After an unexpected second-quarter dip, securities lawsuit filings shot back up in the third quarter. But the reversal, which could trigger more future directors and officers liability insurance payouts, had little pricing impact, experts say.

In a quarterly report published late in October, New York-based Advisen tallied 169 filings in a database that the firm refers to as the Master Significant Case and Action Database (MSCAd). Although the third-quarter figure represented an increase of 11 percent from 152 filings for second-quarter 2009, both the second- and third-quarter counts were significantly lower than a record-setting 249-suit first quarter.

In fact, the first-quarter filing pace was so active that Advisen couldn't even capture an accurate total in an initial report on that quarter's suit statistics published in May of this year. That report had indicated just 169 filings for the first quarter–80 suits below the first-quarter total as it stands today.

"There were quite a few late-reported events," according to David Bradford, co-founder and executive vice president of Advisen. (For details about the initial report, see NU Online News Service, May 25, "First-Quarter Securities Lawsuits Total 169, Advisen Says," at http://bit.ly/LnBDY).

Mr. Bradford noted that the first-quarter numbers "were driven pretty substantially by cases related to Madoff," referring to the litigation fallout from an alleged Ponzi scheme orchestrated by Bernard Madoff. "On the heels of the Dec. 11 arrest, there was just a whole flurry of suits," he said.

Advisen's third-quarter report reveals that Madoff-related filings "fell off a cliff" in the second and third quarters, plummeting from 54 tallied in the first quarter to 17 in the second, and just six in the third.

Also pulling down the overall suit totals was a drop in credit-crisis related suits, Mr. Bradford said. These suits numbered 46 in first-quarter 2009, falling to 24 in the second quarter and just nine in the third.

"It may be too early to call an end to the litigation activity there, but certainly we see some downward activity and may be looking at the end of this [credit-crisis activity] in the coming quarters," Mr. Bradford noted.

Turning to the overall numbers, Mr. Bradford said it is difficult to pick out one quarter as being reflective of the overall trend for the year.

"What's the more representative, the second quarter or the third quarter? It's hard to say. But I think there was probably just a little bit of taking a breath after that frenetic first quarter," he said, explaining the lull suggested by the low second-quarter total.

Annualizing the third-quarter total with a simple extrapolation technique (multiplying the quarterly total by four) produces a 676 suit total for the year–a 3 percent drop from the record-setting 2008 total of 697 securities suits, but higher than any previous year since 2001, when 684 cases were filed in the wake of corporate meltdowns at Enron and other firms.

Annualizing the total for the first three quarters instead, the first-quarter activity drives a higher estimate of 760 suits for the full year.

No matter which extrapolation ends up to be closer to the actual total when the year winds down, Mr. Bradford said one key trend that leaps off the pages of Advisen's analyses for all three quarters is the fact that securities class-action filings–filed by private plaintiffs alleging violations of federal securities laws–did not account for the bulk of securities suit filings this year.

That distinction instead goes to securities fraud suits filed by regulators and law enforcement agencies, Mr. Bradford said.

According to the report, the overall suit filing breakdown for the third-quarter is:

o 70 securities fraud suits, accounting for about 41 percent of the total 169 securities suit fillings.

o 55 traditional securities class-action suits, accounting for 33 percent.

o 27 breach-of-fiduciary suits–16 percent of the total–which may allege some breach on the part of the board of directors, but could name someone else, such as a fund manager, for example, Mr. Bradford said.

(Editor's Note: The inclusion of suit categories other than class actions explains why Advisen's 2008 total of 697 appears out of line with more typical figures reported by other research organizations, which put out numbers in the 210-to-225 range. Advisen reported 230 securities class actions as just one part of its 697-case total for last year.)

Referring to the level of regulatory actions, which has outpaced private class actions for three straight quarters, Mr. Bradford said "the Securities and Exchange Commission, under the Obama administration, is being more fully staffed and has a much more aggressive mandate for enforcement."

Coverage for regulatory enforcement actions has been a hot topic in recent years at the Professional Liability Underwriting Society's symposiums, and Mr. Bradford echoed the beliefs communicated by broker experts speaking at those seminars–that while fines and penalties are typically not covered, defense costs can be covered.

What about costs incurred before a regulator files a suit–during the course of an investigation?

"If you're racking up costs for outside attorneys associated with regulatory action, then that could very well be covered under the policy," he said.

Asked if he thought underwriters might be less inclined to cover such costs going forward, as the securities fraud suit numbers continue to climb, Mr. Bradford agreed that possibility exists–"except at this point in the market cycle, it's still a pretty competitive market outside of the financial institutions sector. Underwriters may be taking a harder look at it, but I'm not sure the leverage is available to them at this point in time to do anything about it," he concluded.

Giving a broker's perspective, Chris DiLullo, senior vice president in the Washington, D.C. office of Lockton, said coverage can hinge on the question of whether the insured is the target of an investigation or is just an involved party in an investigation where a regulator is targeting someone else.

"That fact doesn't change the seriousness and expenses that an organization will incur to comply with the investigation, but it does raise coverage questions as to whether or not their D&O insurance policy gets triggered," he said, noting that not all policies respond.

Asked whether insurers are taking any actions to broaden the coverage or clarify the wording, Mr. DiLullo said that carriers were more likely to broaden A-side contracts than traditional A-B-C policies.

(Generally, A-side coverage responds to non-indemnifiable losses, where a corporation can't indemnify directors because of statutory prohibitions in a state, because the corporation is financially impaired, or for some other reason.)

"Broad-form A-side coverage is the most competitive sector of the D&O industry right now," Mr. DiLullo believes. (For more on Side-A market conditions and buyer interest, see related article in the upcoming Nov. 30 edition of NU's e-newsletter E&S/Specialty Lines Extra to be available at www.property-casualty.com.)

SOFTER PRICING AHEAD?

While experts speaking to NU last year at this time were confident the D&O market would harden in 2009, and while surges in suit statistics early this year might have suggested a turn to higher premiums was imminent, Mr. DiLullo and Mr. Bradford confirm that soft market conditions prevail in the third quarter.

What level of securities suits will it take to change the direction of the market?

"Despite all of the other issues, the power of supply and demand seems to be the X-factor," according to Mr. DiLullo. "It seems to be the most persuasive element driving the market from a pricing perspective," he added, overwhelming the combined impact of regulatory actions, Ponzi schemes, the overhang of the subprime/credit crisis, and increasing numbers of bank failures and corporate bankruptcy filings.

With the stock market improving and the prospect that suit statistics for 2010 will come in lower than 2009, is the opposite prospect a possibility now? Will the D&O market become even more competitive?

Mr. Bradford responded that "claims definitely have an impact, but the bigger impact is the amount of capacity in the market–and right now there is just a tremendous amount of D&O capacity chasing after a finite amount of premium."

Both experts said commercial firms outside the financial institutions segment are seeing stable or declining D&O insurance prices–with one exception, that being highly leveraged commercial organizations.

"I think it started a year ago, [when] the inability to refinance debt because of the freeze in the credit markets caused underwriters to look closely at [insureds'] schedules for debt maturities, their access to capital, and their liquidity or ability to service existing debt," Mr. DiLullo said.

In a market update briefing on Lockton's Web site, he explained the trend further. "With equity valuations impaired across most industries, traditional measurements of risk, such as stock volatility, are currently out of favor," he wrote.

"Companies with liquidity or debt issues can expect to face renewal challenges marked by reduction in capacity, higher premiums and increase[d] retention levels," he wrote, adding that "attempts at coverage restrictions, particularly connected to creditor claims, can be averted through focused and skilled negotiating."

He told NU that factors such as insider ownership of equity can "begin to diffuse underwriter concerns" about potential loss severity. "We are finding that underwriters are still differentiating risk," he said, noting even leveraged firms with good risk profiles can still enjoy flat-to-down pricing.

Asked to give a sense of price decreases possible in the current market for the best non-FI risks with no issues, Mr. DiLullo said he'd seen program decreases in the 10 percent range. "I don't want to mischaracterize that, though. It's not as if everyone's getting a 10 percent decrease," he cautioned.

Still "there is a lot of competition for good business, and an oversupply of capacity to meet current demand," he added, attributing the oversupply to three sources:

o Companies that want to get into the D&O business and have done so.

o Companies that have been in the D&O business, but want to get closer to the risk and get more premiums.

o Companies that have repositioned themselves with stronger appetites.

"There was a movement early this year by some market leaders to firm up the pricing. I think while they tried and were initially prepared to walk away from some business, now that sentiment has changed.

"Those carriers now are motivated to keep what they have and they're willing to negotiate on rate a little more," he said, declining to identify the insurers beyond describing them as "two or three historic leading carriers."

In addition to these "recommitted" markets, some insurers that had traditionally been excess markets now want to compete for primary business, Mr. DiLullo noted.

"There's been some shifting in the underwriting community," he said. "Groups of underwriters have left the companies they were with [previously] to start up [new] facilities [and to join] facilities that were in the business but weren't necessarily known for writing a lot of primary," he said.

Special Reports /

Capacity Trumps All Other Issues Fueling Persistently Soft D&O Market

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