Bear Market Will Spark More D&O Actions, Broker Says

NEW YORK--While insurers are increasingly worried over legal action after the subprime mortgage market collapse, the real concern for writers of directors and officers insurance should be the falling stock market, an Aon broker told an industry meeting.

In a presentation titled "Directors and Officers Insurance Outlook 2008: It's All About The Subprime," Michael D. Rice II, Aon Financial Services Group chief executive officer, said that when it comes to the directors and officers liability insurance market, "subprime itself will not kill the D&O market." He added, "I'm more concerned about the bear market than subprime."

In remarks yesterday at a meeting of the Association of Professional Insurance Woman here he discussed the domino effect that failure of home buyers to pay mortgages they could not afford has on the financial markets.

The ease of issuing credit, which has allowed the debt of individual Americans to balloon 130 percent based on the percentage of individual income, has put people in a position where it is difficult to impossible to pay back their debts, said Mr. Rice.

The dramatic rise in the resulting defaults and foreclosures has sent the economy into a credit crunch, and that is affecting new credit, cutting jobs and slowing spending as well as causing a new bear market (dramatic downward swing in the stock market), he said.

For D&O writers, Mr. Rice asked whether insurers are adequately writing future risk.

He noted that from 2002 to 2006, there has been a noticeable drop in the number of securities suits that drive D&O activity--something that some speculated would eventually put claim activity at 100 or less a year. In turn, premium rates have dropped.

However, Mr. Rice said he believes the cause of this drop is not legal and regulatory reforms to eliminate frivolous lawsuits, but a prolonged bull market (increased swing in the stock market).

"People are making money; why would they sue?" he observed.

In 2007 there were 177 securities claims filed, he noted. He projected that by the end of 2008 there will be around 215 actions. About 75 will be related to subprime investments and the remainder not connected to the subprime meltdown.

Taking into account the fact that the 262 percent increase in D&O premium in 2002 has been relinquished through decreases over the years, Mr. Rice said there are real questions about whether insurers are now collecting enough premium to cover future losses.

He said class-action lawsuits filed today will take about three years to settle, and that each action will cost insurers $22 million, not including defense costs. Those costs, he estimates, are three times what they were in 2000.

The total premium volume today, he estimates, stands at somewhere around $9 billion, and current claims exposure could top out at $6 billion. But those figures are based on optimistic assumptions, he suggested.

Insurers need to be concerned about the future of their D&O underwriting, he said. If claims continue to rise it will prove to be a tough environment for insurers to continue to make money, he predicted. Another concern for the industry is the decrease in reinsurance the carriers have purchased, taking on more retention.

"That scares me a bit," he said.

He said underwriting will change at some point, as losses worsen, but he hoped that carriers have learned lessons from the past and will avoid dramatic increases, such as those they imposed in 2002.

"It should be a more consistent experience and should not happen," Mr. Rice said.