Ponzi Schemes

This week the Insurance Insider wrote about D&O insurance exposure in Lloyd's and the London insurance market to the ponzi schemes in the US.

Quoting from the recent Advisen report on Securities Litigation and the D&O Market, the article lists the proliferation of 2009 litigation (433 Madoff and 9 Stanford not to mention another 70 subprime and credit crisis-related cases). You can buy a list of this litigation here.

Apparently the law firm which represented Enron in its bankruptcy made almost as much as Milberg who brought the class action. This means both sides are racking up big legal bills before even getting to a judgment on the merits of the case.

Therefore these cases are going to lead to use of D&O coverage for mounting legal fees and when merits are judged, it's more likely that significant E&O or Professional Indemnity claims are paid. Core D&O claims are less likely to be paid as the losses were so "systemic" - how could any D or O be more culpable?

Similarly with the ponzi schemes, if you're bringing a case against the Ds&Os, where's the money to go after? Ruth Madoff only has so much jewelry and the rest of the Madoff business isn't worth $50b. Instead and in addition, go after the funds and pros that fed Madoff.

On this point, I remember a ponzi scheme that raced through UVM while I attended. The guys at the top of the pyramid fully knew that it would collapse under its own weight but that so long as they got out at least twice they would be playing with other people's money until the inevitable collapse.

While I'm happy to see Madoff's staff and family (was there really a distinction?) getting indicted like his accountant (all of these people had to be in on it), I am waiting to see how the scheme can be unwound to find the people who gave Madoff money at the beginning of the Ponzi scheme. These are the crooks Madoff is pleading guilty to protect.

On the insurance coverage of ponzi litigation, there could be negligence in due diligence on the part of feeder funds and investment professionals who put their clients into Madoff recently, and that could be covered under E&O insurance. But criminal charges will be overwhelming when they unearth Madoff's true accomplices - those with Madoff at the top of the pyramid. I doubt any insurance company would honor their E&O.

Jack Degnan Speaks Part II

Talking about the market, Mr. Degnan predicted that "2009 will see dramatic hardening across all lines, all sectors" because of deteriorated combined ratios, investment return, rate reductions and poor yields in the market. Chubb CSI saw Q4 rate increases, the first in 18 quarters.

Countervailing measures are there:

• forecasts like the above seem rational, but the insurance industry doesn't act rationally
• the economic implosion reduces exposures and it's hard to raise the top line when demand shrinks

Speaking of the credit crisis, Mr. Degnan thought the "hyperbolic forecasts" of big losses were way overblown. Citing high dismissal rates and other measures he discussed in Chubb's last earnings call, Mr. Degnan thought the $10, 15 20b numbers are overblown. Was he subtly asking Advisen to revise its forecast?

In the Q&A he was asked about direct distribution and said it had been seriously reviewed at Chubb but Chubb is "strongly committed" to working with brokers who provide a significant "value add".

Notes from the PLUS D&O Conference

Always good to see clients, friends and even some folks who admitted to being readers of this blog. We're in the process of redesigning www.advisen.com and will be featuring blog posts from Dave Bradford and me among others and pull in from other favorite commentators.

Dave presented at PLUS about the correlation of bankruptcies and D&O loss and the audience really seemed connected to this important topic. The findings Dave presented were a small part of the research Advisen can conduct and we are looking for equity partners in the project.

This means firms with interest in getting a securities litigation risk score for all U.S. public companies based on their risk of bankruptcy should contact me. By joining others in the initial funding partners will be the only recipients of these risk scores. mpower@advisen.com if interested.

VJ Dowling who I enjoyed meeting at the Allied World party (they have a company rock band which did some good covers), provided a bit of color to Dave about the performance of Odyssey Re (see earlier post about trailing twelve month market cap performance for commercial insurance companies).

Apparently Odyssey's CEO has said he'd love to claim underwriting genius but it was the brilliance of their chief investment officer who foresaw the credit crisis and bet accordingly. If you look at the chart he must have been selling what Joe Cassano at AIG was buying.

Insurance Company Stock Performance

We all know stocks are down and that the financial services sector has been hit the hardest, but I thought it interesting to note the relative performance of the commercial (re)insurance underwriters.

The chart shows that amazingly there are 2 firms in Odyssey Re and Navigators that are up in market cap in the last 12 months.

Unsurprisingly, the firms most in the news including AIG, Hartford, XL & Swiss Re are the firms losing more than 80% of market cap.

I believe the prices reflect investor's opinions of the investment performance and exposure to credit insurance more than underwriting performance, but those underwriting loss ratios will be a big driver of market cap growth as the big claims from subprime and the credit crisis make their way through the system and reserves are set.

E-mail support@advisen.com to get charts like this and other insightful data and analytics.

D&O Liability: Beyond Class Action Lawsuits

Advisen has just published a 38-page report on securities litigation and new challenges to Boards of Directors and the D&O insurance market. Securities class action suits – which were a minority of securities suits filed in 2008 – no longer are a reliable barometer of public company D&O insurance trends.

Methodologies used by the D&O market to price trends in the past are no longer relevant. The Advisen report goes well beyond anything published by other researchers to break out all forms of securities litigation that might trigger Directors & Officers or Errors & Omissions coverage and details shortcomings in D&O claims management that are contributing to higher defense costs.

To help readers track potential exposure by company, Advisen’s report includes the list of companies facing lawsuits in 2008 and the list of companies facing multiple lawsuits over the past thirteen years.

The information contained in Advisen’s report is not freely available on the web or in any other source and is more complete and relevant than reports from other sources which charge far more for their reports.

Click here to purchase your copy.

Among my favorite quotes in the report from an Advisen customer is “We miss Bill Lerach”.

The Advisen report contains new research but follows a series of Advisen research papers detailing the impact of the subprime and credit crisis on the D&O market. The running tally by Advisen now shows more than 660 major lawsuits from this global economic trauma including 148 securities class actions.

Notes from the RIMS NY Chapter Meeting on D&O

Chad Roth has done a terrific job getting to know the markets and market players and below are Chad's notes from today's NY chapter meeting which touches on new and interesting hot topics in the D&O market with some comments in CAPS about ideas we have. Feel free to share your ideas or needs in this area so we can help. Thanks, Mason

I attended this morning's RIMS Chapter Meeting focusing on D&O. The moderator of this session was Brian Wanat (Aon). The panelist were Mike Price (HFP), Tony Galaban (Chubb), Mike Smith (AIG), and Scott Meyer (ACE).

Here are a couple of thoughts / notes I jotted down during the session.

- With all the FI issues out there, portfolio management seems to be a big topic. Making sure your book is diversified is necessary to weather subprime. I was thinking Advisen should try and put together some type of e-mail that describes some of the off-line work we can do w/ to help senior management at carriers better understand their book and explain it to their superiors. Taking some of the data Advisen can provide and then tying it in with their loss info could be kind of powerful. Any thoughts?
TWO THINGS WE CAN DO: (1) WE CAN RUN THEIR POLICYHOLDER LIST AGAINST OUR VARIOUS INDUSTRY/FINANCIAL FIELDS TO IDENTIFY THOSE CLUSTERS OF COMPANIES MOST LIKELY TO REPRESENT ACCUMULATION RISKS. I'M NOT EXACTLY SURE OFF ALL THE KEY INDICATORS WE SHOULD BE LOOKING FOR, BUT I SUSPECT OUR CLIENTS HAVE SOME IDEAS. (2) LOOKING ACROSS LOBs, MSCAd's RELATED CASE FEATURE CAN BE USED TO MODEL ACCUMULATION RISK.

- Red Flag: A red flag that the markets seem to be looking at is large debt payments due in 2009. Typically in the past a company might refinance their debt before these large payments.
Given the current credit environment, they might not be able to refinance or it may be it a higher rate. It may be a fun little exercise to create a list of the companies with the highest debt payments due in 2009. Maybe release that list in conjunction with the PLUS D&O Symposium.

- Counter Party Risk: They were saying how some risk managers are starting to ask more questions about the carriers they use. They want to make sure that those carriers will be around to pay their claims. It seems like they have lost faith in the rating agencies.

- Defense cost is still a hot topic. Underwriters are curious as to who the outside counsel is on their risk and the relationship. I'm not sure what we can do here, but this topic is not going away. It would be interesting if we could do some analysis of the counsels involved in MSCAD cases.
DEFENSE COST IS GOING TO BE A MAJOR PART OF OUR FORTHCOMING REPORT ON 2008 SCAS ETC. IN THE NEW ENVIRONMENT, PLAINTIFFS FIRMS ARE BRAINSTORMING NOVEL NEW THEORIES AND ARE FILING MORE CASES IN STATE COURTS, WHICH WILL MAKE IT MORE DIFFICULT TO CONSOLIDATE CASES INTO LARGE CLASS ACTIONS. AS A RESULT, DEFENSE COSTS ARE LIKELY TO SKYROCKET.

Chad M. Roth
Advisen Ltd.
+1.212.897.4792 desk
+1.917.428.8966 cell
croth@advisen.com

The Professional Lines Market Speaks

Yesterday Advisen published a report on how D&O losses will be $5.9 billion from subprime and the credit crisis, the report is here.

Today we published a report on E&O losses - an additional $3.7 billion. We are the only player to publicly forecast this figure - because we have data that others don't have. The report is here.

In today's press release we also called for the end of the soft market. Not just in D&O or E&O for financial institutions, but broadly. See the release here.

We've had a ton of feedback on this. Tomorrow we're publishing comments from the following: Ryan Collier, Kevin Lacroix, Christopher J. Cavallaro, Peter Taffae, Joe O’Donnell, Chris Warrior, Brian Wanat, Gary Dubois, Paul Schiavone, Chris Duca, Nick Conca, Chris Hewitt, Tim Kelly, Jason White, Larry Goanas, Dennis Donovan and Dennis Gustafson.

I just wish we'd hooked up a chat board around this.

$9.6 billion in Insured D&O and E&O Loss from the Credit Crisis

The PLUS International conference expects over 1,600 attendees in San Francisco this week including 4 from Advisen.

Timed for the start of this conference Advisen has launched a special edition newsletter (see here) to publish news stories about professional liability and most importantly, to publish unique and groundbreaking research by Advisen.

Today we started with a revised forecast (upwards) as a result of the meltdown of the subprime mortgage market and the ensuing credit crisis. for D&O insured loss. In February, Advisen forecast $3.6 billion of insured losses but as the credit crisis has mushroomed into a global financial calamity, we have revised the forecast to $5.9 billion.

The free report on D&O losses is available here.

Advisen is the first to forecast the insured loss for E&O from the credit crisis saying that E&O losses will be centered around mortgage brokers who will see thousands of smaller lawsuits and around mortgage lenders who will see fewer, but higher value suits, the total being $3.7b.


The free report on E&O losses is available here.

AIG has had top market share in both financial institution D&O (19%) and E&O (34%) and Advisen expects new insurers to enter the market. To prepare buyers, brokers & insurers for operating in the new world order in the financial services sector, Advisen has published a comprehensive 38-page study of the changed industry landscape and how it impacts on risk and insurance.

The full report on the financial services industry is available here.

The AIG Liquidity Crisis and It’s Impact on the Insurance Market

Advisen has just published a QuickNote (find it here) which explains how AIG is set up, how one of the smallest of its 4 divisions (less than 10% of overall revenue) got involved in derivatives based on mortgage back securities, including subprime securities.

These securities don't trade on exchanges like stocks and they don't have daily pricing from many sources and as the subprime market collapsed, AIG was forced to show lower value for these securities and the derivatives. This led to the market asking AIG to put up cash collateral (over $40b) and AIG the parent didn't have the cash.

AIG has 2 divisions with many subsidiaries writing insurance policies, 1 division for commercial lines and 1 division for personal lines. Together they are 88% of the parent's total revenue and nearly all of the positive value of the balance sheet. AIG can't take cash from these subsidiaries because state regulators require cash on hand to cover claims. Therefore AIG was forced to announce a plan to sell assets (non-core businesses).

AIG wasn't able to do this quickly enough to provide cash collateral so the government provided an emergency loan, fired the CEO for not averting this crisis and brought in a new CEO to get the assets sold to pay back the government.

Meanwhile the insurance subsidiaries are profitable and have lots of cash to pay claims.

AIG staff have seen their stock wealth disappear, risk managers are getting questions from their officers and directors, the ratings downgrades didn't help. and generally this may lead to a reduction of market share by AIG.

These are the issues in the marketplace and this paper gives buyers and brokers the facts they need to separate the problems in the one division that nearly bankrupted the parent from the sound health of the insurance subsidiaries.

Below is the executive summary of the briefing by Advisen on AIG. The full report is available here.

Liabilities incurred under sophisticated financial instruments ravaged American International Group. As AIG teetered on the verge of bankruptcy Monday and Tuesday, brokers were flooded with calls from nervous AIG policyholders. However, the financial strength of AIG’s insurance subsidiaries was not threatened: insurance regulations insulated the insurance entities from the losses. Tuesday evening the U.S. government announced an $85 billion loan to the company, averting a collapse. Assuming AIG’s customers don’t abandon the company in large numbers, the long-term impact of the crisis on the insurance pricing cycle should be minimal.

This Briefing was written by David Bradford, Executive Vice President and Editor-in-Chief, dbradford@advisen.com, 212.897.4776.

Penny for your thoughts

With the size of these market cap drops, how steamed up are Mssrs. Lerach and Weiss in their cells today?

Notes from the John Street Club Luncheon - New York, Sept 5th

Talking about the soft market:

John Keogh, head of ACE Overseas pointed out that beyond continued overcapacity, rates won’t change while carriers are cash flow positive in a soft market. But that when cash dries up they will have a panic and topping up balance sheets now will not be as easy as in 2005. John thought we’re probably 2 years away from the bottom.

Greg Flood, head of IronPro, echoed those thoughts and noted that the soft market will be strengthened after the end of the releasing of reserves but also pointed out that subprime is percolating and is major, even beyond the D&O market for financial institutions.

Talking about industry M&A activity:

Bill Malloy of Private Equity firm Aquiline Capital talking about actively looking for new investments but finding the challenge in valuations, focused on “distribution space” saying that 1-2% growth doesn’t sustain their desired valuations of 8-10x EBITDA.

How big is the Global D&O Market?

For a number of reasons there isn't a precise number for the total value of premiums on Directors & Officers insurance. For one, every company reports using a different nomenclature or taxonomy for their coverages.

Advisen estimates total global D&O premiums at around $10.5B.

Of this the total U.S. D&O premium is $6.25B of which $4.25B is public company D&O premium, and $2B private company D&O premium.

Our methodology for this figure is based on
(a) Advisen's benchmark databases (the largest online database) where the D&O premium is adjusted by the relative market share of our database participants
(b) estimates of D&O premium as a percentage of total reported Other Liability – Claims Made premium, and
(c) input from a number of large D&O writers as concerns their D&O premium volume and their estimates of their total market share

The figure is important as a reference for what happens when subprime claims hit the market. Advisen's February 2008 estimate of $3.6b in insurable D&O loss will be revised upwards in a soon-to-be-released report (including Errors & Omissions loss estimates), but the single-year impact will not approach total premiums.

The impact will hit the financial institution carriers hard and the resulting ripple effect will be very significant in the D&O space, but is not enough to put the whole market underwater. Let me know if you want to be on the list when the report is announced.

D&O Premium Correction, When not If

Further to my recent posts about the coming change in D&O premium rates (see here), another wholesale broker in London and Advisen client gave some specifics about REIT D&O policies being non-renewed (again, non-renewals are rare) and also suggested an interesting angle about coverage terms.

With D&O underwriters only now issuing new forms in response to the subprime crisis, by the time premiums correct these forms will still be in use meaning that premiums will go up and coverage terms stay broad.

When will premiums correct? His forecast is that general or commercial D&O rates will shift to a hard market in Q2 or Q3 of 2009.

Subprime cases by type of filing

With 282 subprime lawsuits and other actions to follow, the chart above shows the breakdown by type of case including some of the most noteworthy:

82 Subprime Securities Class Action cases

23 Subprime Derivative Shareholder cases

19 Subprime ERISA Class Action cases

15 Subprime Securities Fraud cases

So if Henry Paulson feels the worst is over in terms of the creation of subprime and other credit exposure (story here), the fun is just kicking off for the insurance industry.

282 And Counting

Advisen is now tracking 282 subprime lawsuits and other actions related to the overall credit crisis and yesteray's v7.0 of Advisen enables on-demand charting which I hope readers will find helpful. The above is a distribution by industry sector.

Credit Crisis Loss Review: Clash Cases Abound

In looking at the developing litigation database around subprime, Advisen tracks ‘clash’ cases, also called ‘related cases’ in a number of ways.

First, the classic related case, a single complaint that names multiple parties. In these cases, especially securities class actions, a company is sued and the complaint also names the auditors and/or lawyers for any malpractice and possibly underwriters related to any public debt offerings.

Advisen categorizes these cases by party and allegations made against that entity. A company is entered under Securities, the auditors/lawyers/underwriters are entered under Professional Practices. Losses are associated with the party that actual paid it, making it simpler to calculate D&O losses from E&O losses.

For the Subprime/Credit Crisis, we have 30 related cases as of April 28:
Related ID: 7561 Calamos Global Dynamic Fund 2008
Related ID: 7201 Deutsche Bank 2008
Related ID: 7182 Bank of America 2008
Related ID: 7181 Huntington Bancshares 2007-2008
Related ID: 7061 HSH Nordbank - UBS 2008
Related ID: 7041 Centerline 2007-2008
Related ID: 6982 Nomura 2008
Related ID: 6962 MBIA 2008
Related ID: 6961 Ambac Financial 2008
Related ID: 6941 National City 2008
Related ID: 6862 Morgan Stanley 2007-08
Related ID: 6841 Teletech 2008
Related ID: 6802 Tarragon 2007
Related ID: 6801 Impac Mortgage 2007
Related ID: 6781 E*Trade Financial 2007
Related ID: 6742 Luminent Mortgage 2007
Related ID: 6741 New Century Financial 2007
Related ID: 6321 Bear Stearns 2007 - 2008
Related ID: 6241 Sagittarius CDO 2007
Related ID: 6222 Thornburg Mortgage 2007
Related ID: 6181 UBS 2007
Related ID: 6003 Homebanc 2007
Related ID: 5981 Regions Morgan Keegan Select Bond Funds 2007
Related ID: 5661 Citigroup 2007
Related ID: 5603 Washington Mutual 2007
Related ID: 5283 Hovnanian 2007
Related ID: 5163 Beazer Homes 2007
Related ID: 5162 Countrywide Financial Corp 2007
Related ID: 5161 Fremont General Corp 2007
Related ID: 5021 American Home Mortgage 2007


Second, Advisen tracks cases that have a common initial trigger. Examples of this are Enron, the In Re: IPO cases and the Subprime and Credit Crisis cases.
Subprime & Credit Crisis: Related Case ID 4000 – Total Cases to date: 280; Losses to date: $87,156,390.
Clash cases that are sub-types to the Credit Crisis:
Related ID: 7503 Student Loans - Credit Crisis 2008 - Various cases as secondary to Subprime
Related ID: 7123 Credit Default Swaps 2008 - CDS failures re subprime crisis
Related ID: 7202 Auction Rate Securities 2006 - 2008 - Cases related to ARS, sales practices and credit crunch

Third, we track cases by type of remarkable risk. These types of cases filed by different parties and governmental entities around specific allegations. For example: anti-trust and price-fixing charges, market timing violations and the Foreign Corrupt Practices Act.
The example of this for Subprime/Credit Crisis cases is:
Related ID: 5923 Predatory Lending - Investigations from Mortgage Crisis

Subprime and credit crisis litigation is so pervasive that we now have to track the various strains of it.

The other half of return

Insurance companies make their earnings from underwriting profit and investment profit on the premiums collected. I haven't really covered that angle to date.

While the big story has been the bond insurer subsidiary (SCA), and subprime exposure, yesterday's XL's earnings announcement (here) talks about the hit from investment return.

The Finance Director of Lloyd's gave some comments to assure the markets that the Lloyd's Central Fund is well tended to - see coverage here.

The subprime bodies are buried in both areas and upcoming earnings announcements will show further evidence of what we at Advisen are seeing, an end to the soft market in one important market sector (Directors & Officers and Errors & Omissions insurance for Financial Institutions), although the imbalance of supply and demand is too great to change the overall market dynamic. For more on the topic, click here.

Subprime propaganda

Greg Flood is on a concerted campaign to reverse the soft market. Today Advisen Front Page News carried an article by AM Best in which the Ironshore underwriter explains the magnitude of the claims from subprime on the D&O and E&O markets. See the story here.

Last week Greg was quoted in Post magazine (story here) talking about how he sees insured loss from subprime surpassing $8b.

IronPro is new to the market, is well-rated, and doesn't have legacy subprime exposure to force high reserves. In other words, Greg has been sitting on the sidelines waiting for the right time and apparently he believes the time is now:

“We’re taking excess layers that are very high. We’re looking to reestablish
insurance for companies that are looking to get it.”

Chalk this up as another indicator of the bottom, the end of the soft market, at least for the specific buying of D&O and E&O for Financial Institutions. Greg says his competitors are seeing 30-40% increases in D&O and he wants in. Data from the RIMS Benchmark Survey and from retail and wholesale brokers do not show this type of increase, but we won't be surprised if the next batch of renewals did.

Subprime Updates

Fitch published an estimate of $3-4b in D&O losses from subprime. See press coverage here. Echoing what Advisen published long ago and agreeing with Advisen's stated opinion that losses will be felt by a handful of large underwriters, Fitch said they didn't see a change in overall premium rates.

I have written about the imbalance of broad market supply and demand (here) as too great for even several multiples of the $3.6b estimate insured loss. Next up for Advisen is update this estimate and to include Errors & Omissions losses.

Meanwhile back at the plaintiffs bar ranch, Advisen is tracking 269 subprime and credit crisis-related lawsuits, of which 62 are Securities Class Actions used in modelling insured D&O losses. This count continues to climb.

Q1 2008 Premiums: No broad market impact by subprime

Advisen released the results for Q1 2008 of the RIMS Benchmark Survey. See the press release here. The picture continues to be good for buyers and not helpful to broker earnings nor the long-term profit picture for insurance underwriters.

The cycle has not found bottom despite incredible financial market turmoil. My post yesterday discussed how Lloyd's is not concerned. Advisen clients I speak with are of mixed minds - those that are in the market for professional lines insurance (e.g. directors & officers, errors & omissions, crime) to financial institutions (lenders, investment banks, funds), those guys are not comfortable with what they have written and are looking forward to the influx of claims that will shake up who writes what and how this volatility will increase pricing in this space quickly.

We have to wait and see how litigation progresses - currently we are tracking 259 cases, including 62 securities class actions related to subprime and the credit crisis. The potential is for the concentric circles of loss to mount into something that has ripple effects within the markets far beyond D&O for financial institutions. See a recent post about this here.

The results have been picked up in the trade press already with an additional quote by Advisen's Dave Bradford in a story by Financial Week here.

Mr. Bradford said financial services and investment businesses, which have been
hit hard by the subprime mortgage meltdown, will see directors and officers’
liability insurance rates rise because of the increase in claims they face. But,
he added, there will be a steady decline in rates for most companies not exposed
to mortgage losses. “It wasn’t until the first quarter that underwriters pushed
through significant rates increases for financials. But it hasn’t spread beyond
that fairly narrow group.”