Internet Stock Offerings Face a Surge In Premiums for Liability Coverage
By DEBORAH LOHSE
Staff Reporter of THE WALL STREET JOURNAL
Stock prices aren't the only thing soaring for "dot-com" initial public stock
offerings. So are the premiums that directors and officers must pay for
liability insurance coverage.
The reason is that many of these hot IPOs tend to swoon just as quickly as
they've risen. The volatility has caused a spike in both the number of
shareholder lawsuits that blame a company's executives, and the settlement
costs resolving the suits.
"Everyone is scared" about the prospect of costly litigation stemming from
the ups and downs of fledgling Internet-related stocks, says Kevin
LaCroix, president of Genesis Professional Liability Underwriters in
Beachwood, Ohio, part of Berkshire Hathaway Inc.
Some greenhorn Internet-related companies face paying $40,000, or even
more, per million dollars of coverage -- three or four times what they
would have paid only a few years ago, according to insurance brokers.
Diana Eglin, a senior vice president at insurance broker Willis Corroon
Corp., says a recent dot-com-named client with $7 million in revenue,
planning a $62 million IPO, faced rates of $32,400 per million dollars of
coverage for the first $5 million of coverage, the costliest piece of the
insurance package, more than 60% higher than comparable clients paid a
year ago.
Ultimately, the company, which she declines to identify, struck a deal
amounting to $17,900 per million in a three-year package for $30 million
in coverage, up 58% from the $11,300 per million that Ms. Eglin estimates
such insurance would have cost last year.
Such price increases are "kind of the price of playing poker," says Dean
Johnson, chief financial officer of Value America Inc., an online retailer that
went public last month. He estimates he paid 30% more for his company's
liability coverage than he would have a year ago, although he won't reveal
specifics. "I'm none too happy about it, but you've got to have insurance."
Data collected by National Economic Research Associates, a unit of
insurance broker Marsh & McLennan Cos., back many of the insurers'
concerns about proliferating litigation: The number of securities cases filed
in federal courts seeking class-action status has risen 50.3% since 1995, to
a record 266 in 1998, while the average cost to settle jumped nearly 40%
last year to almost $11 million, from $7.8 million in 1997.
In particular, insurers are raising the stakes for companies likely to attract
lots of investor hoopla but whose business practices indicate there could
be lawsuit-baiting stumbles out of the IPO gate. A company whose board
is peppered with the chief executive's friends can expect to pay top dollar,
for example. And the bigger the planned stock offering, the more nervous
the insurer, says Genesis's Mr. LaCroix, because damages from
stock-price declines grow with larger shareholder bases.
As for attributes that can lower costs, John Cavoores, president and chief
executive of National Union Fire Insurance Co. of Pittsburgh, a unit of
American International Group Inc., says his company looks for "lock up"
features forbidding insiders from selling stock for half a year or more after
an offering, to avoid allegations that management bailed out before
releasing bad news.
For that matter, Mr. Cavoores says National Union also is looking more
closely at whether the securities underwriter taking the company public has
a successful record of IPOs or whether the offerings tend to crash and
burn. Recently, he passed around his office a recent Wall Street Journal
article showing that Goldman Sachs Group Inc.'s Goldman, Sachs & Co.
had the best-performing IPOs since 1998 among top-10 underwriting
firms, and Donaldson, Lufkin & Jenrette Inc. the worst, excluding gains on
the first trading day. Such data have since become part of AIG's
underwriting process, he notes.
The irony is that the pickup in litigation follows 1995 federal legislation
aimed at curbing the number of frivolous suits. While many legal and
liability-insurance experts agree that the law succeeded in raising the hurdle
for lawsuits, the flip side for the insurance industry is that plaintiffs'
attorneys now spend more on building their cases -- and thus are often less
willing to settle on the cheap.
"The price to settle these cases has gone up quite a bit," says Dan Bailey,
an attorney specializing in liability coverage at law firm Arter & Hadden in
Columbus, Ohio. As recently as a year ago, settlements tended to amount
to 10% to 15% of the stock-price decline, plus attorneys' fees and
expenses, but they now can run as high as 40%, he says.
Insurers are trying novel ways to stem losses. As part of its IPO Gold
program -- which sports an endorsement by the Nasdaq Stock Market,
home to many IPOs -- AIG's National Union offers a public-relations
crisis fund of up to $50,000. In case of a stock-drop crisis, the fund will
pay for a public-relations firm's services -- such as hushing up chatty
managements lest they provide fodder to plaintiffs' suits. |
