Professional liability in a financial world

What professional liability exposures do financial institutions face today? Have risks significantly changed since 2001? If so, why?

Major events have had a direct impact on insurers, agents and the industry and have triggered lawsuits and, eventually settlements, changing how CEOs of financial institutions must conduct their businesses, according to expert panelists at the Professional Liability Underwriters Society’s (PLUS) recent Annual International Conference in Chicago in November who addressed “Risks and Exposures for Financial Institutions.”

One major change has been the role of financial institutions in the war against terrorism.

“Comparing 2001 and 2006, it’s not hard to see why the U.S. government’s role in the professional liability industry in this country has been increasing,” said Ray DeCarlo, moderator and executive vice president, AIG-National Union. “First came the terrorist attacks of September 11th that were repeated with efficiency in London and Madrid and have required that Western democracies increase their vigilance to intercept AL Qaeda’s sources of money, its communications and its sleeper cells. All of this means that civilian professionals have to become the eyes and ears on alert for signs of terrorist activity before it again reaches its deadly fruition.”

All financial firm have also been hit by the fallout from scandals. “Second, the corporate scandals and failures of 2001 and 2002 came at exactly the wrong time — on the heels of 9/11. Just as the economy was trying to rebound from the early months of the tech-driven sell-off of corporate entities, investor and consumer confidence had to be restored across the nation and internationally. New and stricter uniform standards of conduct had to be established and fast — for corporate executives, attorneys, accounting firms and others,” DeCarlo noted.

Then there were the “sock waves” from the Spitzer investigations. “Third, and perhaps closest to insurance industry professionals (in this room), are the criminal investigations and prosecutions commenced by New York’s newly-elected governor, Eliot Spitzer while he was state attorney general. These actions were copied by other elective regulators and these actions sent a shock wave through our industry,” De Carlo said.

Patriot Act, settlements and more

Despite the recent flurry of settlements with Zurich, Enron and other court decisions, the numbers of lawsuit settlements should continue to decline over the next several years, claimed some panel members.

“This decline will have a positive effect on the U.S. market,” one panelist said.

But moderator DeCarlo disagreed.

“It seems every year another issue arises where insurers, agencies and agents find themselves in a position of being scrutinized. If it isn’t contingency commissions it is stock options or mutual funds. I don’t see settlements declining in the next couple of years,” De Carlo said.

Panelists did agree that because of the terrorists’ events and the requirements of the Patriot Act — still fresh in the minds of CEOs — insurers must take steps to protect policyholders and the company and follow strict rules.

“Tight record keeping, protecting yourself from identity theft in all the ways we know about and ‘knowing your customers well’ are all key components to protecting assets and customers,” DeCarlo said.

When a financial institution does come under scrutiny, insurers as well as CEOs, directors and officers must be brought into the loop of information immediately, they added.

“Time flies by quickly in these situations. Insureds should be working with their attorneys sooner rather than later,” said David Kistenbroker, manager partner, Katten Muchin Zavis, Chicago. “Knowledge of any impending threat and the direction it is going is crucial to preventing problems down the road.”

The defense costs of $70 million in the Jeff Skilling Enron case and punitive damages of almost $79 million in the Phillip Morris Supreme Court case in Oregon were cited as examples of the types of big awards not likely to go away soon.

Regulatory issues

The panelists also cautioned that increased federal government interest in the insurance indusry must be watched, since regulatory scrutiny increases the exposure of companies and audit committees.

“Attorneys general’s investigations in recent years perfectly illustrate what happens when abusive industry practices that require correction collide with ambitious political motives,” DeCarlo said. “They (investigations) have caused many inside and outside the insurance world to ask whether the patchwork quilt of 50 state regulations of an interstate industry really does make sense.”

DeCarlo cited as examples of federal reaction the House of Representatives’ unanimous passage of the Non-Admitted and Reinsurance Reform Act of 2006 and the introduction of the National Insurance Act of 2006 by Sen. John Sununu, R-N.H.

“While it failed to gain much traction, the fact that both houses of Congress are casting a regulatory eye at the insurance industry is not coincidental,” DeCarlo said.