Big Subprime Loss Forecast For D&O Sector Questioned

Recent legal decisions affecting lawsuits arising from the subprime mortgage market meltdown could mean that a multi-billion dollar loss prediction for the directors and officers' insurance sector is overblown, a consulting firm said.

Advisen's findings in a new briefing paper reacted to the Sept. 6 "worst-case scenario" from the Bear Stearns investment firm, which saw a possible $3 billion loss for D&O insurers resulting from the subprime collapse.

The report also finds that government action related to subprime loans could be a "wild card" affecting results, and the situation could alter D&O rates for some sectors.

Written by the New York-based Advisen's executive vice president, David Bradford, the paper stated that "it seems probable that defendants [in subprime actions] will have strong defenses in many of these cases--defenses bolstered by recent Supreme Court decisions--and the actual toll may fall well short of this worst-case projection."

Mr. Bradford added that, "the fact that there have not been more cases filed to date despite the financial carnage may be an indication that plaintiffs' attorneys recognize that these will be difficult cases to win, and are carefully choosing their targets."

The paper found that a variety of companies have been exposed to a wide range of legal actions resulting from the subprime mortgage industry's collapse, with lenders being the major targets.

In addition to lenders, Advisen said, targets for legal action include bond insurance companies, real estate investment trusts, banks and rating agencies.

Causes of action that were mentioned included: allegations of predatory lending, misrepresentation concerning loan values underlying securities, and actions to disguise delinquencies.

The briefing paper found that for the most part, such suits are "far from a slam-dunk," because companies' management is typically not held liable for bad business decisions or lack of diligence unless grossly negligent.

A core issue is when a company knew it had a problem and how they disclosed it.

"Recent Supreme Court decisions that have made it more difficult for plaintiffs to successfully pursue securities class-action suits should especially benefit defendants in subprime-related suits," the paper stated.

Examining the impact of state and federal law on the situation, Advisen said government regulatory and law enforcement roles could either "increase losses to D&O insurers," or help to reduce them through legislative action to bail out troubled homeowners.

The paper said in terms of pricing of D&O insurance, it is "nearly certain that companies involved with mortgage lending, and perhaps companies throughout the financial services sector, will be subject to more restrictive policy terms," while some companies "will have difficulty finding coverage at any terms."

At this point, the paper said forecasts of the impact on the D&O market are murky. It noted one analyst's report that there are hundreds of billions of dollars of subprime mortgage-backed securities sitting on companies' balance sheets, largely unaccounted for.