More Lawsuits, Firmer Prices on the Horizon for Executive Liability

Property Premiums Fall Sharply; P/C Insurers Post Q3 Losses; Some Sell Stock to Raise Cash for Surplus Woes

More lawsuits and firmer rates for directors and officers liability coverage are almost certainly ahead as a result of the global financial crisis, which is likely to hit insurers especially hard. Given this, what are the most likely scenarios?

Expect widespread litigation involving failing banks and potential mergers and divestitures on several levels, but similar to the hubbub over the purchase of Wachovia Corp., first by Citigroup, then by Wells Fargo. Additionally, investment groups and mutual funds are likely to be accused of faulty due diligence. Further, the use of government loan money is likely to create allegations of management misuse.

Allegations of wrongful termination will increase as financial problems trigger employee layoffs.

Litigation can be expected over the decline in value of employee investments, primarily 401(k)s. This will be exacerbated in situations when employer stock is an investment option or is used as a match within employee retirement funds and benefit plans.

Additional government activity, such as the recent decision to purchase preferred stock in larger banks, seems likely. Banks may be encouraged to avoid businesses not closely related to the lending function. There may be continuing government involvement in some organizations, and continuing government action as a catalyst in certain mergers and acquisitions. The total impact on commercial insurance is yet to be seen.

Expect litigation if the utmost of care is not involved with moving various commercial coverages from one insurer to another, even when the buyer demands it. Although the focus may be on E&O exposure, there likely will be subtle governance overtones affecting D&O.

Attempts to void real estate transactions, based upon various types of misrepresentation to the buyer, are a strong possibility.

Public outcries will continue as senior executives leave failed organizations, “parachuting” with large sums of money.

Good D&O Policies

The companies with the foresight to buy solid D&O insurance with strong, financially secure insurers will be the least stressed, with D&O insurance probably defending claims and negotiating settlements.

In the absence of fraud, D&O coverage could protect “parachuted” executives despite public unhappiness. Most corporate bylaws contain an indemnification provision providing reimbursement to executives who incur personal defense or settlement expenses as a result of such lawsuits.

In addition, most D&O policies will defend executives until there is proof of the allegations against them, an admission of guilt, or a final adjudication. If there is no money left in the coffers because the company has failed, this obviously cannot be done, except with specialized insurance products such as Side A coverage forms. D&O coverage, however, will often reimburse the organization after it has indemnified individual directors.

D&O policies for publicly traded companies typically do not offer protection for claims involving wrongful termination or loss of investment or investment potential in employee benefit plans. However, separate but related insurance policies are available to address these exposures. Private companies generally can combine these coverages into a single policy with combined limits or separate limits for the specific exposures of D&O, employment practices and fiduciary liability.

Finally, the financial viability of many insurers will come into clearer focus as financial issues involving investment portfolios are revealed and examined.

Trends Began Last Year

The trends toward both more litigation and firmer rates began many months ago.

Federal securities class action filings in the second half of 2007 and first half of 2008 rose substantially, following a two-year drop in activity, according to studies conducted by Cornerstone Research and Stanford Law School Securities Class Action Clearinghouse. There were 110 filings in the first half of 2008, and slightly more than the 107 filings in the second half of 2007. In contrast there was an average of 63 semiannual filings in the past two years. There were 17 “mega” filings — defined as those with a market capitalization loss of $10 billion or more — in the first half of 2008.

About half of this year’s filings, the report concluded, were driven by the subprime mortgage/credit crunch. According to Ironshore Claims LLC, there were 448 cases over subprime lending filed in federal courts in the past 15 months. In addition, regulatory agencies have launched dozens of investigation, including at least 36 by the SEC.

Second Wave of Litigation, Banks

“The first wave of subprime litigation is already here; a second wave appears imminent, and companies need to make sure that they have adequate levels of errors and omissions insurance now while the price of the coverage remains reasonable,” Ironshore Vice President Michael Adler said in a recent memo to brokers. He believes the subprime mortgage meltdown is more likely to trigger E&O claims than D&O claims. Lenders may face charges of wrongful foreclosure, predatory lending, and claims that loan terms were not described correctly.

Also vulnerable, Adler believes, are mortgage brokers, lawyers, and appraisers connected with loan origination; alternative investment funds such as hedge funds and private equity funds; and investment advisors.

Overall D&O prices dropped slightly last year, Towers Perrin reported, with premiums down 2.7 percent. The notable exception was in the banking industry, where premiums increased 57 percent. The banking class also reported a 46 percent increase in average limits, which likely explains the increase in premiums.

Today, firmer prices across the board can be expected. Not only have class action filings increased, but investment income for insurance firms also is down.

Question Marks: AIG, New Carriers

Another huge question mark is the long-term role of AIG. AIG is a market leader in D&O underwriting, and we have seen no indication that it plans to retreat. So far, AIG is fighting to keep its insurance business, and a recent Insurance Journal survey found that larger companies so far are tending to stay.

One concern is a possible ripple effect weakening the stability of major players. Both The Hartford and XL Capital have reported heavy investment-related stress.

Another wild card is the recent entrance of new carriers into the D&O market. Some of the fresh capital is from London, some is from Bermuda, and the rest is from a variety of other countries where the economy is a little better. So far, no dominant player has emerged. These carriers have little historical experience as D&O insurers, although they have hired strong underwriting talent from other insurers.

What Should Agents and Brokers Do?

Recognize that insurers are both weary and wary. Even last summer underwriters were starting to say that “business as usual” was no longer possible. Be prepared for rate increases, particularly for financial organizations, real estate operations and any entity with less than sterling financial data.

Plan to spend more time helping incumbent underwriters become more comfortable with the exposures. Begin taking the pulse of alternative potential underwriters if the incumbent indicates strong rate increases or retentions or adversely changed coverage language. This means advance planning for renewals, and strong communication with incumbent underwriters. Be cautious when changing from one D&O insurer to another, especially with regard to warranting application statements to new insurers. Strong relationships with underwriters and policy language comparison technology are important and necessary to obtain the best pricing and the broadest possible coverage. Changing insurers to save costs can backfire — application warranty language and subtle policy language differences can create problems.

The best thing we can do is to focus on the positives while working to improve the negatives, both within our own client relationships and the industry in general.

Topics Lawsuits Carriers Agencies Claims Underwriting AIG Professional Liability