The Madoff and other recent alleged frauds have been compared to the WorldCom and Enron events of the 1990s. But will they have a similar impact on reinsurers? Global Reinsurance asked four industry players for their views.
Antony Bastow wonders what the two latest affairs will mean for claims
"The figures for the Madoff fraud are mind-boggling. But what will it mean for claims? Will we be left reeling from a spate of lawsuits directed at ‘directors and officers’ and financial institutions, as in the Enron and WorldCom collapses?
The types of exposure from Madoff appear far broader. Why? The fraud appears much larger: exposure to insurers could hit $3.8bn. But this is not the only reason.
The Madoff investment fraud is at the centre of a web spiralling outwards. There is a long list of victims, from banks and insurers to pension funds and universities. Madoff defrauded not only those who directly invested, but also feeder funds and funds of funds. Each will have its own set of corporate trustees, financial advisers, administrators, auditors and, in some jurisdictions, custodians.
Insureds may also have a mixture of exposures. There will be accountants who have audited one fund but who will act as an administrator on another. Inadequate due diligence, failure to control and to check security, poor financial advice and corporate governance are all areas of potential vulnerability.
Finally, litigation has begun in Europe as well as the US. This will inevitably increase insurer costs.
Are there any positives? Well, it seems that considerable amounts were placed directly with Madoff without professional third party involvement. Most financial institutions/professionals will be a step removed, so the exposure may become more remote. Perhaps most importantly, it is questionable whether the professionals involved ought to have been aware of the fraud, when the Securities and Exchange Commission failed to find any, despite eight or possibly more investigations."
Antony Bastow is a senior adjuster/claims barrister of Markel International
David McCarthy says reinsurers are unlikely to escape the fallout
"The Ponzi scheme of Bernard Madoff and alleged scheme of Sir Allen Stanford are creating a flow of notifications to the financial institutions (FI) sector in London.
Laura Pendergest-Holt, the chief investment officer of the Stanford Group, has already issued a complaint in the US against the London underwriters of their D&O policy, claiming bad faith and punitive damages.
The far larger potential exposures to the FI sector in London will be from D&O and E&O claims arising from federal securities and class actions by investors against third parties in the US.
These could raise considerable coverage issues in circumstances where regulators were, for so long, unable to uncover any concerns.
In the wake of the collapses of Enron and WorldCom, many reinsureds wanted to aggregate several individual losses as arising from one “cause” or “event” based upon the wording of their reinsurance.
There are likely to be similar issues with Madoff and Stanford. By mid-February, accounting firms Ernst & Young, PwC and KPMG were already facing multiple actions as auditors of funds that invested in Madoff. Major investment bank HSBC has also been named in multiple suits.
Allocation of claims to reinsurers participating in different policy years could also become an issue. This is likely to depend upon when claims were first notified.
The scandal relating to Madoff broke in December 2008. The width of any notifications and in what policy year they were given could be important."
David McCarthy is an associate director at BerwinLeighton Paisner LLP
Steve Robson does not see Madoff as a market-changing event although he predicts rate changes
"The main exposure to Madoff losses for reinsurers will arise under the “clash” covers and individual risk contracts. The broad scope of cover in 2008, and the year before, was designed to allow for the wider aggregation of separate risk losses; these could soon become the main area of concern.
Madoff is not, nor will it be, a market-changing event as coverage will largely remain unaltered. But there will be rate adjustments on account of deteriorating risk conditions in the financial institutions sector.
Reinsurers also are including an additional 20% AP on renewal, dependent on the reinsured’s eventual Madoff payment. It is inherently inequitable for a reinsurer to charge its reinsured a further additional premium to recoup a specific past loss; it should always be based on the past performance of the account in general.
Defence costs are likely to be substantial as they will include issues of causation and quantification of loss with arguments as to how the loss is assessed, given the general deterioration of the financial markets.
It is also apparent that some of the underlying insurances contain conditions that require insurers’ prior consent to any settlement. Despite this, some of the major institutions exposed to Madoff are already offering compensation to their investors, apparently without insurers’ consent.
With the increasing costs of FI reinsurance, there is a bit of the “tail-wagging-the-dog” as the direct rates increase to reflect additional reinsurance cost. In some instances, the reinsurance premiums are pricing direct writers with Madoff exposures out of the market."
Steve Robson is claims director of Max at Lloyd’s
Dean White considers the increasing exposure to fraud
"UK firms are without doubt exposed to heightened fraud and corruption risks as a result of the global recession. When times are hard, people sometimes take unsavoury measures to protect themselves or the organisation they work for.
But companies are more likely to pay closer attention to their balance sheets, which means that the chances of uncovering fraud are far greater.
While companies insure themselves against the risk of fraud, Marsh is concerned that many policies are based on a historical perception of the economic crime landscape. This could mean they are unable to respond fully to the consequences of the emerging innovations in fraud techniques such as phishing or identity theft.
The recession is also fuelling claims. When investors lose money, they look to apportion blame. Claims and class actions have already been issued against financial institutions, funds and investment advisers. More are likely in the coming months.
FTSE 100 companies are buying 20% more D&O insurance than they were 12 months ago in a bid to protect their directors from the growing threat of claims.
While premiums are still coming down, firms with good risk profiles are now receiving single-digit reductions as opposed to double-digit reductions last year.
Conversely, rates for financial institutions are increasing from 10% to more than 50%.
However, insurance is only part of the solution and should be part of a company’s toolkit to manage risk exposure. Risk management expenditure should be one of the last things that they compromise during a recession."
Dean White is managing director, financial and professional practice at Marsh