One of the major impacts of the credit crunch on the insurance sector is the large number of Directors & Officers and Errors & Omissions claims that are expected to be filed. David Sandham assesses the damage.

In the midst of a crisis, it is not always easy to get one’s bearings. By any measure, the subprime crisis (2007-?) rates as a financial disaster on an epic scale.

One measure is the number of legal cases filed, as those hurt in the crisis look for someone to blame.

Previously, the high watermark for the number of cases filed in the United States was 559, as a result of the savings and loans (S&L) crisis of the 1980s. In the S&L crisis, 747 savings and loan associations failed, largely as a result of imprudent lending and scams during a housing bubble (déjà-vu anyone?).

The S&L crisis probably contributed to the 1990-1991 economic recession. By 1991, the number of new homes constructed annually slumped to the lowest rate since World War II.

This time, it is worse: by 30 June 2008, the number of subprime mortgage US legal filings totalled 607, topping the previous high watermark.

Silver lining?

The figures reveal a slowdown in filings through the months of this year. January was the biggest month, May the smallest, with June picking up a little.

But according to Jeff Nielsen of consultants Navigant, we should not be too cheery about this reduction in velocity. The slowdown is happening merely because subprime mortgages are receding into history, as lenders curtail their involvement, or exit the field entirely. Worryingly, securities-related and contract-related disputes have held steady or even increased.

The subprime crisis appears to be still fluid: expect to see episodic bursts of new activity, and new areas of litigation tunnelled out.

More evidence that we are still on the uphill climb of this legal mountain is that in Q2 2008, only 36 cases were disposed, compared to 121 new cases filed: a ratio of 3.36. Although this ratio is less steep than in the Q1 (4.85), it indicates that the downhill portion of the mountain is still some way off.

D&O

The consequences of subprime for insurance claims under Directors & Officers and Errors & Omissions policies are incalculable. In the S&L crisis, the legal payout was $4bn.

Given that more cases have been filed for subprime than for S&L, we could draw the inference that the legal payout is likely to be more than $4bn.

Thomas Hess, Swiss Re’s chief economist, has estimated the D&O and E&O losses at between $3bn and $9bn, roughly equivalent to a medium-sized natural catastrophe.

But we should be wary. The cost of the subprime crisis has been estimated at $1tr, much bigger than the $160bn estimated for S&L. We will not know the answer tomorrow. It could be a decade before all the subprime cases are resolved.

David Sandham is editor of Global Reinsurance.

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