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April 2009 | Volume 1, Issue 2

The Big Picture? Cost Drives Everything

Looking at D&O and Professional Liability Insurance

By Teresa Zink

Some sobering statistics:  Insurer costs are likely to exceed $4.5 billion in 2009 on sub-prime claims alone; legal costs associated with the Madoff scandal could top $1 billion with a conservative estimate of $50 billion in investor losses; year end reports show some insurers paid out more in claims in 2008 than they took in; and many commentators believe this is just the tip of the iceberg.

Paul Wojcicki of Segal McCambridge Singer & Mahoney in Chicago gave these statistics during a panel discussion on professional liability insurance issues at a January conference on the FDIC and the New Banking Crisis presented by HB Litigation Conferences.

Wojcicki, who primarily represents insurers, said cost is a major driving force in much of what is happening in the industry.  “Why do we go out and obtain these types of insurance?  It’s because of the extraordinarily high costs of defending against the allegations of corporate wrongdoing,” Wojcicki said.

Anticipation of an upsurge in criminal prosecutions paired with the very real desire of companies “to go out and fulfill their indemnification obligation so they can, in fact, attract competent, qualified people to serve as directors,” brings issues surrounding professional liability coverage into sharp focus.

Investigation Costs

The high cost of an investigation, criminal indictments, even the threat of indictment can “disable or ruin a company,” Wojcicki noted.  “The fact that an investigation is ongoing, can require the company to spend incredible amounts of money to try to avoid being indicted in the first place.”

According to Wojcicki, “Now we’re in the midst of a litigation surge.  Where is it coming from?  I think we’re hearing about these things daily in the news…we see the credit crisis continuing, the lack of liquidity out there, the sub-prime mortgage cliff continuing to claim more and more victims, and to result in more and more lawsuits.  I think we’re only beginning to see the fallout on the Madoff situation.”  While it seems like the bulk of the upsurge is focused on the financial sector, he noted that litigation is also up significantly in other areas.

Wojcicki said there may be some relief in the revised guidelines recently set out by the U.S. Department of Justice seeking to “tone down Federal prosecutors in the way that they approach dealing with corporate criminal investigations.”   However, he predicts an increase in white-collar investigations and indictments at least in the near term.

What is a Claim?

From an insurance perspective, Wojcicki said, one of the key factors is “whether being the subject of criminal proceedings is a claim and whether that’s likely to be covered under your policy.  It’s been an evolving definition.”

Wojcicki noted that “One of the things that separates D&O and E&O coverage from some other types of coverage, is the fact that it’s not as standardized.  The policy language is not as standardized as in a lot of other areas.  There is actually room for either discussion or negotiation; there certainly is inter-company variability in the terms of the policies used.      So, obviously, looking at the language of the policy and really understanding it is critical, no matter what side you’re on, but particularly if you’re the subject of an investigation.”

Looking Forward, Looking Back

Where are these trends likely to lead?  Wojcicki said that in trying to predict how insurers will react to these emerging challenges, it is helpful to look back to prior financial crises.  “When you look back to the mid-1980s, how did the insurance industry react to that crisis period?”  He noted that it was in the mid-l980s that the number, level, and amount of claims became significant.  “What happened when all of a sudden a fairly quiet sector of the insurance market took on a pretty good head of steam that resulted in a high volume of claims and costs?  The market constricted; people stopped writing that type of coverage,” Wojcicki explained.  “Another thing that the reaction included was, of course, cost containment.  What did that mean?  Insurers that continued to write the coverage began to write it at lower limits.  They began to charge more for those lower limits,” according to Wojcicki.  More specific exclusions were also included in the policies.

“After the mid-1980s, things kind of calmed down through the early to mid-1990s,” Wojcicki said.  “Then we saw another wave of scandal and crisis toward 1999 and the early part of the 2000s.  We again saw a surge in the amount and cost of securities litigation.  You had the major corporate scandals and bankruptcies and had new legislation as direct fall-out from that.  You also had financial and economic ramifications brought about by 9/11.  What did we see?  The same or similar reaction to what we saw back in the mid-1980s.  We see sharply increasing premiums; it’s pretty remarkable.”  Again there was market constriction as insurers stopped writing the coverage and entity coverage emerged.  “Again, the main driver here was the industry trying to contain and minimize costs.”

Differing Perspectives

Wojcicki shared with participants the results of a survey conducted on the concept of timely notice, an issue he calls, relatively speaking, one of the less controversial issues between insurers and insureds.  “I think everyone agrees that some form of timely notice is a fair requirement in the context of insurance coverage.”

However, he said “It was interesting to find out just what the differing perspectives were as to what constitutes timely notice, what parameters should be considered, what factors should be considered in determining whether notice was timely.  I thought you really did see more divergence than one would have expected.”

For example, when asked how strongly they agreed with in the statement “The more significant the economic consequences of a loss, the more time a policy holder should have to notify its insurance carrier” well more than half of the insureds answered “Yes, economic consideration should be a factor,” while insurers responded “quite the opposite.”

There were similar results to the question “Is this a valid justification for not notifying the carrier as quickly that the policy holder does not want to lose control of the resolution of the loss?”  Wojcicki said that “given the high stakes involved in many of these claims, certainly one can understand the insured’s perspective on wanting to keep and maintain control, trying to resolve the loss, and contain the loss.  On the other hand, if the insurance company is going to be the entity that foots all, part, or a significant part of the bill, then it, too, wants to have its opportunity to get involved to work to contain the loss.”

He noted that the survey was not limited to D&O coverage, or any other particular type of coverage.  “It was just to ‘take a pulse, temperature, and get a gauge’ of the different kind of approaches; things that are important on either side of the equation.”

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pwojcickiPaul Wojcicki is a shareholder at Segal McCambridge Singer & Mahoney Ltd. in Chicago where he counsels financial institutions, insurance companies and product manufacturers and sellers in a range of commercial disputes.  Mr. Wojcicki spoke on “Professional Liability Litigation: Insurance Coverage Issues” at the HBLC  FDIC and the New Banking Crisis:  Litigation Challenges Past, Present and Future Conference in January 2009.