SubPrime Litigation May Dent D&O Insurers

State Street Corp.'s (STT) decision to set aside $618 million to cover subprime litigation costs has increased concern that insurers offering policies covering such expenses could be hit with big claims from the credit crisis.
State Street said the reserve was needed to pay for lawsuits and possible settlements stemming from complaints about the fixed-income strategies managed by its State Street Global Advisors investment arm. The funds were hit by exposure to falling subprime mortgage markets and a lack of liquidity, the company explained.
State Street has insurance covering legal costs and expects to get some of the money back from claiming on the policy, Ronald Logue, chief executive of State Street, told analysts and investors during a conference call Thursday. The value of that coverage wasn't included in the reserve for accounting reasons, he added.
Logue was likely referring to directors and officers insurance. These D&O policies protect executives and members of a company's board from liability in the event of a lawsuit against them claiming wrongdoing in connection with their firm's business. The coverage usually pays for the cost of defending lawsuits, after a deductible, and also a portion of any settlement. Errors and omissions policies offer similar professional liability coverage.
Chubb Corp. (CB) and American International Group Inc. (AIG) are the biggest D&O insurers. Ace Ltd. (ACE), XL Capital Ltd. (XL), Travelers Cos. Inc. (TRV) and Hartford Financial Services Group Inc. (HIG) also offer coverage.
Some D&O insurers suffered earlier this decade after the collapse of Enron and WorldCom sparked a flurry of class-action lawsuits against companies and investment banks. But tort reform then made it more difficult to start such litigation, and the number of cases dwindled.
Almost 500 federal securities class-action lawsuits were filed in 2001, making that year by far the most active since 1995, according to Stanford Law School, which tracks such litigation. That dropped to 118 suits in 2006, the lowest in a decade.
The declines appeared on course until the middle of 2007, when litigation activity jumped as the subprime credit crisis hit: 100 companies were sued in the second half of last year. That reversed a trend of eight consecutive quarters with below average litigation, Stanford said in a study released Thursday.
The financial-services sector was hardest hit, with 47 companies sued in 2007, up from 11 in 2006, Stanford said. More than half of those suits are related to subprime market disclosure issues, the law school noted.
That could bode poorly for D&O insurers such as Chubb and AIG, but it's too early to tell how much their earnings could be dented, according to one industry analyst.
"People are starting to worry about it. But it's too early to say that we've got a problem," Paul Newsome, a managing director and insurance analyst at Sandler O'Neill & Partners, said. "If the market continues to fall and if we have more prolonged problems, we will have a lot more lawsuits and it will compound itself."
AIG spokesman Chris Winans said the company is monitoring the development of such claims, but said that, at the moment, it doesn't see any "unusual activity." A Chubb spokesman declined to comment.
It's tough to tell which D&O insurers might be exposed because companies in the business don't usually disclose which industries or specific businesses they've sold coverage to, Newsome added.
Similar concerns emerged in 2006 after the stock-option backdating scandal shook the technology industry. But claims didn't end up being very large, partly because the share prices of the companies involved didn't fall much.
"What saved the industry was the fact that stock prices didn't fall, so there weren't any losses to be recouped," Newsome said.
The subprime mortgage crisis has taken a much heftier toll on share prices though. Bank and brokerage shares have lost roughly a fifth of their value in the past year. Shares of some mortgage lenders have slumped by more than half and others have filed for bankruptcy, leaving shareholders with nothing.
Still, Newsome said the impact may not take a big bite out of the D&O businesses of insurers such as Chubb and AIG. That's because there's still a long-term, broader trend of falling securities class-action litigation. Financial-services companies may make lots of D&O claims, but overall D&O losses may remain in check, Newsome said.
"There may be losses, but results may be so good overall in the D&O business that this might not show up on the radar much," Newsome said.
-By Alistair Barr; 415-439-6400; AskNewswires@dowjones.com
(END) Dow Jones Newswires
01-03-08 1951ET
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