Mr. Kim told National Underwriter that the impetus for increases started in September 2003 with the investigation of Canary Capital Partners, an offshore hedge fund which allegedly had struck illegal agreements with mutual funds to carry out favorable trading at the expense of ordinary investors. (Last September, Attorney General Spitzer's office announced it had reached a $40 million settlement with Canary Capital Partners. The firm has also been cooperating in a wider investigation into other misconduct by mutual fund companies.)

“It all started with Canary Capital. And now, you not only have the other investigations and the potential costs associated with those, but you also have individual plaintiff actions–shareholder suits filed against the fund, fund board and the fund advisor,” Mr. Kim observed. “And then you also have corporate actions filed against any publicly traded corporate advisor.”

He also commented that from these developments, the insurance industry is seeing a spike in liability and loss payments, and thus has been reacting by adjusting premium structure significantly. “This increase in rates is largely due to current regulatory investigations,” he noted, adding that D&O and E&O rates for mutual fund companies have been increasing significantly over the past three or four months.

“Although its hard to say how much theyve been increasing exactly, I would say an order of magnitude of 500 percent increase would not be unusual,” Mr. Kim related.

Furthermore, he said, the rate-revision process is still at a very early stage and its likely that more rate hikes will follow. “As we know, insurance programs renew every 12 months, so the recent rate increases reflect only a few months worth of clients renewed so far,” Mr. Kim said. “So I think clients have to anticipate that even if they are not currently embroiled in all the current investigations, their premiums would increase.”

Some of the largest mutual fund groups declined to comment on their insurance premiums, but the Valley Forge, Pa.-based Vanguard Group, while declining to offer specifics of their insurance coverage, told National Underwriter that the impact of rising rates would be minimal on their financial bottom line. “The premium rates would not have any discernible effect on our expense ratio,” said Brian Mattes, a spokesperson for the group. Vanguard, a company with 17 million institutional and individual shareholder accounts and more than $630 billion in U.S. funds, has not been accused of any misconduct by regulators.

Currently, major players in the mutual-fund product line are The Chubb Corporation in Warren, N.J.; American International Group Inc. in New York; The Hartford Financial Services Group Inc., based in Hartford, Conn.; Zurich American Insurance Company based in Schaumburg, Ill.; and the New York-based Gulf Insurance Company. “And certainly, there is also ICI Mutual, which is the industry captive. All these have had to react to current events,” Mr. Kim from Aon observed.

Shelia January, senior vice president at Zurich North America Specialties, one of the major players in this arena, agreed that most mutual fund companies have seen big jumps in their D&O and E&O rates in the past few months.

She noted that relatively moderate rate increases have been around since early 2001 for professional liability coverages, but that it wasnt until last September–when the Canary Capital case surfaced–that rates began to shoot up dramatically.

“The lowest increases that I have seen in the last couple of months have been in the 10-to-15 percent area, and the highest ones–for some fund groups that have become household names in newspapers–have been in excess of 100 percent,” Ms. January observed. “I think its rare to find a mutual fund group that has not been affected by some level of rate increase.”

Additionally, there are also changes being made to policy conditions, with some exclusionary language or the condition language. For example, some insurers have been adding exclusions for certain mutual fund practices such as market timing on their policies. “So its important for clients and their brokers to really review the policy and the policy language,” Ms. January advised.

(The exact wording used in exclusions for specific types of market timing can be very different, depending on the insurer. Some use the SEC's explanation as a starting point. The SEC says that market timers, at mutual funds with overseas investments, take advantage of time-zone differences between foreign and domestic securities markets. Such market timers buy or sell mutual fund shares based on potential material events that take place after foreign markets close but before the funds' net asset values are established at 4:00 p.m. Market timing itself is actually not illegal, but mutual fund advisers have an obligation to ensure that all shareholders are treated fairly.)

When asked whether she has seen mutual fund companies express surprise at the sudden spike in their insurance rates, Ms. January noted that the insureds have generally been expecting their rates to be affected by regulators investigations: “So there certainly was not a lot of surprise–they knew there was going to be some effect on their rates.”

She noted that many mutual fund companies have been part of the ongoing inquiries, even if they were not accused of any wrongdoing. Also, the industrys trade association, the Washington, D.C.-based Investment Company Institute, has been sending out mailings to its members to keep them informed about new developments in inquiries. “So they are very aware of whats going on. They have been expecting this, and I have not heard any company express surprise.”

The amount of D&O and E&O rate hikes for mutual fund companies also depends on a couple of factors. “It depends on whether they are one of the fund groups that have been named and were involved in these activities, or if they are one of the fund groups that have been part of the inquiry and the information gathering by the SEC and state securities commissioners,” Ms. January commented.

She noted, however, there are some fund groups that have not had any problems at all. “So this creates a real range in rate increases.”

The rate hikes, Ms. January observed, are reflective of claims that have been reported and settlements that have already been seen. “There are definitely more claims and lawsuits that are reported to us.” But she also noted that with regard to mutual fund groups settlements with the SEC and others like the New York attorney generals office, it is not yet clear how much of those could possibly be covered by insurance.

“And then there are also a lot of civil cases being filed. I think further rate increases will depend very much on how these litigations and inquiries develop,” she said. Traditionally, mutual fund groups have been the type of financial institutions that didnt have large claims and lawsuits resulting from industry-wide practices. “So this is the first time that we have seen things that are going across the industry and are affecting a number of insureds,” she said.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, January 30, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.