These carriers not only have to face an environment of growing regulatory scrutiny over financial companies, but also have to cope with the long-tail nature of the coverages they offer, as policies written several years ago now come to fruition.

Indeed, the situation for financial institution D&O and E&O underwriters gets so challenging that "the single most important issue facing the industry every year is the question, 'Will we make money on these two lines of coverage?'" said Barb Stafford, national director for financial institution specialty liability at the St. Paul, Minn.-based St. Paul Travelers, one of the leading carriers offering these two coverages.

"It goes without saying that we'll continue to see various forms of corporate misbehavior resulting in D&O and E&O claims, regardless of class of business. The toll of these claims will no doubt pressure industry profitability."

Ms. Stafford emphasized that since both D&O and E&O are long-tailed coverages, it typically takes three-to-seven years for a claim to fully develop--which means carriers are still paying for long-forgotten financial scandals of yesteryear.

"As an underwriter, the events of the past five years will have greater impact on the D&O and E&O lines for financial institutions and other corporations than what happened in this past year," she said.

Adding complexity to the long-tail nature of the coverage is the fact that both D&O and E&O claims continue to grow in frequency and severity--and that the costs to defend claims is on the rise.

Ms. Stafford also noted that with growing oversight and scrutiny by the Securities and Exchange Commission, institutional investors and other industry watchdogs, underwriters have seen some very high-profile cases impacting the insurance, funds and brokerage industries.

"Add to that economic uncertainty, and what you end up with is a very precarious environment in which to successfully write these two coverages," Ms. Stafford said.

Scott Meyer, president of financial institutions group at New York-based National Union, an AIG member company and also one of the largest providers of financial institution D&O and E&O, echoed similar sentiments about the marketplace. Generally, Mr. Meyer said, loss trends have been deteriorating as old cases from initial-public-offering laddering and investment-banking scandals come to settlement.

(IPO laddering, also known as tie-in cases, alleged wrongdoing in the process by which lead securities underwriters that handled initial public offerings allocated IPO shares to their customers. According to Stanford Law School Securities Class Action Clearinghouse/Cornerstone Research, there were more than 300 laddering cases filed in 2001.)

"Profitability varies by segment and changes every year. And it takes many years to play out," he said.

Mr. Meyer said "policies from 1997 to 2000 are having significant claims. They are at a point now where they have to be paid by carriers. Like Enron and WorldCom, these policies are coming to fruition now."

(Regulatory settlements are usually not insurable, but financial institution underwriters may have to pay for defense costs along with other expenses such as private civil litigation, representatives said.)

Compounding these claims patterns, said Theodore Boundas, insurance attorney and senior principal at Boundas, Skarzynski, Walsh & Black LLC in Chicago, is the fact that with regard to investment banking--in particular with the large strict liability cases such as WorldCom and Enron--the underlying litigation in those cases does not require a finding of fraud. Instead, all that is needed is a showing that the investment bank did not perform due diligence.

"Because the focus is now on due diligence, this negates or minimizes the applicability of the fraud exclusion under most insurance policies," Mr. Boundas said. "This setup results in the potential for large exposure to the investment banks and resulting exposure to their insurers."

Mr. Meyer from National Union also said financial institution underwriters are now working through two issues: mutual funds situations, whose claims are coming in relatively steadily, and the insurance sector, in light of the trouble that insurers and reinsurers have had.

For mutual funds, there are now coverage exclusions that deal with late trading and market timing--activities that were at the center of regulatory investigations. Financial institution underwriters are also responding to regulatory scrutiny over the insurance sector by adding certain exclusions in some cases.

Evan Rosenberg, senior vice president of Warren, N.J.-based Chubb Specialty Insurance, one of the largest providers of E&O and D&O for financial institutions, said that because of concerns over finite reinsurance, E&O and D&O underwriters now sometimes add finite reinsurance exclusions depending on perceived exposures.

"For such exclusions, wording will be different for each customer. It's based on what each account is doing," he explained.

As for pricing, executives from these major financial institution underwriters said premium rates are still stable for most financial institutions--unless they have been a target of investigations or negative publicity.

"Overall, financial institution rates currently are flat compared with rates from a year ago," said Mr. Meyer from AIG. But he forecast that rates may go up by 5-to-10 percent in the next year as more claims from policies written three-to-seven years ago fully develop.

Mr. Rosenberg from Chubb observed that a handful of very large companies in the insurance sector saw large, double-digit rate increases this year. But other than those, there wasn't much increase for the rest, he said.

Ms. Stafford from St. Paul Travelers observed that while there was a brief insurance market correction from 2001 to 2003, during 2004 and throughout most of 2005, there has been ample capacity in the marketplace to drive pricing down and expand coverage terms and conditions.

In current pricing, she added, "what's most perplexing is that many D&O and E&O underwriters are choosing to ignore loss trends, as well as the significance and impact of various insurance industry issues."

And for the most part, recent news of troubles involving the once high-flying hedge fund segment isn't too much of a concern for financial institution underwriters either, since less than 20 percent of hedge fund firms typically buy professional liability, according to AIG.

Chubb added, however, that some underwriters covering hedge funds are taking a closer look at their practices and are in some cases raising rates for more aggressive hedge funds with more complex and esoteric investment schemes.

Michael Ha is a former Assistant Editor for National Underwriter. He is now working as a freelancer in New York City.

Quotebox with a photo:

"Policies from 1997 to 2000 are having significant claims. They are at a point now where they have to be paid by carriers. Like Enron and WorldCom, these policies are coming to fruition now."

Scott Meyer, President

Financial Institutions Group

National Union

In some high-profile investment banking cases, "because the focus is now on due diligence, this negates or minimizes the applicability of the fraud exclusion under most insurance policies," said attorney Theodore Boundas.

"What's most perplexing is that many D&O and E&O underwriters are choosing to ignore loss trends, as well as the significance and impact of various insurance industry issues," said Barb Stafford of St. Paul Travelers.