Mutual Investment Fund Liability Rates Soar

By Michael Ha

NU Online News Service, Jan. 6, 4:17 p.m.EST?Insurers have jumped liability premium rates for somemutual fund companies as much as 500 percent in the wake ofregulators' investigations at a number of firms, a brokerageexecutive said. [@@]

Paul Kim, managing director at Chicago-based Aon Corporation,said the increases in the last couple of months have affectedpremium rates for directors-and-officers and errors-and-omissionsinsurance. In addition to fallout from official inquiries, ratesare reflecting exposures to stockholder lawsuits that result, hesaid. An insurance executive supplied similar information.

The $7 trillion mutual fund business has come under scrutiny inrecent months, by both New York Attorney General Eliot Spitzer andthe Securities and Exchange Commission. SEC action to strengthenits oversight of the mutual fund industry has led to new rules toeliminate abusive market practices.

Mr. Kim told National Underwriter that the impetus forincreases started in September 2003 with the investigation ofCanary Capital Partners, an offshore hedge fund which allegedly hadstruck illegal agreements with mutual funds to carry out favorabletrading at the expense of ordinary investors. (Last September,Attorney General Spitzer's office announced it had reached a $40million settlement with Canary Capital Partners. The firm has alsobeen cooperating in a wider investigation into other misconduct bymutual fund companies.)

"It all started with Canary Capital. And now, you not only havethe other investigations and the potential costs associated withthose, but you also have individual plaintiff actions--shareholdersuits filed against the fund, fund board and the fund advisor," Mr.Kim observed. "And then you also have corporate actions filedagainst any publicly traded corporate advisor."

He also commented that from these developments the insuranceindustry is seeing a spike in liability and loss payments, and thushas been reacting by adjusting premium structure significantly."This increase in rates is largely due to current regulatoryinvestigations," he noted, adding that D&O and E&O ratesfor mutual fund companies have been increasing significantly overthe past two-to-three months.

"Although it's hard to say how much they've been increasingexactly, I would say in an order of magnitude of 500 percentincrease would not be unusual," Mr. Kim related.

Furthermore, he said, the rate revision process is at a veryearly stage and it's likely that more rate hikes will follow. "Aswe know, insurance programs renew every 12 months, so the recentrate increases reflect only two-to-three months' worth of clientsrenewed so far," Mr. Kim said. "So I think clients have toanticipate that even if they are not currently embroiled in all thecurrent investigations, their premiums would increase."

Currently, major players in the mutual-fund product line are TheChubb Corporation in Warren, N.J.; American International GroupInc. in New York; The Hartford Financial Services Group Inc., basedin Hartford, Conn.; Zurich American Insurance Company based inSchaumburg, Ill.; and the New York-based Gulf Insurance Company."And certainly, there is also ICI Mutual, which is the industrycaptive. All these have had to react to current events," Mr. Kimobserved.

Shelia January, senior vice president at Zurich North AmericaSpecialties, one of the major players in this arena, agreed thatmany mutual fund companies have seen jumps in their D&O andE&O rates in the past few months.

She noted that relatively moderate rate increases have beenaround for the past three years, since early 2001, for D&O andE&O coverages for mutual fund organizations, but it wasn'tuntil last September--when the Canary Capital case surfaced--thatrates began to shoot up dramatically.

"The lowest increases that I have seen in the last couple ofmonths have been in the 10-to-15 percent area, and the highestones--for some fund groups that have become household names innewspapers--have been in excess of 100 percent," Ms. Januaryobserved.

The amount of D&O and E&O rate hikes for mutual fundcompanies also depends on a couple of factors. "It depends onwhether they are one of the fund groups that have been named andwere involved in these activities, or if they are one of the fundgroups that have been part of the inquiries and the informationgathering by the SEC and state securities commissioners," Ms.January commented.

She noted, however, there are some fund groups that have not hadany problems at all, "so this creates a real range in rateincreases."

The rate hikes, Ms. January observed, are reflective of claimsthat have been reported and settlements made. But she also notedthat with regard to mutual fund groups' settlements with the SECand others, like the New York attorney general's office, it is notyet clear how much of those could possibly be covered byinsurance.

"And then there are also a lot of civil cases being filed. Ithink further rate increases will depend very much on how thislitigation and inquiries develop," she said.