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Betraying the trust: insurers are likely to challenge the directors and officers coverage for WorldCom by claiming that fraud makes policies null and void. (Briefing).

Revelations of accounting irregularities that inflated telecom provider WorldGom Inc.'s assets by $3.8 billion will most likely put further pressure on an already-beleaguered directors and officers liability market.

Robert Hartwig, chief economist for the Insurance Information Institute, said WorldCom appears to have $100 million in D&O coverage with a $10 million deductible and $20 million in copayments, written by at least five insurers. Four companies believed to be involved in underwriting D&O policies for WorldCom include American International Group Inc., Hartford Financial Services Group, CNA Financial and Swiss Reinsurance Co., according to media reports.

That coverage is likely to be challenged by the insurers, which probably will move to rescind their policies with WorldCom, based on what appears to be either fraud or intentional misleading on WorldCom's part, Hartwig said." The insurers are likely to say that they would not have made the underwriting decisions they did, if they had known what is known now about WorldCom's condition," he said.

According to Hartwig, insurers can move to rescind a D&O policy under one of three exclusions--outright fraud has been committed; there was criminal wrongdoing; or there was an intentional act, such as insider trading. "WorldCom has essentially come close to admitting publicly that there was some sort of fraud involved in the accounting of its expenses," he said.

"When an application is made for D&O coverage, a high-ranking officer of the company, usually the CEO or CFO, has to supply a warranty as to the financial information that the insurer used to make its decision," Hartwig said. "If the warranty were made sometime in the previous five quarters, the period for which WorldCom is restating its results, the case for fraudulent misrepresentation is a strong one."

Whether the D&O policy was obtained while the alleged wrongdoing was under way is an important point, said Hartwig. If the policy was signed before the period during which WorldCom's finances were misstated, coverage may be severable, meaning certain directors and officers who had no knowledge of illegal acts would be covered. But if the policy were finalized while the misstatements were under way, the insurers have a good case that the contract is null and void.

"Usually, these contracts are written for one year, so it's probable the insurers can move to rescind," he said. "Even if the policy is longer, the [U.S. Securities and Exchange Commission] is talking about investigating WorldCom statements going back to 1998. Some companies have multiyear D&O policies, but none of them goes back that far."

The D&O market is hardening rapidly as other high-profile corporate fiascoes, such as the bankruptcy of energy trader Enron Corp. and telecom company Global Crossing and the possible bankruptcy of Xerox Inc. and the criminal indictment of accounting firm Arthur Andersen-- fallout from the Enron debacle--raised a complex set of questions about the extent to which D&O insurers should be held to their contracts in the face of corporate wrongdoing.

"We are seeing a surge in securities-related suits against directors and officers," said Hartwig. "WorldCom and Enron are unusual in their size--the largest bankruptcies in U.S. history. And these stocks were widely held, making a broad class of plaintiffs. Another thing that's unusual is the speed with which the information on these companies is coming out."

The rapid pace of corporate failures and scandal over the past year or so is contributing to a rapidly hardening D&O market, as insurers move quickly to cut their exposure to possible future WorldComs and Enrons. "As I've been saying about the D&O market, we don't insure houses that are on fire, and there's now a conflagration spreading through corporate board rooms;' Hartwig said.

In a March report on the D&O market, broker Willis Group Holding Inc. found that companies with favorable or no claims experience are likely to see increases averaging 35%, or more for companies in sectors with higher presumed risk profiles, such as telecommunications, health care, high technology and biotechnology. Larger public companies in all industry sectors can expect to see increases of at least 50% for one-year renewal programs, and higher for multiyear placements.

Companies with weaker financials or significant claims experience will see premium increases of more than 50% for expiring one-year policies, said Willis. "For financially stressed companies, premium increases may be impossibly high;' the report said.

Willis said D&O loss experience is "staggering," citing research from the Securities Class Action Alert that estimated $4.4 billion in class-action settlements reported for 2000. "Although it is unclear what portion of this amount was recouped from D&O insurers, that figure would clearly be significant," the report said. "The number of claims against directors and officers continues to escalate, with the number of securities class actions filed in 2001 reaching an all-time high.'

According to the Stanford Securities Clearinghouse, the 487 federal securities fraud class-action lawsuits filed in 2001 easily dwarfed the high point for the previous 10 years-236 in 1998.

RELATED ARTICLE: Insurers Caught in the WorldCom Whirlpool

A.M. Best Co. analysis shows that the insurance industry had an aggregate $7.2 billion invested in corporate bonds of WorldCom Inc. and its various subsidiaries as of Dec. 31, 2001, the latest date for which reliable industrywide figures are available. Several insurance companies have sold their WorldCom holdings since then.

Insurance companies continue to release information about their investments in WorldCom Inc. and its subsidiaries. Among the most recent to announce losses is life insurer AmerUs Group Co., which said it will write down about $50 million of investments in WorldCom.

AmerUs said that when WorldCom announced June 25 that it had overstated earnings for the past five quarters by $3.8 billion, the insurer held $35 million in WorldCom bonds, and $15 million in bonds of a WorldCom subsidiary, Intermedia Communications.

Other insurers that have announced investment exposures include:

* Citigroup Inc. said its investment exposure is at least $375 million.

* Prudential Financial had $323 million in WorldCom investments as of Dec. 31, but its holdings are significantly smaller now.

* Principal Financial Group had $61 million in exposure.

* Sun Life Financial Services of Canada said it has $45 million in exposure to WorldCom.

* American National Insurance Co. said it holds about $6 million in WorldCom bonds and $17.1 million in stock.

* National Western Life Insurance Co. said it has about $11 million in WorldCom bonds in its $3 billion investment portfolio.

* UICI, a Dallas-based specialty life and health insurer, said its insurance subsidiaries hold an aggregate $7.52 million worth of WorldCom bonds.

* ProAssurance Corp. had $4.7 million of WorldCom bonds in its portfolio.

Among European and U.K. insurers reporting estimated investment losses related to WorldCom are Aegon, $200 million; Axa Group, $40 million; Munich Re, $80 million; and Prudential plc of London, $150 million.

Investments in WorldCom

Insurers' aggregate investment holdings in WorldCom Inc. and its subsidiaries using par value as of Dec. 31, 2001.

Corporate bonds

Property/Casualty Insurers: $1.3 billion

Life/Health Insurers: $5.9 billion

Total Industry: $7.2 billion

Preferred Stock

Property/Casualty: $54.2 million

Life/Health: $25 million

Total Industry: $79.2 million

Common Stock

Property/Casualty: $420.5 million

Life/Health: $367.5 million

Total Industry: $788 million

Source: A.M. Best Co.
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Comment:Betraying the trust: insurers are likely to challenge the directors and officers coverage for WorldCom by claiming that fraud makes policies null and void. (Briefing).
Author:Pilla, David
Publication:Best's Review
Geographic Code:1USA
Date:Aug 1, 2002
Previous Article:Comment.
Next Article:By the numbers.

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