By Katie Kuehner-Hebert
As the scandal surrounding the manipulation of the London Interbank Offered Rate (Libor) continues to unfold -- with more and more lawsuits being slapped on the world's largest banks after Barclays PLC announced its $450 million settlement with regulators -- speculation is rising on the ultimate impact on the banks' insurers holding their directors' and officers' policies.
While the alleged manipulation of the Libor rate occurred as early as 2005, the scandal began to make international headlines in June after Barclays announced that it had settled with U.S. and U.K. regulators for attempted manipulation and false reporting of the Libor and the Euro Interbank Offered Rate (Euribor).
Specifically, the authorities alleged that certain Barclays traders requested that Barclays Libor and Euribor submitters contribute rates that would benefit the financial positions held by those traders. The Barclays traders also allegedly communicated with traders at other financial institutions to request Libor and Euribor submissions that would be favorable to their trading positions. Moreover, certain members of Barclays management directed that Barclays U.S. dollar rate submissions be lowered, without respect to the bank's actual borrowing costs (Barclays' CEO Robert Diamond and Chairman Marcus Agius resigned after the announcement).
In its June 27 press release, Barclays said that the "resolution is part of an industry-wide investigation into the setting of interbank offered rates across a range of currencies."
Indeed, numerous U.S. municipalities, pension funds, institutional investors and even community banks have filed civil lawsuits not only on Barclays, but also on the other LIBOR-setting banks and their parent banking companies, including Citigroup Inc., JPMorgan Chase & Co., Bank of America Corp., Credit Suisse Group AG, HSBC Holdings PLC, Lloyds Banking Group PLC, Deutsche Bank AG and The Royal Bank of Scotland Group PLC. The parties in the various types of claims have alleged that their portfolios, interest income and/or bottom lines have been hurt by the rigged Libor and Euribor rates.
Kevin LaCroix, an attorney with RT ProExec in Beachwood, Ohio and a blogger with The D&O Diary, said the exposure for these banks' D&O carriers depends on the type of lawsuit being filed -- antitrust, shareholder derivative, securities class-action or fraud.
So far, D&O carriers have little exposure to antitrust lawsuits filed against their bank clients, LaCroix said. Judge Naomi Buchwald in the Southern District of New York consolidated numerous antitrust suits against the Libor-setting banks into one large proceeding that has been pending since 2011. In August, Buchwald placed a second round of antitrust lawsuits on hold until decisions are made on the first round.
"The only defendants named so far in the antitrust lawsuits are corporate entities and no individuals have been named as defendants," he said. "Individuals would have coverage if they were named in antitrust lawsuits, but there is no entity coverage under a public company D&O policy for antitrust claims. The antitrust claims by far are the biggest potential exposure for the company, but not for their insurance carriers."
The second type of lawsuit is the shareholder derivative lawsuit, with one currently filed against Citi and another against Bank of America, LaCroix said. The lawsuits are filed on behalf of the corporation, for failing to take appropriate steps to protect the bank from the consequences of the manipulative behavior.
Shareholder derivative lawsuits are typically filed on U.S. corporations and only three Libor-setting banking companies are U.S. domiciled -- Citi, Bank of America, and JPMorgan Chase, he said.
"Shareholders derivative lawsuits may represent serious exposure for defendants and their carriers, but only three LIBOR-setting banks are domiciled in the U.S., so there won't be many of these kinds of lawsuits," LaCroix said. "So the overall exposure for carriers with this kind of lawsuit is not much."
By far, the biggest exposure to D&O carriers are damages arising from securities class-action lawsuits, one of which has already been filed against Barclays, he said. Only companies that have shares or American Depositary Receipts (ADRs) that trade on U.S. securities exchanges can be sued under this type of suit.
"Barclays, Credit Suisse and Deutsche Bank have securities traded on the U.S. exchanges, and that represents a significant exposure for carriers, LaCroix said.
Justin Psaki, Arch Insurance Group's vice president, Executive Assurance Division, FI/FS Department in New York said the real threat from this scandal under a D&O insurance policy would be any follow on litigation brought by shareholders in the form of securities class-actions or derivative lawsuits. However, the majority of large U.S. banks purchase only what is commonly referred to as Side A coverage, which typically responds only to claims against directors and officers when the entity is unable to indemnify such individuals due to financial insolvency or legal prohibition.
"This meaningfully reduces the amount of coverage available for these lawsuits," Psaki said. "From what we know today, the real exposure to D&O insurance carriers from this scandal comes by way of potentially large derivative settlements or judgments which companies may be prohibited from indemnifying under statutory law."
Psaki would not say how much potential exposure Arch has regarding the Libor scandal.
Regarding fraud claims against the Libor-setting banks, LaCroix said that D&O carriers might have to pay damages if any of the banking companies lose on lawsuits claiming fraud, but it's typically difficult for plaintiffs to prove intent in those cases, so the overall exposure to carriers is likely limited.
The actual number of carriers that are exposed to the Libor scandal is also limited, he said, as the industry pulled back significantly on insuring large banks even before the financial crisis, and even those that offer D&O polices do so under limited conditions and require very large self-insured retentions, such as $50 million. LaCroix estimates the most exposed carriers are Chartis, a unit of American International Group Inc., Chubb Group of Insurance Cos., XL Insurance, Zurich Insurance Group, and various Lloyds of London syndicates.
In Chubb's second quarter earnings call, Paul Krump, Chubb Corp.'s executive vice president and president of the carrier's commercial and specialty lines, commented about the carrier's potential exposure to the Libor scandal.
"For Chubb, only 3 percent of our worldwide professional liability book is comprised of public D&O covers for financial institutions," Krump said. "As respect (to) any potential D&O exposure for larger banks, the vast majority would be Side A covers or high excess layers for traditional Side A and B covers. These are the key points when thinking about Chubb because Side A only covers claims brought against a director or officer, if the corporation is unable or not allowed to indemnify them."
Moreover, Chubb's financial institution clients have very large self-insured retentions, Krump said.
"The primary layers will typically absorb much of the defense cost," he said. "Another data point for perspective is our average attachment point on our excess, FI, D&O book at Chubb, is in excess of $80 million."
In XL's earnings call, Gregory S. Hendrick, executive vice president and chief executive officer of XL's Insurance Operations, said that because it's a developing event, it will take some time for the company to come up with any kind of precise loss estimate.
"As with the case of our entire portfolio, the financial institutions book has a blend of Side A, full coverage D&O and E&O," Hendrick said. "In fact, over half of our large financial institutions exposure is Side A only, which is a far more limited coverage potential. Specifically, to our international financial institutions business, we reduced our average limit by 20 percent over the last few years, which will mitigate any potential loss severity. The only thing I can add is ... we are monitoring the situation very closely."
LaCroix said that most of the affected carriers in their second quarter earnings calls have been expressing belief that their ultimate exposure will be limited, either because of the type if financial institutions they have chosen to cover, or the small limits on those particular policies.
"Most likely the overall exposure among the affected carriers is dispersed," he said.
LaCroix estimates that the collective losses to both the banks and their carriers would be akin to the losses suffered by both industries after the IPO laddering scandals surrounding the dot.com crash in the early 2000s. The Internet bubble had created an opportunity for investment underwriting banks to sell shares in an IPO, and then guarantee that the IPO would go up, thus requiring their clients to purchase more shares after the IPO at market prices.
The aggregate settlement cost of lawsuits filed against the banks in that scandal was about $1 billion -- for both the banks and their carriers -- about what LaCroix estimates the collective costs will be due to the Libor scandal. In comparison, the settlement costs to date from lawsuits due to the credit crisis have been in the tens of billions of dollars.
However, there is speculation that the Libor scandal could spread to include lawsuits on other entities, he said.
"There are conspiracy theories that there were other organizations, entities, agencies that somehow facilitated or perpetuated the manipulation, where its auditors failed to see this behavior," LaCroix said. "Plaintiffs attorneys may be thinking of who else they can sue."
Psaki said that insurance industry brokers, underwriters and risk managers should be wary of assuming that targets of these investigations and lawsuits are limited to the 16 Libor-setting banks that were on the Libor Panel during the time period of the alleged rate manipulation.
"The employees at these banks involved or aware of the conduct during the alleged rate manipulation may have left for other banks not involved in the Libor rate setting but traded and profited from interest rate sensitive securities such as derivatives," he said. "I would not rule out that some of these bank employees shared this information with key clients such as hedge funds and business partners such as brokers who then passed this along to their valued brokerage clients."
Matthew Rolph, managing director, head of management liability for Marsh U.K. in London, said that a number of insurers have privately expressed to him apprehension that the Libor scandal could have some contagion and expand into the errors and omissions market (in Europe, the professional indemnity market), if customers file lawsuits alleging they have been damaged.
Indeed, while many customers, such as homeowners refinancing their mortgages, may have benefitted from a suppression of the Libor rates, other customers, such as counterparties to derivative contacts, may have suffered losses when rates were suppressed.
"With the complexity of financial contracts -- where there's always a loser on the counterparty to a winner -- there will be situations where customers can allege that they were disadvantaged at the suppression of these rates," Rolph said. "Insurers are not saying these types of lawsuits are a slam-dunk, but a couple of them have expressed concern that this could happen."
Moreover, the investigation of the Libor rate manipulation could lead to other investigations of key U.S.-based benchmarks or indexes that are conceived by data provided by industry participants, Psaki said.
"This scandal could conceivably accelerate any already hardening or tightening of policy terms," he said, "and pricing in the management and professional liability lines for financial institutions, if not all industry classes."
KATIE KUEHNER-HERBERT, a freelance writer based in San Diego with more than two decades of journalism experience with expertise in financial writing.
September 4, 2012
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