Commentators Disagree Over D&O/E&O Exposure from Subprime Litigation

A recent report by Lehman Brothers Equity Research (“Lehman”) concluded that the estimated impact to D&O/E&O insurers from subprime issues will likely be no more than $1 billion.  Lehman Brothers arrived at this estimate using past financial institution professional liability problems as a benchmark.  Lehman explained that, in its view, this is a manageable amount for the industry based on the syndicated structure of these coverage as well as reinsurance protection.

At the same time, however, Securities Law 360, a popular news source for the securities industry, reported that hedge funds faced an increasing threat of subprime litigation.  Any such litigation would obviously impact at least the E&O market.  The Securities Law 360 pointed to several trends as evidence of this increased threat of litigation.  Most notable are the investigations by federal and state agencies into problems with hedge funds and other institutions that heavily invested in subprime debt.  As noted in the article, the SEC has instituted nearly a dozen informal inquiries into “collateralized debt obligations” in which certain hedge funds were heavily invested.  The article also pointed to the SEC settlement with First BanCorp for $8.5 million, which involved $4 billion in collateralized mortgages.  The SEC is not alone in pursuit of these issues.  As noted in the article, both the New York and Ohio attorneys general are investigating losses faced by Bear Stearns’ subprime hedge fund, which we reported on earlier (see here).

While many fear an increase in D&O and E&O claims as a result of these investigations, some believe that the real threat is in the defense costs necessary to defend these suits.  Dr. Robert Hartwig and Dr. Steven Weisbart, both of the Insurance Information Institute, have said that it is difficult to see how subprime losses could rise to the multi-billion dollar level without bankruptcies of major financial institutions, which appears highly unlikely.  If that is true, defense costs could cost insurers more than payments to settle lawsuits.