Insurance for Liability Is at a Premium : Malpractice Coverage for Firms’ Officials Considered Too Risky
Bank of America, in a nervy move earlier this year that infuriated the insurance industry, sued six of its own officials and tried to collect on insurance policies covering officers against shareholder and customer lawsuits.
The fallout was immediate. The bank’s liability coverage was cancelled. Spurned by the insurance industry, Bank of America was forced to create its own insurance subsidiary for one client--itself. And the move added to the difficulties that banks nationwide are having finding affordable directors and officers liability insurance.
Banks aren’t the only businesses having trouble obtaining coverage to protect their executives against lawsuits these days. Unocal is suing four insurance companies that cancelled its directors and officers liability policies the day that T. Boone Pickens Jr. disclosed his takeover attempt. And executives of chemical firms and utilities who face potential huge future claims from worker deaths or toxic spills or nuclear accidents are virtually uninsurable.
Will Affect Consumers
Insurance industry and corporate officials say American consumers eventually will feel the effects of the squeeze on what has been an obscure cost of doing business.
Higher insurance premiums will be passed on the public, as will the cost of increased reserves that businesses will be forced to set aside to pay uninsured claims.
Banks will adopt more conservative lending policies and other firms will take fewer risks that could expose them to lawsuits. Bigger losses by insurance companies means bigger premiums for all policyholders.
In addition, companies will have more difficulty recruiting top-notch outside directors who will fear putting their personal fortunes in jeopardy because of decisions taken by the firm.
“This has become a zoo. The statistics are quite appalling,” said David Simmons of the Insurance Information Institute. “What I see as the outcome of this is the reluctance to write D&O; (directors and officers liability insurance) on the part of anybody by underwriters, who are losing money by the ton as it is.”
The crisis in directors and officers insurance--also known as corporate malpractice coverage--grows from a number of factors converging at once.
The insurance industry suffered losses last year in excess of $3.5 billion and is dropping unprofitable lines. Shareholders, customers and regulators are quicker to sue than ever before.
Bank failures and takeover battles have led to hundreds of costly lawsuits against corporate managers and board members. And courts are increasingly liberal in interpreting corporate and individual liability.
Banks Hit Hard
Banks are among the hardest hit, bankers and insurers say, because their losses come so often and in such massive doses.
Bank of America, for instance, is seeking to recover $95 million lost in an alleged mortgage fraud that the bank blames on negligent employees.
Chase Manhattan is suing six former workers in an effort to recover $175 million in losses stemming from the Penn Square Bank failure.
Ohio bank regulators have sued the former officers and directors of the closed Home State Savings Bank for $372 million. The Federal Deposit Insurance Corp., which insures deposits at nearly all U.S. banks, wants to recover more than $1 billion lost in the Continental Illinois debacle.
“The situation is worst in the banking industry,” said Warren G. Brockmeier, vice president for risk management at Wyatt Co., a Chicago actuarial and insurance consulting firm.
“One of the reasons is that the FDIC has declared open season on D&O; policies of failed institutions. The other aspect is claims by banks themselves against their own directors and officers.”
The so-called “offensive” use of liability policies, most dramatically seen in the B of A and Chase cases, originated in 1978 at the tiny Bank of Warren County in McMinnville, Tenn.
The bank, after suffering substantial loan losses, sued its own board of directors for mismanagement and filed a claim with the bank’s insurer.
“The D&O; carrier screamed, said that’s not what was intended in the policy. But there wasn’t anything in the policy that prevented this type of action,” said attorney Pat Ardis of Memphis, who represented the bank. “We settled the case quietly. This was just a country bank and didn’t have the impact of a B of A or Chase.”
In fact, the market barely noticed. Demand for D&O; policies was growing, so much so that today, an estimated 98% of New York Stock Exchange-listed companies carry some sort of executive malpractice coverage. Competition drove rates down and coverage limits up, in some cases as high as $200 million.
Then, last year, the hammer fell. Insurers were losing money across the board and began looking for ways to recoup.
Pay-outs on D&O; policies, particularly at banks and other financial institutions, amounted to three times income from premium. Insurers began abandoning D&O; for banks, or getting out of the D&O; business entirely.
“Look at what’s going on around you in financial institutions. Look at the number of them in distress. Look at the amount of litigation,” said Joseph P. DeAlessandro, president of National Union Fire Insurance Co. of Pittsburgh, the nation’s largest writer of D&O; policies. “The easy way out is to say we won’t write that line.”
DeAlessandro said, however, that his company would continue to insure banks, although some troubled institutions have been dropped. He wouldn’t identify them.
Dozens of Suits
A wave of bank failures in the last two years touched off dozens of suits by shareholders and prompted the FDIC to seek recovery from former officers and directors of failed banks--and their insurers--a tactic that regulators said was not new.
“We’ve been doing this for years. What’s changed is that more banks are failing and bigger banks are failing,” said Mark Rosen, assistant general counsel at the FDIC.
He said the agency currently has 60 D&O; claims pending and is contemplating filing another 150. All, except the $1-billion action against Continental Illinois, involve closed banks and were brought by the FDIC as receiver or liquidator.
Then, in rapid succession, three events occurred that threaten to wipe out the D&O; market for banks entirely.
Last fall, Chase sued several former officers for $175 million. In January, the Delaware Supreme Court held the directors of Trans Union Corp. personally liable for gross negligence in approving the firm’s $700-million acquisition by the Marmon Group, a decision certain to spark scores of claims against directors of firms in takeover fights or bankruptcy actions. And in March, B of A filed its suit against six employees and two insurance firms to try to recover the mortgage scheme losses.
Some banks, such as B of A, have been cancelled in the middle of their policy terms. Others are seeing premiums rise from 50% at the healthiest companies to 1,000% at larger or more vulnerable institutions, according to Brockmeier.
Coverage Shrinking
At the same time, coverage limits are shrinking to $30 million or less from $50 million or $100 million and deductibles are rising to $10 million from $2 million. As limits fall and deductibles rise, the policies begin to look very much like self-insurance.
Bank of America, which was paying $312,000 per year for $80 million worth of coverage, couldn’t find anyone to insure it at any price.
“The industry was not willing to give us satisfactory quotes,” said Norm Wintemute, the bank’s vice president for risk management. “I hate to see them take such a negative attitude. Lloyd’s of London underwriters always take the position that there’s no such thing as a bad risk, only a bad rate.”
But the American insurance industry did deem B of A a bad risk. And Lloyd’s, which traditionally has backed D&O; policies written by American companies, is increasingly reluctant to provide such “reinsurance” for U.S. banks, a Lloyd’s official said.
Employers Insurance of Wausau (now called Wausau International Underwriters), which carried Bank of America’s D&O; coverage, dropped the bank and said it was getting out of the D&O; business entirely. The insurer, citing the pending lawsuit filed against it by B of A, declined to comment on the case.
Formed Own Firm
Bank of America, concerned that its executives and directors were unprotected, established its own offshore “captive” insurance arm, BA Insurance (Cayman) Ltd. Wintemute would not detail the limits or premiums, saying only that they were consistent with market rates.
“To retain good people in management, it was imperative to have this coverage,” he said.
Arthur F. Brimmer, a Washington consultant and a member of the Bank of America board of directors, said the crisis in D&O; insurance could lead to a reluctance on the part of qualified people to serve on corporate boards.
“Every company is faced with this problem. In the last month, I’ve been to several board meetings in which this subject has been discussed,” said Brimmer, who also sits on the boards of United Airlines, Gannett, International Harvester, American Security and Bell South.
“If companies were unable to get coverage or it became so narrow that the exposure of directors would increase substantially, then I would anticipate that directors would be more reluctant to serve--in fact, some would resign.”
Brimmer suggested that banks may be forced by hostile private carriers to band together to form their own cooperative insurance units. A task force of representatives of the nation’s biggest banks is exploring the subject in an unpublicized series of meetings. The group met most recently June 7 in Chicago.
Potential Benefit
There is one potential benefit of the insurance crisis, analysts say. Corporate directors, knowing they will be held accountable for their decisions, will exercise more active oversight.
“It’s quite obvious that litigation in recent years has really added a great deal to the potential liability of any directorship, whether it be in banks or any other publicly held company,” said Jack A. MacAllister, president and chief executive of U.S. West, a major regional telephone company based in Denver. He serves on the boards of a top-10 bank, First Interstate Bancorp, and a big insurance firm, the St. Paul Cos.
“When you do accept the responsibility as a director, you have to be deeply involved in the fundamental direction of the business, or else you’re in trouble.”
