The credit crisis is going to reverberate further into the insurance industry, with $5.9 billion in directors and officers liability insurance losses, a new report contends.
“It’s really an unprecedented situation right now,” said David K. Bradford, executive vice president of New York-based Advisen Ltd., which produced the report.
The losses will be spread across 2007, 2008 and 2009, thanks to a dramatically increased number of securities class action suits, securities fraud suits brought by regulators and law enforcement agencies, losses under Side A policies from bankruptcies and shareholder derivative suits, the report said. The figure also includes defense costs with dismissed suits.
Directors and Officers liability insurance, commonly known as D&O, is the policy companies buy to protect their executives and board members from lawsuits related to the performance of the company. Lawsuits filed by consumers will also likely arise from the mortgage crisis, but most of those claims would be paid by errors & omissions insurance – costing the insurance industry another $3.7 billion, according to Advisen.
The $5.9 billion figure for D&O claims is an increase from the $3.6 billion Advisen predicted in February, prior to some of the major financial institution meltdowns.
Unanticipated Claims
One concern is that many companies have only been buying Side A coverage, which is a limited version of D&O insurance that kicks in if the purchasing company is unable to cover the lawsuit costs itself. These policies were relatively inexpensive compared to more comprehensive policies, because they only apply in rare situations – like bankruptcy. The unexpectedly high number of financial institution failures have made claims on these policies much higher than anticipated. “With the number of bankruptcies beginning to rise, all of this really cheap coverage that was sold with enormous limits is suddenly exposed,” Bradford said.
Some of the biggest writers of D&O insurance for financial firms are also some of the biggest names in the industry overall. In fact, according to Advisen’s estimates, the largest – with 19 percent market share – is AIG.
As a side note, while the portion of the D&O market related to financial institutions is being decimated by claims and the premiums are skyrocketing, not all segments are suffering. D&O insurers that cover other sectors are doing relatively well and continue to have plenty of capacity. This is in spite of the current volatility in the stock market – something that normally results in many shareholder lawsuits.
Bradford called the current environment is “uncharted territory,” adding, “I have to believe that the level of volatility is not going to result in as many lawsuits as might be expected.”
This is because plaintiff’s attorneys seem to be cautious about filing claims right now, due to the high costs, and because “there’s a belief that the market cap losses are going to be attributable to these macro causes that are out of control of the particular companies,” he said.
However, Bradford warned that if the mortgage crisis extends deeply into the prime mortgages, there could be a whole new round of lawsuits that could increase the D&O costs for insurers and affect segments of the industry beyond the financial services sector.
“The question becomes, at what point does the whole credit crisis just become the economy?”
