The combination of corporate bankruptcies, high-dollarshareholder derivative lawsuit settlements and declines in Side-Apricing may soon turn a profitable niche of the directors andofficers liability insurance market into a money loser, carrierexecutives say.

In fact, according to one veteran D&O underwriter,participants in the Side-A market would already be bleeding red inkon their bottom lines if not for government bailouts of coveredfinancial institutions in recent years.

"Absent that, I think we would have adebacle of proportions that you can't imagine" in the Side-Amarket, said Greg Flood, president of New York-based IronPro.

Mr. Flood and John Rafferty, executive vice president of ArchInsurance Group in New York, gave their views on the Side-Acoverage niche of the D&O market early this month during theD&O Symposium of the Minneapolis-based Professional LiabilityUnderwriting Society held in New York.

Following the meltdowns of Enron and WorldCom, "the A-marketreally exploded," Mr. Flood said, recalling a time when directorsbegan worrying about the potential to face personal liability atthe same time as full D&O A-B-C policy limits were being erodedat troubled companies.

The "A" coverage part of a full D&O A-B-C policy and theseparate Side-A policies that began to proliferate during the lastdecade both respond to non-indemnifiable D&O losses—in otherwords, losses for which a corporation can't indemnify directorsbecause of statutory prohibitions in a state, because thecorporation is financially impaired, or some other reason.

Separate Side-A policies can provide added limits for certaingroups of directors above the coverage of an underlying A-B-Cpolicy and may provide drop-down coverage or carry fewer exclusions than A-B-C policies.

Since the Side-A policies came on the scene during the lastdecade, the market has "grown pretty much exponentially," Mr. Floodobserved, while Mr. Rafferty speculated that there might be 60carriers now offering the coverage.

In the years between the Enrons and WorldComs and the creditcrisis, however, Side-A policies were not really called upon torespond to losses, Mr. Rafferty said.

"We've seen panels like this talk about this in theory foryears"—that the losses would come—"and now finally we're here," hesaid, highlighting recent settlements of shareholder derivativecases, including a $75 million case against pharmaceutical giantPfizer, which was covered by the Side-A carriers.

Mr. Rafferty went on to admonish D&Oinsurers for failing to keep Side-A coverage pricing at levelsadequate to cover the derivative-suit losses and claims related tocorporate bankruptcies.

This "has been the best subset of the business…for allconstituents, [including] the underwriters, the reinsurers, thebuyers and the brokers," he said. Reviewing the good run thepolicies have had for these groups, he noted that Side-A:

• Gives a tremendous amount of comfort to thebuyers.

• Has been welcomed by brokers because it is generallya new product for them to talk to insureds about.

• Represents a part of a primary carrier's portfoliothat has been easy for reinsurers to model, thereby helpinginsurers get better reinsurance terms and pricing.

"I think we were all fat, dumb and happy around SideA," Mr. Rafferty concluded. "It was fairly easy to write thatproduct to a minimal if not nil loss ratio year after year if youavoided failures—and there weren't any failures," he said.

That was before the global financial crisis and the economicdownturn.

"Now, we have been in an environment where there are hundreds ofcorporate bankruptcies. So not only is that portion of the equationharder—that's a tougher bullet to dodge—but now you've got solventcompanies that might have derivative settlements that are tens ifnot hundreds of millions of dollars, all while we just crushed thepricing," he said.

Mr. Flood said there are "certain industries that don't deservea break on anything" related to D&O coverage, including Side-Apolicies, referring specifically to financial institutions that hadto be bailed out by the federal government.

Going back in history, he reviewed bank failures during theSavings & Loan crisis in the 1980s. "The federal government hadto intervene. The Resolution Trust Corp. was formed. The bad assetswere assumed by the government. The good assets were put back out,and the government declared that they were going to have a muchhigher level of regulatory alignment with the risks of the banksand that this was a once-in-a-lifetime event," he said. "It was thefirst time since 1930" that anything like the S&L crisis hadhappened.

Fast forward less than 30 years later, "and we have somethingthat is so spectacularly [messed] up that it takes the entireglobal economy down and has a level of intervention that exceedsanybody's wildest imagination," he said, referring to the downfallof investment banks as a result of the subprime meltdown and creditcrisis.

"And what happened to the benefit of the D&O market?" heasked. "The government took [some of the] blown-up companies androlled them into healthy ones, and the Side-A contracts never paidout," Mr. Flood said.

"Think of what would have happened if Merrill had gone down, ifBear Stearns didn't get rolled into Chase. Just start rolling themoff in the back of your own mind. They are big, big dollars," hecontinued.

"We got really, really lucky, and if we're stupid enough toignore that fact and price ourselves into the ground until the nextone comes around and we're wiped out, it's our own fault," heconcluded. "The evidence is in front of us."

Mr. Rafferty offered some arithmetic to make a similarpoint.

"If every facility would go and just isolate [and] look at yourSide-A book, look at the limits you have exposed, if you have anysizable book at all, that number is in the billions," he said,advising the underwriters to then compare that exposed-limitsfigure to the total premiums they're collecting on the samepolicies. "It's not that much. Start doing the math," he said.

He noted that there's only a 5 percent subset of the industry,representing the toughest D&O risks, that pays $100,000 permillion of limit for Side A. "If you carve that, then really whatyou have left is a book of business that might be priced at fivegrand per million," on average, he said. "How many of those risksdo you have to write to fund one loss? 225? 250? 275? And is thatreally realistic?" he asked.

"I have a concern that this wonderful part of our business,we're just crushing," Mr. Rafferty concluded.