Securities Lawsuit Filings Are Up, So What About 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 the 172 securities lawsuits filed in 2007, and nearly a 90 percent increase over the 119 securities lawsuits filed in 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 activity result in higher directors and officers (D&O) insurance pricing? It may eventually, but not right away.

The most significant factor in 2008’s heightened securities litigation filing activity was the number of subprime and credit crisis-related securities lawsuit filings. Of the 226 new securities cases filed that year, 101 were subprime or credit crisis-related. There have been 141 total of these cases filed overall during 2007 and 2008 combined.

Another factor that increased the 2008 filings was the influx of lawsuits related to the Barnard Madoff fraud scheme. Investors have initiated Madoff-related securities class action lawsuits against at least seven distinct investment groups, and every sign indicates that this litigation will continue to flood in during the early weeks and months of 2009.

The predominance of the subprime and credit crisis-related litigation during 2008 is borne out in the profile of the companies that were sued in securities lawsuits during the year. Although the companies targeted represent more than 90 different categories in the U.S. Department of Commerce’s Standard Industrial Classification (SIC) Codes, fully 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).

While securities suits against companies in the financial sector were a predominant factor in the 2008 securities lawsuits filings, there were other SIC Code categories that also saw significant litigation activity, including SIC Code 3674 (Semiconductors), which also saw 10 filings; SIC Code 2834 (Pharmaceutical Preparations), which saw nine lawsuit filings; and SIC Code 3845 (Electromedical and Electrotherapeutic Apparatus), which had five filings.

The concentration of cases in the financial sector also affected the geographic distribution of the 2008 case filings. Although securities lawsuits were filed in 48 different federal district courts (as well as several state courts), 97 of the 226 securities filings in 2008 were filed in the Southern District of New York. The federal district with the second-highest number of new lawsuit filings was the Northern District of California, where 12 new securities lawsuits were filed. Other districts with a significant number of filings include the District of 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 new filings, was the most active quarter during the year. There were a significant number of filings (32) in December, which is typically a quiet month for securities lawsuit filings. Indeed, the filings in the fourth quarter of 2008 and during December 2008 represent, respectively, the highest quarterly and monthly totals in more than five years. Those late-year trends suggest that the heightened level of securities filings 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 from the heightened filing levels is not widespread throughout the D&O industry. D&O carriers are not yet experiencing the impact of the filing levels 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, even with respect to the heightened activity levels, 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. Because the number of companies sued is less than the number of new lawsuits initiated, the aggregate claims frequency level is less than the overall filing levels might indicate.

Third, many of the defendant entities are not publicly traded companies. Many of the defendant entities in new 2008 lawsuits were mutual funds, investment partnerships, hedge funds or other investment vehicles. The incidence of litigation against those types of entities would have only an indirect impact at most on the market for public company D&O insurance.

Fourth, a significant amount of the securities litigation activity in 2008 involved claims likelier to create errors and omissions (E&O) insurance losses, rather than D&O losses. For example, the Madoff-related litigation and the auction rate securities litigation may or may not produce D&O insurance losses, but may well produce significant E&O losses. The spread of losses to other insurance lines could dilute the overall impact from the 2008 litigation on the D&O carriers.

Fifth, most of these cases are still in their earliest stages, and it will be some time yet before the losses begin to accrue. Until loss payments begin to mount, D&O pricing is unlikely to make dramatic changes (at least as a result of securities filing activity levels).

All of that said, 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, a leading industry observer, is predicting that a hard market for insurance will develop toward the end of 2009.