Beware – The Topsy Turvey Economy
It is anticipated that by the summer of 2008, 500,000 of the two million sub prime borrowers in this country will default on their mortgage. As a result of lending becoming more restrictive by banks and other lenders, borrowers are finding fewer lenders willing or able to fund loans for amounts greater than $417,000 or "jumbo" mortgages. The President is proposing to aid hundreds of thousands of borrowers hit by the housing market slump. Accredited Home Market Lenders traded at $10 per share off a 52-week high of $60 per share; Fremont General Corporation traded at $5 per share off a 2004-high of almost $30 per share; home building company stocks have also suffered serious declines in their stock price; and New Century filed for bankruptcy. The overall stock market has suffered a decline resulting in the fed cutting the federal funds rate by half a percent, exceeding the quarter point cut most economists expected.
In addition to all this bad news, hedge funds have disintegrated overnight, and housing starts are expected to decline by 3.7 percent in August of '07 with a 3.4 percent decline in permits.
Based upon the expected continuing decline in the housing market and the expected rise in mortgage defaults, it is likely that the fallout will continue. The stock market will likely experience continued volatility with continued significant declines in certain sectors (financial services, banks and construction), and real estate problems may have a dramatic impact on the overall economy.
What does this mean for the insurance industry and for insurance agents, especially that segment of the industry either writing or selling professional liability policies? Will claims against stock brokers, investment advisors, financial planners, mortgage brokers increase in the upcoming months? Will it be necessary to raise deductibles, premiums and tighten underwriting standards? Will certain sectors of the professional liability insurance market unceremoniously exit the halcyon days of low claims, high premiums and high deductibles?
The signs all point to a yes answer for all of these questions. For the past four years, for example, the claims against stock brokers have declined dramatically. In 2003, there were almost 9,000 claims filed against stock brokers and broker-dealers at the National Association of Securities Dealers Dispute Resolution (NASD), now known as FINRA, up from an average of almost 6,000 claim filed per year in the late 1990s. However, in 2007, the claims are down to about 225 per month and on track for almost 3,300 annualized. Premiums remain higher for broker-dealer E&O policies as well as deductibles. These terms have resulted in the industry's ability to recoup some of its significant charges and payouts that were incurred during the time when claims were sky rocketing a few years ago. Although it does not appear at this point that the stock market will suffer as it did between March of 2000 and March of 2003, we have already seen significant sector corrections. These corrections have led to losses for public customers of broker dealers, and the customers are seeking compensation. Customers who have suffered the most serious losses are those with concentrated investment positions in housing company stocks and/or certain lenders or who own derivatives, and they have suffered magnified, or even complete losses, in their brokerage account.
Losses such as these, especially incurred by those unable to recoup such losses, lead invariably to claims. This potential rise in claims comes at a time when the insureds are demanding lower deductibles and lower premiums based upon the current low claims environment. However, when negotiating rates and setting underwriting standards, caution for the next market cycle must be maintained.
The current market environment is also affecting people, such as mortgage professionals, who are faced with claims not only by the borrowers but also by the lenders. The borrowers are now claiming that the full amount of their new monthly payments were not disclosed, there was no disclosure of an interest rate reset on a variable mortgage or any balloon payment due in the future. Lenders claim that applications have inaccuracies with respect to income which is overstated or credit history which was not disclosed. Lenders are blaming the mortgage professionals and, in certain situations where a contract between those entities exists, are requesting that the mortgage professional, in fact, buy back the mortgage. However, smaller companies who have operated in the mortgage services industry have suffered significant income declines as a result of fewer mortgages and/or fewer re-financing. This decline in income, coupled with the cost of lawsuits, is placing these businesses in jeopardy.
The insured is now faced with substantial claims and is forced to report the claim and seek coverage. This increased claim activity comes at a time when the mortgage industry is in decline and fees are dramatically reduced. The financial impact to these professionals has greatly impacted their ability to remain in business, and the additional costs associated with defending legal actions will cause some firms to exit the market altogether.