Financial Institution Underwriters

Weathering Very Volatile Conditions

Carriers face growing claims frequency and severity, but ratesstable for most insureds

It's not easy being a directors and officers or errors andomissions underwriter for financial institutions.

These carriers not only have to face an environment of growingregulatory scrutiny over financial companies, but also have to copewith the long-tail nature of the coverages they offer, as policieswritten several years ago now come to fruition.

Indeed, the situation for financial institution D&O andE&O underwriters gets so challenging that "the single mostimportant issue facing the industry every year is the question,'Will we make money on these two lines of coverage?'" said BarbStafford, national director for financial institution specialtyliability at the St. Paul, Minn.-based St. Paul Travelers, one ofthe leading carriers offering these two coverages.

"It goes without saying that we'll continue to see various formsof corporate misbehavior resulting in D&O and E&O claims,regardless of class of business. The toll of these claims will nodoubt pressure industry profitability."

Ms. Stafford emphasized that since both D&O and E&O arelong-tailed coverages, it typically takes three-to-seven years fora claim to fully develop--which means carriers are still paying forlong-forgotten financial scandals of yesteryear.

"As an underwriter, the events of the past five years will havegreater impact on the D&O and E&O lines for financialinstitutions and other corporations than what happened in this pastyear," she said.

Adding complexity to the long-tail nature of the coverage is thefact that both D&O and E&O claims continue to grow infrequency and severity--and that the costs to defend claims is onthe rise.

Ms. Stafford also noted that with growing oversight and scrutinyby the Securities and Exchange Commission, institutional investorsand other industry watchdogs, underwriters have seen some veryhigh-profile cases impacting the insurance, funds and brokerageindustries.

"Add to that economic uncertainty, and what you end up with is avery precarious environment in which to successfully write thesetwo coverages," Ms. Stafford said.

Scott Meyer, president of financial institutions group at NewYork-based National Union, an AIG member company and also one ofthe largest providers of financial institution D&O and E&O,echoed similar sentiments about the marketplace. Generally, Mr.Meyer said, loss trends have been deteriorating as old cases frominitial-public-offering laddering and investment-banking scandalscome to settlement.

(IPO laddering, also known as tie-in cases, alleged wrongdoingin the process by which lead securities underwriters that handledinitial public offerings allocated IPO shares to their customers.According to Stanford Law School Securities Class ActionClearinghouse/Cornerstone Research, there were more than 300laddering cases filed in 2001.)

"Profitability varies by segment and changes every year. And ittakes many years to play out," he said.

Mr. Meyer said "policies from 1997 to 2000 are havingsignificant claims. They are at a point now where they have to bepaid by carriers. Like Enron and WorldCom, these policies arecoming to fruition now."

(Regulatory settlements are usually not insurable, but financialinstitution underwriters may have to pay for defense costs alongwith other expenses such as private civil litigation,representatives said.)

Compounding these claims patterns, said Theodore Boundas,insurance attorney and senior principal at Boundas, Skarzynski,Walsh & Black LLC in Chicago, is the fact that with regard toinvestment banking--in particular with the large strict liabilitycases such as WorldCom and Enron--the underlying litigation inthose cases does not require a finding of fraud. Instead, all thatis needed is a showing that the investment bank did not perform duediligence.

"Because the focus is now on due diligence, this negates orminimizes the applicability of the fraud exclusion under mostinsurance policies," Mr. Boundas said. "This setup results in thepotential for large exposure to the investment banks and resultingexposure to their insurers."

Mr. Meyer from National Union also said financial institutionunderwriters are now working through two issues: mutual fundssituations, whose claims are coming in relatively steadily, and theinsurance sector, in light of the trouble that insurers andreinsurers have had.

For mutual funds, there are now coverage exclusions that dealwith late trading and market timing--activities that were at thecenter of regulatory investigations. Financial institutionunderwriters are also responding to regulatory scrutiny over theinsurance sector by adding certain exclusions in some cases.

Evan Rosenberg, senior vice president of Warren, N.J.-basedChubb Specialty Insurance, one of the largest providers of E&Oand D&O for financial institutions, said that because ofconcerns over finite reinsurance, E&O and D&O underwritersnow sometimes add finite reinsurance exclusions depending onperceived exposures.

"For such exclusions, wording will be different for eachcustomer. It's based on what each account is doing," heexplained.

As for pricing, executives from these major financialinstitution underwriters said premium rates are still stable formost financial institutions--unless they have been a target ofinvestigations or negative publicity.

"Overall, financial institution rates currently are flatcompared with rates from a year ago," said Mr. Meyer from AIG. Buthe forecast that rates may go up by 5-to-10 percent in the nextyear as more claims from policies written three-to-seven years agofully develop.

Mr. Rosenberg from Chubb observed that a handful of very largecompanies in the insurance sector saw large, double-digit rateincreases this year. But other than those, there wasn't muchincrease for the rest, he said.

Ms. Stafford from St. Paul Travelers observed that while therewas a brief insurance market correction from 2001 to 2003, during2004 and throughout most of 2005, there has been ample capacity inthe marketplace to drive pricing down and expand coverage terms andconditions.

In current pricing, she added, "what's most perplexing is thatmany D&O and E&O underwriters are choosing to ignore losstrends, as well as the significance and impact of various insuranceindustry issues."

And for the most part, recent news of troubles involving theonce high-flying hedge fund segment isn't too much of a concern forfinancial institution underwriters either, since less than 20percent of hedge fund firms typically buy professional liability,according to AIG.

Chubb added, however, that some underwriters covering hedgefunds are taking a closer look at their practices and are in somecases raising rates for more aggressive hedge funds with morecomplex and esoteric investment schemes.

Michael Ha is a former Assistant Editor for NationalUnderwriter. He is now working as a freelancer in New YorkCity.

Quotebox with a photo:

"Policies from 1997 to 2000 are having significant claims. Theyare at a point now where they have to be paid by carriers. LikeEnron and WorldCom, these policies are coming to fruition now."

Scott Meyer, President

Financial Institutions Group

National Union

In some high-profile investment banking cases, "because thefocus is now on due diligence, this negates or minimizes theapplicability of the fraud exclusion under most insurancepolicies," said attorney Theodore Boundas.

"What's most perplexing is that many D&O and E&Ounderwriters are choosing to ignore loss trends, as well as thesignificance and impact of various insurance industry issues," saidBarb Stafford of St. Paul Travelers.