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D&O rates soften despite Tyco loss

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D&O rates soften despite Tyco loss

Risk managers should continue to count on a softening directors and officers liability market despite Tyco International Ltd.'s multibillion-dollar settlement of class action claims against the company and former officials, according to market experts.

Absent unforeseen market-turning factors, D&O insurance rates likely will continue to fall through the Jan. 1, 2008, renewals as plentiful capacity remains in the market, experts said.

Although Tyco reached a nearly $3 billion settlement with class action claimants last week, insurers on the risk would have expected and reserved for a substantial or full-limits loss years ago and factored that into their current rating structure, experts said.

The highly diversified Pembroke, Bermuda-based company said last week that it would take a $2.98 billion charge this quarter to account for the settlement it reached with investors who purchased Tyco securities between October 1998 and June 2002.

The investors sued Tyco and numerous former officials and board directors in early 2003 after an investigation into the company's management and accounting practices revealed that former officials had looted the company of more than $600 million.

Tyco replaced its senior management and board in 2002 after the scandal was exposed. Two top Tyco officials--former Chief Executive Officer L. Dennis Kozlowski and former Chief Financial Officer Mark H. Swartz--have since been imprisoned for looting the company. In addition, the Securities and Exchange Commission has fined other former officials for their roles in misleading investors through fraudulent accounting practices.

Tyco's former and current insurers and brokers would not comment on the company's D&O insurance.

Sources, however, said that Tyco can apply the bulk of its $200 million of D&O coverage to the settlement. The remainder has been used to cover the legal costs of former Tyco officials who have not been convicted of crimes for their roles in the scandal, sources said.

Warren, N.J.-based Chubb Corp. leads the coverage. American International Group Inc. of New York and Bermuda-based ACE Ltd. participate on excess layers, sources say.

Chubb unit Federal Insurance Co. filed suit in New York state court in January 2003 in an effort to rescind its coverage, arguing that Tyco had obtained coverage on the basis of fraudulent financial disclosures. But Federal halted that effort five months later, after Tyco paid a total of $92 million of additional premium to its D&O insurers to maintain and extend coverage (BI, May 19, 2003).

London-based Willis Group Holdings Ltd. placed the coverage.

Tyco's D&O coverage would amount to less than 10% of the cost of the company's settlement, which must be approved by a court. But, the settlement still results in a full-limits loss for the D&O market. In addition, the loss far exceeds the 2006 average settlement of $86.7 million, according to figures developed by Securities Class Action Clearinghouse, a joint project between Stanford Law School and Cornerstone Research of Boston (BI, Jan. 8).

Declines up to 15%

Even so, market experts say they do not expect the loss to have any impact on the D&O market, where rates are falling 10% to 15%.

"I would be shocked if underwriters didn't reserve their full limits years ago," said Steve Shappell, managing director of the legal and claims practice for Aon unit Aon Financial Services Group in Denver.

As a result, "this really should have zero impact on the D&O market," he said.

Plus, the loss does not skew the market's loss expectation for 2007, Mr. Shappell said. It would be the sixth full-limits loss this year, so "we're pretty much on pace" with the number of full-limits losses over the past few years, he said.

"In our view, it's not something that makes us re-examine the marketplace or our strategy," said Carol A.N. Zacharias, senior vp and chief counsel for ACE USA in New York.

As for the marketplace, "I think it's already had its impact," Ms. Zacharias said.

Much of the impact has been a change in risk managers' buying habits, she said, pointing to the recent popularity of Side A-only towers of limits and the elimination of professional liability and employment practices liability coverages from D&O programs.

While the settlement "obviously takes everyone's breath away, it's not totally unexpected," said Lou Ann Layton, a managing director and the national D&O practice leader for Marsh Inc. of New York.

Ms. Layton said the market might have tightened somewhat if another company had announced a similar settlement that underwriters had not expected.

Despite the market's expectation of the Tyco loss, it still is "a little bit of a wakeup reminder that significant cases remain outstanding," said Gary Dubois, a New York-based senior executive with Bermuda-based Ariel Reinsurance Co. Ltd.

But, Mr. Dubois, who is working on setting up a U.S. operation for Ariel, said he "certainly doesn't see the announcement changing the competitive environment" of the D&O marketplace through next year's January renewals, "absent other external factors."