By DAN REYNOLDS, senior editor of Risk & Insurance®
When some of the nation's largest financial institutions ran headlong into a brick wall in late 2008, the phrase "too big too fail" chewed up a lot of ink in the financial press. In stepped the U.S. government and the likes of Citigroup, AIG and Bank of America received life support.
And, perhaps due in the main to that government lifeline, from the perspective of directors' and officers' (D&O) liability insurance, the subprime collapse and the credit crunch didn't end up being all that bad for insurers, according to Forbes Geekie, a senior vice president, financial lines, with Bermuda-based Endurance Specialty Insurance Ltd.
"In terms of the financial services D&O market, as opposed to the E&O market, we ultimately survived the whole credit crunch/subprime maybe better than we had feared back in the dark days of the second half and certainly the fourth quarter of 2008," Geekie said.
But now, as we turn into the first quarter of 2011, it's not those sexy big names that are giving financial institutions D&O underwriters the biggest worries. Rather, the thousands of small community banks, the resting place of small-business loans and the financial dreams and aspirations of good old Main Street--not "depraved" Wall Street--are most at risk.
Unemployment in the United States has remained stubbornly high, and it could be argued that a significant long-term shift has taken place in U.S. consumer spending habits. A generation of Americans, if they hadn't learned how to before, are trying to discipline themselves to save, which isn't such good news for an economy that has increasingly becoming dependent on personal consumption and a thriving service sector and less and less on traditional mainstays like manufacturing.
Geekie stipulated that the ongoing malaise will eat away at smaller banks, some of whom might only have two or three branches and are much more vulnerable than the big banks, with their vastly superior resources and what amounts to a federally mandated layer of insurance in the form of the Troubled Asset Relief Program.
"Real economic factors are now adversely affecting these smaller banks," Geekie said.
He cited such things as continued unemployment, an inability to pay mortgages, credit card delinquencies, and rearward auto and student loan payments.
"Frankly, any other form of uncollateralized lending that was out there. But these are the issues that the newspapers aren't reporting on a daily basis as they are not sexy headline generators, but they are eroding the capital base of these smaller banks," Geekie said.
"And I don't anticipate the situation improving markedly," Geekie added.
According to another executive, the credit crunch created its own bifurcated market, between financial institution (FI) D&O and other types. Now we have another type of bifurcation within FI, between D&O for the big banks and D&O for the smaller banks.
"What we have now is a subsector in the FI for banks," said Trevor Howard, a New York-based senior vice president of U.S. management liability with Liberty International Underwriters.
Howard pointed to the more than 150 U.S. bank failures in 2010, which outpaced the 140 or so in 2009 and which has pushed the total amount of bank failures since 2008 to more than 300.
That number could grow even more, according to Geekie.
"The smaller tier of U.S. banks, be they community banks or the smaller regional banks, is still an area that, personally, I believe should as a sector continue to generate a great deal of concern," Geekie said.
TRANSLATING INTO RATES AND EXCLUSIONS?
So what are those smaller banks looking at from a D&O insurance perspective? Rates overall have remained flat or gone down a peg, thanks in large part to that aforementioned government paternalism that saved the big boys.
Smaller banks, however, will be looking at more regulatory exclusions on their D&O policies, according to Howard, something the larger banks might not see.
"So banks that are under cease-and-desist orders or potentially could be seen as not as stable as some of their larger brethren, the underwriters may take a hard line and put that in there," Howard said.
The scary thing for underwriters, or some of them at least, is that those vulnerable small and regional banks have got lots of insurers dancing toward them, ready and willing to offer them coverage at a reduced rate.
In recent weeks, we at Risk & Insurance® have heard some weird things, verging on the paranoid. Some worry that the current soft market is permanent, that the economy that insurance supports has been permanently altered and that price hikes will never come back--never ever.
Endurance's Geekie, like other insurance executives in other lines, watches as new capacity waltzes into financial D&O and is wincing at what he sees.
"I think for starters the glaring issue in the larger FI D&O market--be it the small guys or the bigger Fortune 1,000 companies--is that there is simply far too much capacity in the marketplace," Geekie said.
Geekie estimated that $300 million to $350 million of insured capacity has entered the U.S. domestic marketplace since the end of 2008 and the beginning of 2009.
"We are swamped by an abundance of new carriers that are increasingly eager to use their capacity," Geekie said.
Pile that reality on top of a small banking universe that Geekie is certain contains a swamp of D&O claims and their attendant legal fees, which can suck the fiber out of layer upon layer of insurance coverage: It's not a pretty picture, and there isn't much in the way of a fence to keep the unwary out of the game.
"As long as a carrier has a rating and a shingle hanging above the door, they can compete for this business," Geekie said.
These newbies are taking advantage of an inflated renewal base. Those spikes in financial D&O rates that occurred in 2009 make any discount look pretty good, which further aids the entry of newcomers.
"If carriers do not have a legacy or subprime credit crunch liability, then they are actually taking advantage of an inflated renewal base, and 10 to 15 points off of this inflated base is perceived to be acceptable underwriting," Geekie said.
January 1, 2011
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