Bear Stearns subprime conference call with Kevin Lacroix

Yesterday (28th Jan) David Small, Bear Stearns' insurance sector equity analyst, hosted a conference call with Kevin LaCroix of the D&O Diary as a briefing on the status of litigation that will impact the D&O and E&O industries. Thanks to David for including Advisen on the call.

David Small explained a few points about his report of last week where the worst-case scenario for D&O subprime exposure was tripled to $9.3b:

• the estimate is gross, not tax-effected
• much of that will be reinsured, though what amount of that is insurable is not known
• with each insurance company defining Financial Institution coverage differently, assessing market share is tough, David says there's roughly equal market share between AIG, Chubb, Travelers, Lloyd's, XL and maybe CNA a bit below that

David then then introduced Kevin LaCroix who:

• is a partner in Oakbridge Insurance Services, an Executive Liability specialist wholesale broker, and Kevin works in their Beachwood, Ohio offices
• writes the widely-read D&O Diary found at http://dandodiary.blogspot.com/
• is a past President, a member of the Board of Trustees, and very active with PLUS

Kevin's full profile including contact details is found here

Kevin highlighted his tracking of 41 subprime-related Securities Class Action Suits (SCAS) (including 4 filed in Jan '08) and 9 subprime-related ERISA lawsuits. This data closely tracks Advisen's database of such lawsuits though we list more ERISA cases and also different types of subprime-related cases including fraudulent trade practice, shareholder derivative cases, underwriting malpractice, etc. with 173 in total.

Please contact london@advisen.com for more information about the Advisen database of subprime lawsuits, our complete listing of subprime write-downs, changes in premium due to suprime, market share by insurance company and much more.

Of the SCAS, Kevin noted concentration in the 6798 SIC (REITs) and banking & mortgage lending, noting that this rash of suits reminds him of the the S&L crisis with a broad array of targets, but high concentration in financial sectors.

Kevin pointed out that the full impact of companies not in financial sectors who have made investments and need to value them ahead of impending reporting deadlines will be very interesting, this could lead to a new wave of suits.

Moving on to claims scenarios, Kevin pointed out two cases which illustrate the unique nature of subprime suits:

1. the complexity of the case against MBIA with the complaint being about "CDO squared" deals with complex securities and complex transactions with intricate procedures for accounting and valuations before even getting to disclosure
2. State Street setting aside $618m "to address legal exposures" has been misinterpreted in the media as being for D&O exposures when no Ds nor Os were named and there are not allegations based on alleged violations of the securities laws so it is not an entity claim under a D & O policy so it's more to deal with the investments made

Moving on to assessing the size of the D&O loss, some cases will be difficult to win (pleading obstacles, hurdles), many losses won't be covered (many large banks self-insure or have side A only towers and side A doesn't cover) and an important part of this story will be the legal costs (see MBIA point above about complexity which means legal costs will be higher)

In terms of general trends in SCAS, Kevin cited recent NERA / CORNERSTONE reports showing a return to normal historical frequency levels. 2007 frequency was higher than 2006 even without subprime cases with activity in pharma, semiconductor, radio/telephone, prepackaged software all above 2006 levels, and those sectors aren't in subprime ground zero.

Kevin pointed to two recent trials JDSU (verdict for defendants) and Apollo Group (verdict of up to $277m for plaintiffs). Given that few cases go to trial, there is heightened interest in these verdicts but in Kevin's opinion, they don't point to an increased likelihood of securities lawsuits going to trial.

I thought it noteworthy that Cornerstone says 33-40% of SCAS are dismissed.

To put the subprime estimates in perspective, David noted that Enron was $7.2b and WCOM $6.1m D&O events (although not all of those losses were insured) and that from a severity perspective, this is much greater than back-dating but less than the corporate scandals (Enron/WCOM) as those huge companies went bankrupt while Merrill, Citigroup, UBS, etc. are still thriving businesses.

Kevin added that an important part of this story will be legal fees (Apollo said their fees in connection with their recent jury trial were $25m). Also, Kevin noted that this isn't a one-time event (noting that D&O is characterized by a series of one-time events), that lawsuits will continue through 2008 and into 2009.

In sum I took from the call that:

• losses are likely to be closer to those of the corporate scandals, greater than those of the options back-dating scandals
• $9.3b is the current estimate of a worst-case scenario, but that it's likely to be less as not all is insurable
• Kevin LaCroix agrees with Advisen's stated opinion that these cases are likely to be very hard to win, though legal defense costs are likely to be very high and when cases are settled the amounts will be high