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September 2012 Bermuda Re/insurance


“For financial institutions pricing had increased, driven by the volatility of results, stock prices and what has happened to financial institutions since 2008.”


Jim Gray, chief underwriting officer—professional liability insurance at Alterra, spoke of a “stabilisation of pricing and a potentially upward turn” on non-financial D&O, with financial D&O making similar upward movement, but with pricing at more generous levels. Addressing financial institutions D&O, Gray said that while commercial banks have always exhibited “much larger buying appetite” than other corporates, capacity has been that much more constrained as the loss performance of financial institutions has lagged behind those of the corporate entities. “As a result, pricing has been a little higher on a price-per-million basis, as expectations are that the level of claims will remain high”. Irvine likewise indicated that for financial institutions “pricing had increased, driven by the volatility of results, stock prices and what has happened to financial institutions since 2008”.


Gray said that two factors were playing into the pricing dynamic.


The first of these was the fact that “additional capacity coming into the market seems to have stabilised”. Linked to this and playing its part in the rate environment is the “investment return climate, which is affecting the return on equity of most re/insurers, meaning that underwriting pricing has necessarily become more important for earnings”. These factors have outweighed the additional capacity of recent years, he said, with price rises evident in the primary and low loss excess layers of business, with “higher excess layers still exhibiting price reductions as excess capacity there remains plentiful”, although Gray did predict that this would stabilise “as the cycle works its way through”.


Shades of Madoff


The most seismic event of recent years for professional liability was the financial crisis of 2008–2009, which continues to have lasting repercussions for the line. The fallout from that period has been protracted and the scandal over Libor—which, according to a professor of finance at MIT “dwarfs by orders of magnitude any financial scam in the history of the markets”—suggests that liabilities emanating from the crisis are not likely to go away any time soon. And neither has shareholders’ desire to recoup losses regarded as being the fault of the financial institutions in which they were stakeholders. Some of the losses may well stem from plain bad luck as the shock waves of the crisis affected the earnings of financial institutions, said


Gray. In other instances malfeasance or misfeasance was involved and exactly which is the case “is still winding its way through the system. Insurers have already paid a significant amount in losses” related to the crisis, said Gray, with further sums to come. He predicted that the period would likely “result in an overall industry loss for underwriters involved in the financial institutions (FI) business”.


Jeffrey Jabon, senior vice president and head of professional lines at ACE Bermuda, said that the crisis had proved a major issue for the line as “significant additional exposure was introduced into the insurance market by virtue of the solvency risk associated with companies’ financial difficulties”. Legal action against troubled firms had risen sharply since 2008, he said, with “litigation a function of increased exposure relative to deteriorated credit profile, share-price devaluations and with conditions further complicated by additional regulatory scrutiny”. He added that an initial challenge for plaintiffs was identifying particular issues with an institution in the wake of such a systemic event as the financial crisis, but indicated that the financial sector can nevertheless expect to face further litigation, with evident implications for D&O as issues specific to the management and corporate governance of some institutions come to light. He suggested that greater public awareness of corporate misconduct and malpractice has left “blood in the water. And when that happens, it tends to attract sharks”.


Further complicating the issue of FI D&O has been the “number of companies that went bankrupt as a result of the crisis and the number that are now, for all intent of purposes, nationalised”, said Irvine. The nationalisation or part-nationalisation of financial institutions significantly increased scrutiny—from both shareholders and the regulators—he said, with the crisis helping to usher in regulatory measures such as Dodd-Frank and Basel III, which will create further potential pitfalls for the sector. These developments have in turn “created challenges for insurers as they have sought to understand how they write professional liability coverage with the new regulations in place”. And nationalisation has not meant that potential liabilities have gone away. As Irvine indicated, shareholders that have had their positions wiped out during the financial crisis are still pursuing claims against nationalised entities. “Those liabilities live on. Shareholders are still looking to losses associated with the financial crisis.”


Jabon suggests that “such behaviour is nothing new”, rather it is a product of the cycle—“when the tide goes out you can see what has been going on below the surface”. Jabon warned that “whenever the stock market depreciates there is the effect of an inverse relationship to increasing shareholder litigation risk.” Gray added that following the crisis and its ensuing scandals the “banks are still sorting out their business strategies and profitability, while underwriters are struggling with expectations of future loss flow and increased regulation—both current and anticipated. It has been one issue after another for the sector”. Libor is just the most recent incarnation and Gray reckoned


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