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By CYRIL TUOHY, managing editor

This time, though, the dynamics are a little different than 2000 and 2001 when carriers were on the hook for policies covering the Jeff Skillings of the world, in their brazen attempts to circumvent accounting standards in a quest to boost their net worth and that of their companies.

"Because there's a potential for bank failures, it's an opportunity to test the policy," said Evan Rosenberg, senior vice president for Chubb & Son, speaking at the annual meeting of the Professional Liability Underwriting Society earlier this year.

At least 150 banks will fail in the United States in the next two years, according to a report by RBC Capital Markets. Compare that with the 10 quarters from the second half of 2004 to the end of 2006, when there were no bank failures.

Side-A provides coverage directly to directors and officers for loss resulting from claims made against them for wrongful acts. By contrast, Side-B coverage of typical D&O policies reimburses a corporation for its loss where the corporation indemnifies its directors and officers for claims against them.

Angry investors are bound to name directors and officers of those failed banks, accusing them of neglecting their fiduciary duty.

But it's the legal settlements--some of which could take months or years to resolve--that will ultimately decide how much protection Side-A coverage provides to directors and officers named as defendants in subprime-related litigation.

And in many cases, proving wrongdoing on the part of directors and officers could be difficult, according to some insurance attorneys, as mortgage lenders and brokers, operating against a backdrop of cheap credit, can say they bought and sold mortgages to companies that professional analysts at ratings agencies declared healthy.

"What we have here is a washout stemming from liquidity issues: the interest rate environment was very attractive, and this is a little bigger than it was in 2001 because it was an industrywide issue as opposed to one or two companies," said Sal Pollaro, executive vice president of the management solutions business unit at Zurich North America.

Hannah Findlay, a senior consultant at SMART business Advisory and Consulting in the London office, said that, compared with Enron, which was a case specific to one company, "in this case, you're almost talking about market practices."

Dozens of classes of financial professionals could be affected, said Rick Bortnick, an insurance lawyer with Cozen O'Connor.

Bortnick said those professionals include mortgage lenders, bankers, brokers, originators, real estate brokers and agents, appraisers, loan correspondents, commercial retail banks, investment trusts and banks, investment funds, investment advisers, investment managers, ratings agencies, REITs, trust funds, pension plan fiduciaries, law firms, accountants, auditors, accounting advisors, bond mortgage insurers, issuers, financial underwriters and securitization trustees.

Losses have been astronomical in the range of more than $400 billion, according to one estimate.

"I'll tell you, my math skills don't go that far, that's for sure," said John Ellison, a partner in the insurance recovery unit with the law firm Reed Smith. "And those kind of dramatic events always lead to disputes between insurance companies and their customers."

The legal stakes and the just how the litigation will affect Side-A cover will become clear by the end of the year as policyholders digest the position taken by insurers and the battle lines between policyholders and carriers come into focus.

While the ramifications of the subprime crisis for the insurance industry are broader than the effects on the industry wrought by the WorldCom and Enron deals, talk of hardening rates for the D&O lines is "a little premature," said Ellison.

Yes, rates climbed in the wake of Enron and WorldCom, and the D&O market went from soft to hard as carriers across the board raised their rates. But because rates are so soft now, were rates to go back up, they wouldn't amount to much more than a bump, according to Findlay.

In commercial D&O, prices are competitive, added Pollaro. But in the narrower segment of financial institutions D&O, where there are fewer insurers underwriting that risk, "you are starting to see premiums reflect the risk," he said.

September 1, 2008

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