Subprime loans lead to sublime times for the plaintiffs' bar.The credit crisis has spread beyond arcane financial instruments,such as credit default swaps and collateralized debt obligations.It is affecting all businesses, large and small.

Insurance professionals know the truism, “Bad times lead toincreased claims.obCrLf We are in a bad time, as measured by anoverall drop in equity markets, more bank failures than in the last5 years combined and large-scale layoffs. Some types of claimsalready are on the rise, such as shareholder class-action andderivative lawsuits against corporate directors and officers ofteetering and failed financial institutions. Like an earthquake atsea, the credit crisis hit the financial sector immediately anddramatically.
Our shared experience during the tech-driven equity meltdownbeginning in mid-2000 tells us that although a ripple effect toMain Street on claims is likely, it's unclear how high that wavewill be. Brokers and agents can act now to lessen the likelihoodand severity of claims that may be coming their ways.
Another Fine Mess
Oliver Hardy's classic put-down of his comedy partner, Stan Laurel,should be the title of the eventual Congressional investigativereport of the credit crisis. Today's “fine messobCrLf follows anoft-repeated pattern in the business world, one which we never seemto recognize until it's too late. Whenever somebody starts talkingabout a “new paradigm,obCrLf we should run for the hills, because“new paradigmobCrLf is code for “ignore thefundamentals.obCrLf
We saw it during the savings and loan (S&L) crisis of the late1980s and early 1990s. More than 1,000 S&Ls failed, havingloaned unregulated multiples of their actual assets. The resultinglosses totaled $160 billion, of which you and I (meaning the UnitedStates) paid $125 billion. The loan-to-asset value ratio is one ofthe fundamentals.
We also saw it in the tech-driven stock climb up to mid-2000, theirrational exuberance as then-Federal Reserve Chairman AlanGreenspan called it, followed by the inevitable tech meltdown. The“irrationalobCrLf part was believing, just as some later did withcollateralized mortgage obligations, that a company's stock valueis whatever someone will pay for it, not the value of its earnings.The earnings-to-equity ratio is another fundamental.
The credit crisis resulted from another failure to recognizefundamentals. For years the lending industry relied on anever-inflating housing market, rather than borrowers' actualincomes, to pay for jumbo mortgages with low teaser rates and bigpayments after the first 2 years or so.
These past crises were followed by investigations, token criminalprosecutions, floods of civil lawsuits and new regulations. Thatpattern is being repeated in the credit crisis. We are just seeingthe first inning of what may be a long game.
For the insurance agent or broker, the fundamental principles ofavoiding an E&O claim are the same as they always have been.When a broker has promised to review the policyholder's insuranceneeds, or where the law imposes on the broker a duty to do sobecause of a long-term relationship with a customer, three stepscan mean the difference between winning and losing an E&Olawsuit: 1. Provide options to customers, even for lines or amountsof coverage that you're not certain they are interested in, butmight need 2. Provide options in writing, or send a writtenfollow-up to a discussion about the options
3. Confirm in writing any coverage or limits that the customerdeclines.
Stock Market Drop, Take Two
Because many insurance brokers are dual-licensed in securities, the2000-2004 market drop directly affected them. Annuities, especiallyvariable ones, in retirement plans came under close regulatory andlegal scrutiny, but in a marketwide meltdown there is no safe placeto hide, except for Treasury notes and other government-backedinvestments.
One reliable barometer of investor claims is the number of bindingarbitrations filed against securities brokers in the FinancialIndustry Regulatory Authority (FINRA). In 2008, the rate of filingsof FINRA arbitrations is projected to nearly double the reportsfrom 2007. Through September, 3,469 FINRA arbitrations were filed,a 46 percent increase over 2007, and the number of FINRA casesclosed decreased by 34 percent, indicating the system is becomingoverloaded. The recent peak year for new FINRA filings was 2004,when nearly 9,000 arbitrations were filed.
Insurance agents and brokers who are dual-licensed in securitiesmay find themselves in FINRA arbitrations or civil lawsuits. Ifthey advise or are fiduciaries of any employee benefit plans theymay face suits brought under ERISA, and if they place E&Ocoverage for securities brokers, they may see claims from theirbroker-customers if there are problems with that coverage.
This is an opportunity for us to perform our own risk analysis, toidentify the accounts that may be problematic, and to make surethey have been thoroughly handled and documented.
Policy Limits
Mortgage borrowers often arecontractually required to insure the residence with a sufficientpolicy limit to protect the lender's interest in the home. In adeflating housing market, some borrowers might be tempted to reducetheir home insurance payments, but their agent must know whatamount of coverage the borrower has agreed to maintain. Seeing isbelieving-don't accept at face value a request to reduce propertycoverage limits. Ask the real estate agent and confirm thatresponse in writing.
Financial sector insureds aren't the only ones who might be exposedto credit crisis claims. A good answer to the “how muchobCrLfquestion will provide more than one option.
Where the gist of the claim against an insurance broker is that hefailed to recommend sufficient limits, a plaintiff's lawyer canfind an expert witness who will testify that higher limits wereavailable, affordable and procurable. The best defense is theability to show in writing that the policyholder chose not to buy ahigher limit before the loss occurred.
Insurer Insolvency
So far, no major insurers have gone out of business due to thecredit crisis. But if they do, what can agents do to protectthemselves?
Most states follow the rule that a broker is not liable for placinginsurance with a carrier that is, at the time, admitted in thestate where the risk attaches. One seminal case is Wilson v. AllService Insurance Co. (91 Cal.App.3d 793 [1977]), in which alicensed broker had placed auto insurance for a customer withTransnational Insurance Company, a California admitted insurer.After an auto accident, Transnational was declared insolvent by theCalifornia DOI. Before Transnational was formally liquidated, theinjured plaintiffs settled with Transnational for $10,000, thoughthey claimed they were entitled to $30,000 in damages and $50,000in punitive damages against the carrier for its pre-litigationhandling of the claim. The Court of Appeal in Wilson held that abroker may rely upon the DOI finding that an admitted carrier isfinancially able to do business in the state, and dismissed allclaims against the broker.
It's the insurance commissioner's responsibility to investigate anddecide whether carriers are sufficiently solvent to meritadmission. The broker has no legally imposed duty beyond that. Theinsured's recourse in the event of an admitted insurer insolvency,at least in consumer coverage like auto, is the state's insuranceguaranty association, not the broker's E&O policy.
For non-admitted carriers, the broker's task is not so easy. Ratingagencies may not act immediately to downgrade insurers' ratingsamid rumors of financial trouble, so the broker has little hardevidence to rely upon.
Changing insurers can create risks for brokers, especially innon-standard lines of coverage. For example, no two miscellaneousE&O policies are identical. Once the decision is made to switchinsurers, a careful comparison of alternative policies and coverageterms is needed. An insurer with better financial security won't domuch good if the policy won't cover a typical loss because of anadvancing retroactive date or a material new exclusion. If theinsured decides to change carriers because of concerns about thefinancial health of the incumbent, the broker has done what ispossible to make herself bullet-resistant, so long as the insured'sinformed choice is reflected in the broker's file, preferably in awritten communication to the insured.
Unemployment and EPL
With hard times come layoffs and the temptation to characterize alegitimate downsizing as a personal vendetta by the employer.Insurance professionals are as exposed to the risk of employmentpractices liability (EPL) lawsuits as are their customers. EPLclaims include unlawful discrimination, sexual harassment,retaliatory termination and wage/hour law violations.
Now is a good time to review your own EPL insurance policies andcoverage limits, and suggest that your customers do likewise. TheU.S. Bureau of Labor Statistics keeps track of extended masslayoffs, quarterly tallies of reductions of 50 or more employees bya private employer lasting at least 31 days. There were peaks inmass layoffs in late 2001 and in late 2005. A peak has beenbuilding through most of 2008, and if announced layoffs actuallyoccur, 2008 will set the record for the past 10 years.
EPL complaints filed in the U.S. Equal Employment OpportunityCommission (EEOC) tend to increase in years that follow spikes inlayoffs. The 2001 spike was followed in 2002 by an increase in EEOCfilings (called “chargesobCrLf) of about 5,000 above the 10-yearaverage. The short-lived 2005 spike did not lead to an increase incharges in 2006, though there were 7,000 more charges in 2007 thanin 2006. Since most EPL civil lawsuits are not preceded by EEOCcharges, the impact of mass layoffs on future EPL claims may begreater than these figures indicate.
Desperate times lead to desperate claims. The average cost ofdefense fees in an EPL case in California is $150,000 (notincluding settlements or verdicts), which means that the fees ofgoing through trial are much higher, since more than 90 percent ofsuch cases settle. Against that kind of exposure, a higher premiummay seem reasonable.
A Stitch in Time
Ignoring the fundamentalsled the economy into its past and current slumps. For the agent orbroker, the market slump poses the challenge of not making thepolicyholder's problems your own problems.
Like a cleanly fielded ground ball or an alert runner stretching asingle into a double, a confirming letter or e-mail can change theoutcome. As usual, the fundamentals make all the difference.

Louie Castoria defends brokers and other professionals, andis a humorist in his spare time. He is a partner in Wilson ElserMoskowitz Edelman & Dicker LLP in the firm's San Franciscooffice. The views expressed herein are the author's and are notlegal advice.