How Securities Lawsuits Will Affect D&O Pricing
The pace of securities lawsuit filings increased significantly in 2008 compared to recent years. There were 226 new securities lawsuits filed in 2008, which represents a 31 percent increase over 2007, and nearly a 90 percent increase over 2006.
The 2008 filing total also represents the highest annual filing total since 2004. All signs seem to indicate that the heightened filing levels will continue into 2009.
Will this increased litigation result in higher directors and officers (D&O) insurance prices? It may eventually, but not right away.
The most significant factor in 2008’s heightened securities litigation activity was the number of subprime and credit crisis-related lawsuits — of the 226 new cases, 101 were subprime or credit crisis-related. A total of 141 of these cases were filed during 2007 and 2008 combined. Another factor was the influx of lawsuits related to the Barnard Madoff fraud.
The predominance of the subprime and credit crisis-related litigation during 2008 is borne out in the profile of the companies sued. Although the companies targeted represent more than 90 different categories in the Standard Industrial Classification (SIC) Codes, 99 of the lawsuits affected companies with SIC Codes in the 6000 series (Finance, Insurance and Real Estate), including 19 in SIC Code 6021 (National Commercial Banks) and 20 in SIC Code 6211 (Security Brokers and Dealers). There were other categories that also saw significant litigation activity, including Semiconductors (10 filings); Pharmaceutical Preparations (9); and Electromedical and Electrotherapeutic Apparatus (5).
The concentration in the financial sector also affected the geographic distribution of the 2008 filings. Although securities lawsuits were filed in 48 different federal district courts (as well as several state courts), 97 of the 226 securities filings were in the Southern District of New York. The federal district with the second-highest number (12) was the Northern District of California. Other districts with a significant number include Massachusetts (10), and the Central District of California (9).
The pace of new lawsuit filings increased as the year progressed, with 105 during the first half and 121 in the second half. The fourth quarter, with 69, was the most active quarter during the year, suggesting that the trend will continue into 2009.
The uptick in securities lawsuit filings in 2008 might well be expected to have an upward impact on D&O pricing, and indeed it may yet have that effect. But particular features of the 2008 filings might moderate that expected effect, at least in the near term.
First, the concentration of the filings in the financial sector means that the impact is not widespread throughout the D&O industry. D&O carriers are not yet experiencing the impact across their entire portfolio, and carriers that do not have significant financial industry exposure may not yet be experiencing elevated claims activity, although that likely will change as the credit crisis litigation wave spreads outside the financial sector.
Second, the impact is muted somewhat by the multiple different lawsuit filings against the same companies. The D&O impact from the third, fourth or fifth new lawsuit against the same company may not increase the aggregate losses to which insurance applies.
Third, many of the defendant entities are not publicly traded companies; they are mutual funds, investment partnerships, hedge funds or other investment vehicles. Litigation against these entities would have only an indirect impact on public company D&O insurance.
Fourth, a significant amount of the securities litigation activity in 2008 is more likely to create errors and omissions (E&O) insurance losses, rather than D&O losses. Examples include the Madoff-related litigation and the auction rate securities litigation. The spread of losses to other insurance lines could dilute the impact from 2008 litigation on D&O carriers.
Fifth, most of these cases are still in their earliest stages, and it will be some time before losses begin to accrue. Until then, D&O pricing is unlikely to make dramatic changes (at least as a result of securities filings).
The increase in litigation activity in 2008, together with the disruption involving market leader AIG and other leading carriers, as well as the prospect for continued significant litigation activity in 2009, are likely to create uncertain conditions in the D&O marketplace and could lead to increased carrier caution as 2009 progresses. Indeed, Advisen is predicting that a hard market will develop toward the end of 2009.