LIBOR probe: Hitting home

As the investigation into the Libor manipulation scandal establishes itself, Jon Guy assesses the potential impact on the D&O liability market

As legal teams and shareholders prepare for what is expected to be a series of bloody legal battles with the management of major banking institutions implicated in the Libor (London Interbank Offered Rate) fixing scandal, underwriters are similarly scrambling to assess their own exposures. If businesses have anything to fear as a result of the manipulation of the Libor rate, it is likely to be higher rates for directors’ and officers’ coverage moving forward.

As the investigation unfolds and the various legislative implications unravel, a growing fear is emerging that the manipulation will be met with a swathe of claims against banks over the coming weeks and months. There are also rumblings of potential claims that the rate fixing has impacted on the cost of loans and other financial instruments. To make matters worse, there is also an increasing sentiment in the market that, as more banks get sucked into the scandal, the levels of compensation claims will run into hundreds of millions of pounds in the months and years ahead.

This scandal is another dark chapter in the recent history of the banking sector and one that has claimed some major scalps – not least that of Barclays CEO Bob Diamond who has fallen on his sword following the bank’s alleged involvement in the manipulation of the Libor rate to enhance their financial and business performance.

What is clear is that the regulatory burden on senior management continues to grow, and new governance rules, which give shareholders a far greater level of influence in terms of bringing their senior management to book, has only exacerbated the need for directors and officers in to ensure they have the necessary levels of insurance coverage.

The use of D&O insurance has grown dramatically in the past decade as business leaders seek to ensure they can protect themselves, but there is some concern that the recent slump in interest driven by the economic slowdown may have left some businesses dangerously exposed. Like many areas of the insurance market in recent years, rates have been under considerable pressure, although more recently, there have been reports of a rise in the offing as underwriters seek to get prices to a sustainable level.

The concern now is that D&O rates will be subject to a sharp rise as underwriters scramble to understand just how great an exposure the banking crisis may become.

Getting covered

Standard D&O cover will indemnify the board and senior management for the expenses incurred should they be sued by their clients, shareholders or taken to book by the regulators.

Shareholders and clients now find that taking a firm to court is getting easier, and the legal and liability minefield has become more complex. In the UK, the introduction of a new Bribery Act has removed the defence for senior managers and directors to plead they were simply not aware of any bribery undertaken in their name, be that in the UK or abroad. The act also tightens up on the definition of what is deemed a bribe by bringing corporate hospitality into the mix.

Now, however the rate-rigging scandal has galvanised the market and is set to drive a sea change for many underwriters in the expectation of what is to come. One London market broker said: “There are some very nervous faces in the market as this crisis deepens.

“Underwriters were worried about the reactions from the shareholders of the banks when the news started to filter out that this rate manipulation had been undertaken and the huge fines which had been levelled at Barclays. “I think many in the market thought Barclays had taken the decision to own up, take the fine and move on but it has spiralled out of control and is now moving to the other side of the Atlantic, and we are all aware of the way in which law suits and class actions in the US can suddenly become huge.”

“We now have more and more banks involved and shareholders may well be asking why they should take the hit on the share price after some torrid years due to this scandal. So we have the liability to the shareholders but we have now seen a number of law firms looking at how this could have cost customers due to the lending rate applied to their loans,” he adds.

He explains if customers claim they have been negatively impacted it would see the company’s errors and omissions policies triggered, which would be another body blow for the liability insurance market: “If we get a wave of cases, then the market may well be struggling. It is a mess and there are a lot of underwriters who are looking at their exposures and their pricing.

“It is expected that it will take two or three years for claims to begin hitting the courts, and in the meantime underwriters are set to push pricing up for no other reason than to build up their reserves for the eventual expected claims.”

“One thing you can guarantee is that if the situation starts to spiral; and claims rise to significant levels, underwriters will look to deny coverage in some areas,” he adds.

One glimmer of light for the insurance market would be if the bank’s management were convicted of criminal charges, given that the vast majority of D&O covers are negated should the management be proved to have acted illegally.

Steve Foulsham, head of technical services at the British Insurance Brokers’ Association (BIBA) says the current market for D&O remains a tough sell despite the growing need for UK businesses.

“The economic climate has made directors’ and officers’ a very difficult product to sell in the UK at the present,” he explains. “This is particularly the case with the SME market and there are a large number of brokers that are finding it difficult to market at present, which given rising exposures, really should not be the case.

“The onus is on the management, and corporate governance has increased and in 2008 we saw the introduction of the Corporate Manslaughter Act which, if anything, has given D&O far greater relevance to the UK’s businesses. While we have not seen any high-profile corporate manslaughter convictions, it is still very much a real threat for managers who have a duty of care to ensure the safety of their staff and the public.” Foulsham adds that despite these rising risks, the market remains competitive and cover is not prohibitively priced.

“There is a growing ability to buy the product using online quote and buy facilities and pricing remains competitive as D&O, like the rest of the commercial lines market, has been undergoing a very soft pricing cycle in recent years, and shows no real signs of softening.

“I think what has to be considered is this is a product that will indemnify against the costs of defending an action even if it is not proved and the costs of defending an action can be considerable.”

In relation to the rate-rigging scandal itself, Foulsham believes the full effects will not be known for some time. “Much of the debate has centred around the international markets in terms of the effect on the D&O sector given the nature of the issues which may or may not result in any claims.

“Current opinion is that it will be those businesses operating across international markets which could be impacted by any change in thinking by the D&O underwriters. However, depending on the scale of claims, it is quite possible that an impact may be felt by companies in the UK in the future. Still, it will take some time for the full claims situation to be established.”

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