Subprime mortgage crisis may spark E&O and D&O liabilities

Insurance companies may be exposed to greater directors and officers liability (D&O) and errors and omissions (E&O) liability claims in the wake of the current subprime mortgage crisis, warns Marsh.
Higher interest rates and falling property prices have contributed to rising mortgage delinquencies among high-risk or subprime borrowers, a Marsh statement says.
This, coupled with increased relaxation of underwriting standards, has led to the bankruptcy of several mortgage lenders, the collapse of hedge funds, increased regulatory scrutiny surrounding lending practices, and ratings downgrade of 2005 and 2006 vintage residential mortgage-backed security bonds, it continues.
In addition, the mortgage market problems have ignited concerns about the potentially large exposure insurance companies may have to securities backed by subprime mortgages, including investments in collaterized debt obligations and collaterized loan obligations with subprime exposure.
Potential litigation arising out of D&O and E&O liability include, among other possibilities:
lender lawsuits against banks it is likely there will be claims of improper margin calls and flawed valuation of underlying collateral on the part of banks;
shareholder suits against underwriters shareholders could make claims of misrepresentation and omission related to accounting for residuals, as well as claims of bad valuation and poor underwriting standards; and
insurer lawsuits against lenders large insurance claims on failed subprime collateral may lead to accusations of poor underwriting on the part of lenders.
Although the D&O and E&O insurance market has been largely stable, if there are a high number of costly claims under these insurance policies, this trend may reverse and costs may begin to rise, Jill Sulkes, a managing director in Marshs Financial Institutions Practice, said in a statement.
Companies should be prepared to provide a detailed description of their subprime exposure to their insurers when purchasing D&O and E&O coverage.