Seeking Stability in the D&O World

The world of directors & officers coverage may be hanging out signs these days or posting messages on the Internet that simply read—Wanted: Stability. That commodity has been extremely hard to come by in recent years as major D&O cases have been splashed across the headlines of television and newspapers.

According to Bill Cotter, chief underwriting officer of National Union Fire Insurance Company of Pittsburgh, an AIG subsidiary (www.aig.com), “Until there is stability in the D&O industry’s loss costs, premiums will continue to increase dramatically.” He added that, “We are seeing a continuation of significant increases in premiums in 2003.”

The year 2002 was a record one in terms of the number of companies sued in Securities Class Actions (259 according to Stanford Securities Clearinghouse—excludes the 2001 laddering claims). Average settlement amounts for Securities Class Action claims were a record as well ($29.4M/settlement through 8/02 according to NERA). Another record was the number of public companies restating their financials (330 according to Huron Consulting).

“However, 2002 was not an anomaly to the D&O industry from these statistics,” Cotter reported. “Rather 2002 simply represented a continued and worsening trend ever since 1996 in all three categories.”

Katy Lewis, assistant vice president of California-based Lemac & Associates Inc., (www.lemacga.com) said there is a balance that must be struck.

“The balance is between obtaining the justified rate increases while getting back to the basics in the D&O market place and trying to accommodate the needs of the public companies who have been forthright and have consistently exhibited satisfactory controls to try to mitigate such catastrophic losses that have been played out all over the media,” Lewis said.

As Lewis pointed out, “There is not much dispute that the D&O product for publicly traded companies has lost its true essence originally intended to cover board members from shareholder litigation. However, are we prepared to deal, again, with claim issues such as allocation in the event that entity coverage is not covered in the D&O policy? Or will board members be exposing themselves for a potential derivative action in the event that they elected not to purchase the entity coverage, when it was in fact made available?”

Experience plays a major role in the success or failure of those D&O writers, and as Cotter noted, “The companies who are feeling the brunt of the problems in the D&O industry are those carriers who aggressively got into this business in the late 1990s, with no prior underwriting or claims experience.

“Their strategy was to underprice the D&O policy thinking that the worst was behind the industry. The net result for these carriers is a dramatically underpriced portfolio that cannot sustain the losses underwritten during their brief tenure in this product line. As a result, many of these carriers are leaving the industry or severely reducing their capacity.”

Evon Riof, brokerage manager with San Diego-based Katie Freeman Insurance Services, agreed that the market is seeing prices continue to grow and she doesn’t see a near-term end in sight.

“The market at this point continues to harden,” Riof said. “Capacity is certainly available, but rates are going up and I honestly don’t see any change in the near future. Prices have been going up for quite some time now. I think there is a combination of reasons. Not just the tragedies, things that have happened in our country, but also the stock market and the catastrophic losses that have occurred are finally taking a hit.”

As for the underwriters’ take on the current D&O market, Riof noted, “There certainly isn’t a concern about capacity, that’s there. They’re going to charge what they want to charge for the coverage, they call the shots. I suspect this marketplace will continue for the next three years, possibly even longer. I think some of these losses, especially in the medical field, have to get into some control and there has to be some sort of cap.”

According to Cotter, “The real crisis in corporate governance that we are now seeing first-hand, is that talented professionals do not want to take the risk of being an independent director in today’s litigious environment.

“With traditional D&O policies being rescinded due to fraud, settlement values at record levels, and new exposures being created by Sarbanes-Oxley, independent directors are concerned that the traditional D&O policy does not provide them with the necessary cover to protect their personal assets.”

Where are we headed?
National Union has introduced a new product into the marketplace, IDL Premier that addresses that specific issue. The policy offers non-rescindable coverage to a company’s independent directors that is dedicated solely to their own exposures as independent directors. The company has found that while prices continue their upward climb, the underwriting process has become more of a challenge.

“The D&O underwriting process continues to be a very intensive methodology for the underwriters in trying to understand the unique risks inherent in any given individual company,” Cotter said. “In today’s environment, many companies are trying to find ways to differentiate themselves to their underwriters. One of the best ways to facilitate this underwriting process is to have the senior officers of the company, including the head of the audit committee if possible, meet with the underwriters and be as transparent and forthcoming on the risks of the company as possible.”

Having all your ducks in order may mean the difference between being a survivor and watching from the sidelines.

According to Cotter, “In today’s environment, it is critical that the D&O policy be able to respond as it was originally created to do. First and foremost, this means that is has to protect the personal assets of innocent directors and officers who become targets of shareholder litigation. Unfortunately, the current D&O contract, with its broad terms and conditions (as a result of the soft market in the late 90s), has in many ways stopped providing this critical function. In order to return the D&O policy to its original purpose of protecting personal assets, the coverages in the contract, e.g. entity coverage, need to be cut back so that it can meet this important function.”

Lewis added that, “A publicly traded company, regardless of its size, is to be held accountable by the same standards, and has the same duty to its shareholders. However, the consensus is that the smaller, and true middle market publicly traded companies are being given the same broad-brush treatment as Fortune 500 companies. Rate increases and tightening up of the D&O contract is expected, and when applied in moderation, can be viewed as a return to more responsible underwriting. However, the middle market public companies that we represent want to feel that the merits of their controls are being examined and accounted for, as well as the exposures that are driving the increases. Somewhere between these two issues, it is up to all of us in the D&O industry to find this balance.”

And as Riof noted when asked about how important experience is in this market, “They better know what they’re doing.”

Experience and striking the perfect balance may be the winning combination to making a go of it in today’s D&O market.

To comment on this story, email dthomas@insurancejournal.com.

Topics Underwriting