The scope of the investigations that are unfolding in the wake of the charges against Barclay’s Bank that it rigged the London Interbank Offered Rate (Libor) have taken on the proportions of a major catastrophe.
“17 of the 24 largest banks are now under some form of investigation,” said Torus Insurance Sr. VP and Chief Underwriting Officer, Global Professional Lines (US) Jeff Grange. These include more UK banks as well as banks in Europe that are under investigation for having manipulated the Euro Interbank Offered Rate (Euribor).
The immediate question from the insurance industry is how deeply these investigations will go – probably very deep – and what exposures it may have for directors and officers (D&O) liability and errors and omissions (E&O or professional) liability?
D&O covers senior bank personnel for acts of negligence, omissions or misleading statements. Grange explained that it’s generally classified into three categories, labeled A, B and C.
’A’ type D&O coverage is the most common. It covers the legal expenses, settlements, adverse judgments and related expenses incurred by the banks officers and directors. E&O covers other professionals accused of essentially the same faults.
‘B’ type coverage indemnifies the banking entity itself for the expenses it has incurred, minus any retentions, in defending its directors, officers and other professionals. “However,” Grange explained, “this type of coverage has become increasingly rare, as the costs of obtaining it have risen since 2002,” mainly due to a number of other banking scandals, unrelated to the Libor/Euribor manipulation.
As far as ‘C’ type coverage, which insures the banking entity directly, it has virtually ceased to exist, as its cost has become prohibitive, and “most banks have assets that are bigger than the insurance companies,” Grange said.
He added that the capacity for D&O coverage is “not as deep,” as one might think. A significant portion of it falls into the specialty lines category, which is centered “in Bermuda, London and the U.S.” Specialist insurers and the brokers who handle specialty lines are usually very careful with the type and the extent of the risks they will underwrite. As the last 10 years or so have evinced, banking isn’t exactly risk free.
This is particularly true in E&O coverage applicable to investment banking, while it is less so in the corporate lending area. “It [E&O for investment banking activities] is very limited,” said Grange, “as the market just won’t take it; there have been too many scandals, even before 2008.” As a result investment banking risks are for the most part covered by self retentions.
The Libor investigations, coming only a short time after the multi-billion dollar loss suffered by JP Morgan/Chase, which was thought to have had very good risk management, has refocused the attention of regulators on the banking sector. “The pump was primed,” Grange said, and now “there are [a number of] regulators who are investigating and looking for data.”
There’s certainly no shortage of that. Libor, and its Euribor companion, figure in literally millions of trades, contracts and other agreements – virtually anywhere that an interest payment is specified. “There are a staggering number of customers,” Grange said. He foresees “three waves” of potential litigation.
Multiple breaches of “senior officers and/or directors breaching their duty of care will be found,” he continued. Any failure to adhere to the applicable rules and regulations constitutes such a breach, and therefore becomes a potential foundation for a lawsuit against the bank and those senior officers who managed it.
Grange also pointed out that the lawsuits won’t be limited solely to those who may have improperly avoided regulatory strictures. “Most of these banks are publicly owned,” he said. “If there’s a big fall in their share prices, shareholders will bring lawsuits for the lost value of their holdings.”
Those two types of actions will be joined by a third. All of those contracts, trades and agreements using the Libor/Euribor interest rate settings have two or more parties, one side of which has suffered a loss caused by the actions of the banks. “They [the losing party] may have overpaid, or may have gotten something of less value that they bargained for,” Grange said. “Whoever sold [such an instrument] could be accused of misrepresentation, which in turn would justify a legal action.”
As far as the insurance industry is concerned, Grange said “it’s too early to tell what the financial impact will be,” but the scandal “will certainly be one of the largest ever to impact the financial sector, which isn’t even out of the financial crisis.” As a result, prices for D&O and E&O coverage in that sector will continue to rise. “Availability and the cost of coverage will accelerate,” he said. There’s already “very thin capacity for financial institutions, and now there will be even less.”
He foresees a number of the companies, who currently underwrite financial products, reexamining these lines, “pulling back” and in some cases “cutting the lines and walking away.”
On into 2013 there will be further investigations, requests for compliance and more revelations. Grange described the situation as “having gone viral,” and being “the equivalent for financial lines of the Japanese earthquake/tsunami.”
The one somewhat positive conclusion that can be extrapolated from that analysis is that the specialty lines insurers, the excess carriers and the reinsurers may have limited their exposures to financial sector catastrophes more than was the case with Japan. As usual, time will tell.