conservatism and possibly, if the claims trends continue, the prices will be tightening,” said LaCroix.
Underwriters will be watching to see if claims spread beyond D&O. Some observers have asked whether auditors, lawyers and even credit rating agencies should bear some of the burden for investors’ loss of capital.
Others have questioned whether corporate gatekeepers sufficiently scrutinized the exposures of some of the subprime lenders and other mortgage-related facilities.
Others affected
Dave Kodama, director of Policy Analysis for the Property Casualty Insurers Association of America, agreed that it’s too early for a complete assessment but noted that with criticisms being leveled against securities rating agencies such as Moody’s and Standard & Poor’s, others will likely be brought into the fray.
“Pension funds are going to have to step back and look at their portfolio and see what is their exposure,” as individuals will want to hold the funds’ directors and officers accountable.
“Definitely insurance companies, including our members, are having to address this with their shareholders — address what is their exposure in their investment portfolio [with] these types of securities,” Kodama added.
Kodama emphasized that the primary purpose of D&O insurance is to protect the corporation and its directors and officers, not the investments of individuals. “The primary loss incurred by that product is mainly for defense costs for protecting the interests of the corporation, as well as its directors and officers,” Kodama said. “That’s the primary issue.”
D&O coverage is typically negated where intentional acts of fraud, such as defrauding the public, the Securities and Exchange Commission or investors by intentionally withholding information, are found. “The defense is not there for intentional acts of criminal activity found through the adjudication process,” Kodama said.
Beyond claims
In addition to the claims scenario, companies with both insurance and mortgage affiliations or with subprime-related investments are being watched.
Moody’s reported that U.S. P/C insurers’ exposure to subprime mortgage-backed securities is minimal. The ratings agency issued a report indicating that P/C carriers tend to invest conservatively and that overall the industry’s exposure subprime-related investments is less than $15 billion.
The world’s largest insurer, American International Group, has subprime exposure as a lender, investor in mortgage-backed securities and supplier of mortgage insurance. But AIG characterized its exposure as minimal and said it would take declines of 30 percent to 40 percent in home values to dent the market for mortgages with stronger ratings, where most of its holdings lie.
Balboa insurance
Countrywide Financial Corp., which is the largest mortgage lender, is the parent of Balboa Insurance Group, which includes Balboa Insurance Co., Meritplan Insurance Co., Newport E&S Insurance Co., Newport Insurance Co., Balboa Life Insurance Co. and Balboa Life Insurance Co. of New York. It also owns Balboa Reinsurance Co., a provider of reinsurance coverage to primary mortgage insurers; Countrywide Insurance Services Inc., an independent insurance agency; and DirectNet Inc., a third-party insurance agency.
It remains to be seen if Countrywide’s mortgage troubles will spill over into its other businesses. Earlier this year, Balboa cited aggressive plans to expand nationwide with new products including its auto insurance program and two home warranty products, and vowing to develop operating efficiencies between lending and insurance divisions.
On Aug. 16, Countrywide tapped a $11.5 billion credit line from a group of 40 banks to help it fund loans and began eliminating 500 jobs from the lending division. But it said it would continue its insurance growth plan.
“Countrywide continues to recruit and hire sales professionals in its pursuit of profitable market share growth. It also is carrying on with its strategic growth initiatives in its banking, insurance, capital markets and global endeavors,” the firm said in a statement.
Ratings under review
A.M. Best Co. placed the ratings of Balboa Insurance Group, Newport E&S and the life operations under review with negative implications citing the financial pressures at Countrywide Financial Corp.
A.M. Best said the ratings will remain under review pending discussions with Balboa and CFC to explain the current situation and the proposed strategic initiatives put in place to lessen any potential negative impact on the insurance operations.
“Prior to the conclusion of these discussions, any further deterioration in the financial condition at CFC, as perceived by A.M. Best, would result in a downgrading of all FSRs and ICRs of Balboa’s insurance companies. A.M. Best notes that due to the volatile and quickly changing market conditions surrounding CFC, that maintenance of the present ratings will be difficult, due to the perceived drag on the insurance operations,” A.M. Best stated.
Countrywide did not respond to several calls from Insurance Journal for comment on the subprime situation.
But Countrywide has taken out ads in the Los Angeles Times and Detroit Free Press, attempting to reassure investors and banking customers that the company will not go bankrupt as smaller lenders have.
“The future is bright,” the ads say.
Insurance Journal West editor Patricia-Anne Tom and The Associated Press contributed to this report.
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