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TRADERS' UNAUTHORIZED ACTS NO LONGER UNINSURABLE

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NEW YORK-Financial institutions seeking coverage against catastrophic losses from securities traders' unauthorized acts could see a burgeoning insurance market for the risk.

J.P. Morgan & Co. Inc. has just secured $400 million in excess coverage from the conventional insurance market.

Last fall, FMR Corp., better known as Fidelity Investments, obtained such coverage in a program that includes finite risk as well as conventional insurance coverage.

Additionally, Lloyd's of London underwriter Stephen Burnhope is currently working on a financial bond coverage that would cover unauthorized activities.

Financial institutions buy bankers blanket bonds that cover them for fraudulent activities of employees, but the bonds do not normally cover unauthorized transactions that are not considered fraudulent.

Normally the employee must make a personal financial gain from the fraud to trigger bankers blanket bonds.

Until now, insurers largely have shunned the risk of loss from unauthorized activities, said Mr. Burnhope, a director at SVB Syndicates Ltd.

Anything that has to do with trading has normally been seen as something in the normal business risk area, and it is difficult to underwrite, he said. Financial institutions "fire people up with big salaries and bonuses," so it is difficult to assess how driven an employee might be to make an unauthorized trade and generate losses, he said.

While financial institutions normally have accepted the risk as part of business, high-profile loss-risk, Mr. Burnhope said.

Most spectacularly, Barings P.L.C., one of the most respected banks in London, underwent a more than $1.3 billion collapse in 1995 that was blamed on the activities of a single trader in its Singapore office, Nicholas Leeson (BI, March 6, 1995).

Mr. Leeson is serving a prison sentence in Singapore.

William J. Kelly, senior vp and risk manager at J.P. Morgan in New York, has been critical of insurers for not taking on the potentially catastrophic risks of financial institutions.

"We want insurance that is responsive to exposures that are real," he said.

Consequently, Mr. Kelly began working 10 months ago with Minet P.L.C., which is now part of Aon Corp., to put together a catastrophe insurance program for the investment bank.

Last week, the coverage was finalized with a three-year policy term and a single aggregate limit of $400 million excess of $100 million. J.P. Morgan has varying levels of primary coverage.

The catastrophe coverage includes: unauthorized transactions; corporate professional liability; excess directors and officers liability; crime, including computer crime; employment practices liability; and millennium liability relating to the risk of converting systems to avoid the so-called Year 2000 problem.

In addition to the unauthorized transactions coverage, the policy gives J.P. Morgan broad organizational liability coverage, explained Jennifer J. McElroy, executive vp at Aon Financial Services Group, which helped develop the policy.

"If you wanted to buy $300 million to $500 million in D&O coverage, you could probably scrape it up, but it would be very difficult to get that kind of capacity for professional liability coverage," she said.

The lead insurer on the policy is American International Group Inc. Other insurance companies participating on the risk include Chubb Corp., Zurich Insurance Group, Swiss Reinsurance America Corp. and other insurers in the United States, Bermuda and London.

Mr. Kelly would not disclose the premium.

The policy gives J.P. Morgan extensive coverage without having to turn to alternative markets or blended programs, according to Mr. Kelly.

The aggregate limits would not have been as large under a blended program, he said.

Risk managers at large banks, investment banks and insurance companies would be the most likely buyers of the coverage, Ms. McElroy said.

The coverage bought by J.P. Morgan could have a broad appeal to financial institutions if it is affordable and has variable attachment points that would be attractive to policyholders that are considerably smaller than J.P. Morgan, said Michael R. Vogler, a principal and risk management consultant at Coopers & Lybrand L.L.P. in Atlanta.

"It provides a warm, cozy feeling to those people that are investors in the investment companies" that have aggressive sales techniques, he said.

It is difficult to find underwriters willing to provide insurance coverage for unauthorized transactions, agreed Judy M. Lindenmayer, vp-Fidelity insurance and risk management for FMR Corp. in Boston and the 1997 Business Insurance Risk Manager of the Year.

In September, Fidelity put together a three-year financial insurance program that includes conventional coverage and finite risk insurance to respond to unauthorized transactions and a broad range of other financial risks (BI, April 14). AIG is the sole insurer on the program.

Fidelity has not suffered any losses from unauthorized transactions, but the highly publicized losses of other financial institutions indicate the need for the coverage, Ms. Lindenmayer said.

"We're getting larger and larger, and while we have excellent compliance procedures, when you read about incidents that happen around the world it makes one think whether there are other forces which could cause us to have a loss," Ms. Lindenmayer said.