The directors and officers liability insurance marketplace is in a state of flux these days. Corporate scandals, bankruptcies, Securities and Exchange Commission investigations, mergers and acquisitions, and missed earnings releases have all made front-page news. Along with that, a wave of securities class-action lawsuits, shareholder derivative lawsuits and ERISA "tag-along" lawsuits have arisen. However, there is an upside to all of the bad news. It has made directors and officers liability insurance a high priority for corporate boards and risk managers. As they review their insurance portfolios, many want to know more about the market direction and the trends that might affect them.
In order to determine where the D&O liability insurance market is headed, it's important to take a historical look at the market. During the mid-1990s, there was an unprecedented increase in capacity as new carriers entered the marketplace to buy market share.
That, in turn, drove prices to historic lows. Carriers were not only competing on price but also on expanded coverage terms that would later prove to be costly for insurers. The negative pricing trend continued until late 2000 when the market appeared to hit rock bottom. Then, under a sea of financial restatements, a wave of corporate scandals, the technology fallout and an increasing number of securities claims, mounting losses forced a number of carriers to exit the market.
The result, from mid-2001 through late 2003, was a firming market trend in which prices were on the increase. The average price increase during that time period was 20 percent to 50 percent, with some industry segments experiencing rate increases well above the average.
Lawsuit statistics also tell a grim tale. From 1996 to 2004, the number of securities class-action filings more than doubled, and the average settlement value rose from $8.6 million in 1996 to $27 million by the end of 2004.
Many underwriters would argue that the claims environment is expected to worsen. To support this rationale, one need only look at the number of claims settlements that exceeded $100 million during the past five years. From 2000 to 2002, there were 11 settlements in excess of $100 million, and 12 each in 2003 and 2004. Through August 2005, there have been 15 securities class-action settlements that have exceeded $100 million, and the number is likely to grow before the end of the year.
What's driving these trends? One of the key factors appears to be financial restatements. Restatements can be a catalyst for securities class-action claims and SEC investigations. Since 2001, restatements have increased from 270 annually to 414, a record high, in 2004. Cases alleging accounting issues and irregularities can raise the average settlement value by more than 20 percent.
The number of restatements may continue to rise as a result of Sarbanes-Oxley and the additional scrutiny it places on public companies' corporate governance and accounting functions. However, the impact of SOX on the D&O marketplace may not be known for some time. What we do know is that the annual probability a publicly traded company will face a securities class-action lawsuit has increased 23 percent since 1996.
With that as a backdrop, the events of the past year can only be described as irrational and unpredictable from an underwriting perspective. Once again, new capacity entered the market and prices began to fall. On average, primary prices decreased between 10 percent to 15 percent with the excess placements experiencing 20 percent to 30 percent decreases throughout 2004. The year was equally unpredictable as new capacity battled for market share and traditional carriers focused on account retention.
Behind the scenes, reinsurers were paying close attention to the 2004 market dynamics, hoping that history would not repeat itself. Carriers seeking to renew their treaties found the reinsurance environment challenging to say the least.
Higher net lines, loss-ratio caps, reduced capacity, underwriting restriction concerning market cap and industry segments are just a few of the obstacles carriers faced. If the current 2005 pricing trend continues, renewal discussions will be sure to involve much of the same or worse.
Although reinsurance plays a vital and key role in the D&O marketplace, its full impact on the marketplace is somewhat delayed. As carriers are forced to take higher net lines on their 2004 and 2005 treaties, the impact may not be fully known until those claims are paid in three to five years.
To date, the pricing trends have not reversed themselves.
This year appears to be the "soft landing" year many carriers were hoping for in 2004. What lies ahead is anyone's guess, but a stabilizing rate environment from slight decreases to increases in the 5 percent to 10 percent range could be possible.
In addition to the rate trends, there are some other developments influencing the marketplace and buying decisions for D&O liability insurance. Many policyholders are purchasing additional Side A limits, either to sit above their current program or in a stand-alone tower. The current litigation climate has left many directors and officers vulnerable to claims that may not be indemnifiable, thus increasing the demand for this type of coverage.
Despite a general decline in D&O pricing, some industry segments continue to face challenges. Large money-center banks, airlines, some technology accounts, and large biotech and pharmaceutical companies are not experiencing the same type of premium relief as the broader marketplace.
In fact, many received premium increases during the 2005 renewal season. However, this "risk differentiation" could be a leading indicator of a stabilizing marketplace. It would seem that the often discussed "underwriting discipline" in the marketplace has appeared in certain market segments.
Another positive development has been the additional attention given to an insurance company's financial strength. Many policyholders are choosing to build their insurance programs with only the most financially stable carriers--in other words, those companies that will have the ability to pay claims four to five years down the road.
The D&O insurance marketplace remains challenging for policyholders, brokers and underwriters. And, unfortunately, trends would suggest that the frequency and severity of claims will continue to rise.
How much and how fast is anyone's guess. Rate decreases appear to be slowing, and the market may be entering a period of stability with many experts projecting rates to be flat or modestly positive next year. There will still be plenty of capacity available, but risk differentiation and underwriting discipline will be more evident in 2006.
All in all, buyers who decide to build long-term relationships with financially strong carriers should find greater pricing stability within their D&O insurance program.
MARK LAMENDOLA is national D&O product manager, financial and professional services, at St. Paul Travelers.
November 1, 2005
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