Many of the prognosticators have been saying for months that the subprime market “correction” would have catastrophic implications not only on financial institutions but the overall economy. You cannot pick up a copy of the Wall Street Journal without reading about a company filing for bankruptcy or taking enormous write downs. It is believed that this is just the tip of the iceberg and that Wall Street has yet to see the worst. It is already trickling into other industries. As banks tighten up on credit, companies are unable to refinance their debt or obtain the infusion of cash needed to maintain adequate working capital. Thus, for the six month period ending June 30, 2007 compared to the first half in 2006 there has been a steady rise in Chapter 7 and Chapter 11 filings. Many market analysts feel that it will only get worse before it gets better.

If the upward trend of defaults on loans and bankruptcies continues, it will have a negative impact on the D&O market. It is already evident that corporations with direct exposure to mortgage backed securities, CDOs, CLOs and similar financial instruments will see increases on their D&O premium and retentions for their 2008 renewals. Moreover, carriers are assessing the amount of exposure they have in this area. There is speculation that underwriters will be looking to decrease their exposure in the financial arena by cutting back on the amount of limits they offer or by adding restrictive endorsements to the policies.

However, it would be naive to think that only financial institutions that have a direct link to the subprime markets would feel a negative impact to their Executive Liability programs. Although the D&O market in general continues to be soft and underwriters are still aggressively competing for business, it is uncertain how much longer this may last. If corporate bonds continue to be downgraded, defaults on loans continue to increase and the upward trend of filing for bankruptcy does not slow down, we can expect that the D&O market will go from soft to hard very quickly.

These events have a direct correlation with an increase in D&O claims. The underwriting community believes that there is already over $1.5 billion in outstanding claims due to the subprime mess and that it will only get worse in the near future. Whether this will come to fruition or not will depend on a few factors, such as:

1. Can the economy avoid a recession?
2. Will the Federal Reserve continue to lower interest rates?
3. Can a bear market be avoided?

Because the impact the subprime market will have on corporations’ Executive Liability programs is uncertain, we recommend the following steps:

1. Work with your broker early in the renewal process to ensure the best possible marketing results.
2. Verify through your broker that you have coverage with a carrier that has longevity in the Executive Liability market. (Many carriers enter the D&O arena when things are going well but are also the first to exit.)
3. Try to lock into multi-year policies or guaranteed renewal programs, if available. This will allow you to avoid drastic price swings that may arise due to the uncertainty the subprime crisis will have on the D&O market.

If the D&O market does begin to turn, you may not be able to avoid unwanted changes to your insurance program, but preparation will allow you to minimize the amount of negative implications.

For more information, please contact Jeff Rubocki (312-980-7857, jrubocki@equityrisk.com)
or your Equity Risk Partners professional.