Tale Of Two Markets For Fiduciary Liability

Rates rise for public companies, stay flat for "everyoneelse"

Fiduciary liability insurance is increasingly gaining attentionas a valuable product, although, as with many insurance products,this is only occurring because recent events have spotlighted whyit is needed in the first place.

Once considered to basically be a "throw-in" with thetraditional directors and officers coverage, a wave of majorlawsuits in recent years has brought fiduciary liability coverageinto the spotlight.

"The fiduciary liability market is getting some very rudeawakenings," said Steve Shappell, senior vice president for AonFinancial Services Group. The industry is now seeing a number oflarge fiduciary claims and increased litigation activity, he said,with the Enron case being perhaps the most well known.

Fiduciary liability insurers, he added, are seeing oneparticular kind of litigation rising, based on the federal EmployeeRetirement Income Security Act. These ERISA-based lawsuits, whichoften "tag along" with a traditional securities lawsuit, can occurif the employee pension plan has purchased stock in thecompany--and the stock declines due to some adverse financialdisclosure. In the tag-along suits, traditional securities lawsuitclaims are repackaged to allege breaches of fiduciary duty.

Suits such as these are becoming more frequent, making for whatMr. Shappell called "a very volatile market right now."

Evan Rosenberg, a senior vice president and global specialtylines manager for Chubb Specialty Insurance, said the fiduciaryliability market is currently being viewed as two separate groups:publicly owned companies with company stock in their 401(k) plans"and everyone else."

Although Enron was the first case to draw significant attentionto the fiduciary liability issue, Mr. Shappell noted it was not thefirst case to raise those issues. "This phenomenon actually startedbefore Enron--although not to the enormous size that we've seen inthe last few years," he said.

Stan Quirk, president of ARC-Mid Atlantic Excess & SurplusInc., also pointed to the rise of so-called "tag-along" lawsuits asa cause for the "turmoil" being experienced in the fiduciaryliability market.

For buyers of insurance, Mr. Shappell said, the environment hasled to an increased awareness of their responsibilities andpotential liabilities when it comes to the employee pension fundinvestments.

When these investments lose money, or fail to live up toexpectations, these parties "recognize they're at risk," he said."It's their job to get that money back in the plan."

Cases for fiduciary liability have resulted in settlements, someof which Mr. Shappell noted were "very large" and not in line withthe expectations held by many companies when policies tagged forcoverage were written.

The reason companies--and their insurers--are agreeing to suchlarge settlements, which are typically for the full policy amount,according to Mr. Rosenberg, is because the means of beating theseclaims remains undiscovered.

"There are no good court cases out there to show any gooddefenses," Mr. Rosenberg said.

In response to increasing claims payouts, Mr. Shappell notedthat insurers have raised rates. "The corresponding result is thatprices...have risen as companies have been taken by surprise alittle bit," he said. While some claims are always expected byinsurers, he said "the insurance market is being surprised by thefrequency and the severity" of these claims.

As an example, Mr. Rosenberg said that a fiduciary liabilitypolicy with a $25 million limit and a $100,000 deductible wouldhave cost roughly $125,000 two years ago. Now, he said, that samecompany could only get roughly $10-to-$15 million in coverage, witha deductible likely around $2 million and premiums as much astwo-to-three times higher.

Mr. Quirk noted that insurance companies have also begun to keepa much closer eye on what coverage they are writing, trying todetermine the extent of potential liability that a policy cancarry.

"Insurance companies have a problem," he said. "They have to askthemselves 'Do I want to write this account?' and 'How do I feelabout the risk?'"

Chubb is among those companies that have raised prices, and Mr.Rosenberg said the company believes that prices will continue to goup. He noted, however, that some of the company's competitorsappear to feel as though prices are adequate.

As other companies maintain their rates for fiduciary liabilitycoverage, he said that at some point--"in the next year ortwo"--their reinsurers will take notice of the exposure and beginreducing their capacity.

"It will take a while for the reinsurers to see," he said. Chubbis among the top three companies for fiduciary liability coverage,which Mr. Rosenberg said gives the company a better perspective onthe market. "There tends to be a lag between what we see and whatothers see."

Mr. Shappell also feels the market can expect to see continuedtrends of increasing premiums and careful underwriting.

"The market is not hard," even though pricing for fiduciaryliability coverage on its own "is catching up with D&O," Mr.Shappell said. "There's still room to go up."

But the problems facing fiduciary liability insurers are fairlylimited to those companies with public ownership and company stockin their 401(k) plans, experts say. Conditions for the "everyoneelse" portfolio, Mr. Rosenberg noted, actually remain quitefavorable. "If they don't have any company stock in their 401(k)plan, the market is actually very reasonable," he said, withpolicyholders seeing "modest increases" or flat renewals.

Going forward, Mr. Shappell said that fiduciaries, and theirinsurers, should not expect the wave of litigation to end at anytime in the near future.

"Unfortunately, we're going to have to continue to feed theselions," Mr. Shappell said of the plaintiffs' bar, which he addedhas "found a niche" in these types of suits in which they cancontinue to make money.

From a legal standpoint, Mr. Shappell said, the problem is that"tag-along" lawsuits are "low-hanging fruit." In a securitieslawsuit, he said, the plaintiffs need to prove there was some actof fraud, but the standard of proof for these ERISA-based claims ismuch lower, making it easier for plaintiffs to make their case andproviding more inducement for defendants to settle.

Mr. Quirk took a similar line of thinking, explaining thatpublic companies should just assume that if they face a regularsecurities class action lawsuit, then a "tag-along" ERISA suit isinevitable.

"We've got to deal with it," he said. "If you're going to get asecurities claim and your plan has company stock, then guess what?You're getting an ERISA 'tag-along' claim."

Additionally, he noted that the cases have caused insurers toseek more restrictive limits on their fiduciary liabilitypolicies.

With seemingly no successful strategy for insurers in defendingagainst these "tag- along" lawsuits, Mr. Rosenberg said that Chubbhas been working to change the system on which they are based. Thecompany has been meeting with the Department of Labor and severaltrade groups, he said, seeking to devise some rule to help limitthese suits, or some industry "best practices" to help companiesavoid them.

The insurance industry, on the whole, has achieved a fairmeasure of success this year in getting tort reform measurespassed, such as class action reform legislation. But Mr. Shappellsaid it would be unrealistic to think that a similar solution willhappen for fiduciary liability legislation, or even that such asolution would be proposed.

Given all the attention paid to cases such as Enron, or the morerecent WorldCom case, he said, "it would be political suicide" forany policymaker to even suggest changing those laws.

"Tag-along" lawsuits are "low-hanging fruit," with much lowerstandards of proof required to bring these cases than securitieslawsuits, Aon's Steve Shappell said.

"There are no good court cases out there to show any gooddefenses."

Evan Rosenberg, SVP, Chubb Specialty

Art caption:

According to fiduciary liability market experts, tag-along suitsare an inevitable companion to securities lawsuits. "We've got todeal with it. If you're going to get a securities claim and yourplan has company stock, then guess what? You're getting an ERISA'tag-along' claim," says Evan Rosenberg of Chubb Specialty.