Directors' and officers' liability insurance (D&O), along with errors and omissions (E&O) coverage and fiduciary liability, constitute property and casualty (P&C) insurers' most direct underwriting exposure to the financial crisis, says Moody's Investors Service.

In a new sector commentary, Moody's affirms its rating actions on D&O/E&O insurers have been negligible to date, reflecting the overall solid financial profile of most insurers through the financial crisis, aggregate coverage limits, and the relatively small size of the D&O segment within the context of the overall P&C insurance markets.

"Although P&C commercial lines insurers were among the least affected financial institutions by the financial crisis, says Moody's VP Alan Murray, author of the report, “insurers specializing in D&O, E&O and fiduciary liability insurance coverage have been front-and-center as claims are often triggered upon the emergence of corporate financial or operational failures."

Securities class action claim activity under D&O and related coverage surged with litigation related to weaknesses in sub-prime mortgage origination and securitization in 2007. The most direct targets of litigation, securities fraud and shareholder derivative suits, and regulatory enforcement actions have been financial institutions, particularly those involved in real estate finance. Financial crisis-related class actions peaked in 2008-09, subsiding more recently in late 2009 and early 2010, notes the report.

"We believe insured losses, including legal defense costs, which are generally reimbursed under D&O policies, will be particularly high for the 2007/08 policy years," notes Murray. "Given coverage limits in many of the policies, legal costs alone will likely exhaust the insurance and, in turn, should cap the insurers' claim exposures."

Further, the latency of the claim process, and sharp premium rate increases in the interim for publicly traded financial institutions have dampened the impact on insurers' reported results.

"The challenge of attributing liability given the complexity of the financial crisis and its multiple contributing causes, along with precedent-setting court decisions in recent years clarifying standards of proof for plaintiffs, will likely mitigate total insured losses and the percentage of cases that reach the settlement or adjudication stage," said Murray.

However, potential SEC enforcement actions against firms alleging intent to defraud may lead to large judgments being awarded in high-profile cases, resulting in substantial insured losses, Murray added.

"External influences, like the government's response to the financial crisis, will to a large degree impact the potential losses D&O/E&O insurers will have to deal with," said Murray. "And this is likely to be a lengthy process."

The report, "D&O/E&O in the Cross-hairs of the Financial Crisis," is available at moodys.com.

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