Parrying the Litigation Threat

Insurers develop a specialty that covers companies facing pending legal liabilities.

Samsonite Corp. was struggling with some heavy baggage as it attempted to recapitalize a couple of years ago. The cause of the load: shareholder litigation, filed in the wake of the stock-price free fall from a failed attempt to sell the company. The suits hampered the Denver-based manufacturer’s recapitalization efforts–and threatened consequences even more dire. “No one wants to put money in a company and have it paid out in litigation,” explains Samsonite CFO Richard H. Wiley.

The company managed to remove its litigation burden, but not in any of the usual ways. “We insured it,” says Wiley. By transferring the risk to an insurance company, in this case American International Group Inc. (AIG), Samsonite eased the worries of the investors it was courting. “The sword of Damocles that hung above us, in terms of how much these shareholder lawsuits would end up costing, disappeared like that,” says Wiley, snapping his fingers. “We could focus on recapitalizing the company free from the time-consuming distraction of litigation.” In October 1999, six months after buying the insurance, Samsonite got the shot in the arm it needed, raising $55 million.

Pending-litigation insurance, a line first cultivated by AIG, together with insurance broker Aon Corp., both based in New York, has expanded significantly in the past few years. Its recent growth is due in part to Axcelera Specialty Risk, a company started by two AIG executives credited with helping pioneer the strategy. The executives, Gregory Flood and Michael Mitrovic, got major financial backing for Axcelera from Zurich-based Swiss Reinsurance Corp., and they now focus their coverage on what they call “litigation loss mitigation.” Other insurers now in the game include Liberty Mutual, the Gulf Insurance unit of Citigroup, and Bermuda-based XL Insurance Co. Companies evaluating the market include Chubb Corp., Kemper Insurance, and Hartford Insurance Group, says Michael Schoenbach, a managing director of loss mitigation at Aon.

While so far most of the pending-litigation deals involve securities lawsuits, insurance can also absorb existing or prospective claims stemming from product, professional, environmental, and employment-practices liabilities. “I’ve even put together a policy for personal-lines litigation,” says Schoenbach. His client, a large corporation, was being sued by an injured employee in Europe, and wasn’t adequately covered. “Aon helped them design a travel and accident insurance policy that effectively capped the litigation,” he says.

Driving the growth in pending-litigation insurance is, not surprisingly, the robust mergers and acquisitions environment. Mergers or divestitures often spur a company to buy the insurance so that outstanding suits against it won’t be a problem in valuation. “Typically, the seller in an M&A scenario that is subject to pending litigation sees the case costing x, while the buyer sees it as x-plus-a-lot-more,” says Scott Carmilani, Flood’s replacement as AIG’s M&A division president. “We come in as the deal facilitator, bridging the gap that can kill the deal.”

But even without such a transaction in the works, the insurance can have its uses. “When the company is faced with serious litigation, the treasurer has to carry a large reserve to protect against an adverse outcome,” explains Patrick M. Cunningham, vice president of the M&A practice at insurance broker Marsh, in New York. “Rather than tie up assets in a large contingency reserve, many companies are deciding to transfer the litigation to an insurer and take it off the books to protect the balance sheet. That approach enables the company to focus on its core business and priorities.”

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