Several observers and analysts have recently tried to estimate the insurance industry’s aggregate subprime-related loss exposure. At one end, Bear Stearns has estimated the industry’s exposure at $8 billion to $9 billion. By contrast, Lehman Brothers estimated that the insurance industry’s losses might range up to $3 billion, and Advisen has estimated that the industry’s ultimate losses at $3.6 billion.
I don’t envy these experts whose must quantify something as big, amorphous and evolving as the subprime-related litigation wave. Nor do I know whose estimate is more accurate or what the ultimate number will be. I do have some observations about considerations that are or should be taken into account in making these kinds of estimates, in light of the circumstances surrounding the evolving subprime meltdown.
To Be Considered
First and foremost, I think it is important to note that we are only at the very earliest stages of the emergence of the subprime-related litigation. To be sure, there are (as of Feb. 12, 2007) already 43 subprime-related securities class action lawsuits, as well as nine subprime-related ERISA lawsuits, but there are going to be many, many more of these and other kinds of lawsuits. As a leading plaintiffs’ attorney observed at the 2008 PLUS Directors & Officers Symposium, there are likely to be more securities class action lawsuits in 2008 than any year since the passage of the Private Securities Litigation Reform Act in 1995. In addition, the subprime-related litigation wave is likely to continue to emerge well into 2009 and possibly beyond.
Second, the estimates seem to presume that the insurance industry’s subprime-related losses will be limited to the financial institutions sector. I do not think this is a conservative assumption. To the contrary, I think it should be assumed that the subprime-related litigation wave will both spread beyond subprime and beyond the financial sector. The recent securities lawsuits against student loan company SLM Corporation and residential developer Levitt Homes underscore that the claims have already spread. Bristol Myers Squibb’s recent $275 million write-down for subprime-related investment losses further highlights that the credit crisis is no longer just about the financial sector.
Third, much of the analysis has concentrated on potential losses for D&O insurers. But the potential losses in coverage lines outside of D&O could also be substantial.
For example, State Street’s recent $618 million charge for anticipated subprime-related litigation expenses was in connection with lawsuits that do not appear to implicate D&O coverage, but that could present significant fiduciary liability or even investment management errors and omissions losses.
Other professionals undoubtedly will find themselves caught up in subprime related litigation, including lawyers, hedge fund and pension fund managers, mortgage brokers, appraisers and surveyors, real estate brokers, and insurance agents, among others. The cumulative losses could be very substantial, and at this early stage particularly difficult to prognosticate.
Fourth, no particular significance should be attached to insurers’ current marketplace behavior. My comment here relates specifically to the comment in the Lehman Brothers’ report that “if insurers were concerned about suffering multi-billion dollar subprime D&O losses that could spread outside financial institutions sector, the market would tighten significantly.”
If the D&O industry had a long record of adjusting prices to changing exposures, this remark might have greater validity. Unfortunately, the industry’s history suggests that it is capable of disciplining itself only when losses become so painful that it is forced to change. The current D&O pricing environment is a reflection only of available capacity, not of any calibration to emerging exposures. The marketplace will remain competitive until losses force the changes of necessity, and then any changes would be abrupt and disruptive — as they have been in the past.
Fifth, as most of the analysts have noted, the defense expense associated with the subprime cases could be staggering.
As an example, Apollo Group recently reported that it had spent $25 million taking the securities lawsuit pending against the company through trial. Because of the complexity surrounding the subprime cases, they could be extremely costly to defend. For each of the securities cases, the defense expenses are likely to be many millions of dollars, and, for the cases in the aggregate (including those already filed and those yet to be filed), to be many hundreds (and possibly thousands) of millions of dollars. To these costs must be added the costs of defending the claims raised against other professionals.
Far From Over
By any measure, the subprime meltdown is and will for years continue to be a very significant event for the professional liability insurance industry. Only time will tell the event’s true magnitude. But in the interim, there is one last thing that should be kept in mind — that is that the subprime litigation wave is only one of several important trends currently affecting the D&O insurance industry. Recent securities litigation levels would be elevated over the preceding two years’ levels even without subprime. The turmoil in the financial markets and the heightened claims frequency levels are creating significant challenges for D&O carriers. While it is still far too early even to think of calling a turn in the market, conditions that ultimately could trigger a turn may be starting to accumulate.
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