D&O Market Firming Near?

Some insurers think rate declines will stop by year-end, aftersingle-digit cuts earlier in '05

While last year's directors and officers insurance market shoredup the old adage of what goes up must come down, this year'spricing proved it does not necessarily have to go up again.

David Bradford, executive vice president for Advisen Inc., aprovider of information, analytic and benchmarking tools forcommercial insurance professionals in New York, said that in thethird quarter of this year, the average D&O policy renewed at adecrease of about 8 percent overall.

"But the thing that is interesting is that it is veryinconsistent for different types of companies and different sizesegments," he said.

Midsized companies, with revenues between $100 million and $1billion, benefited most from the price competition for theirD&O coverage, Mr. Bradford said.

Jim Nestheide, vice president of financial and professionalservices for The St. Paul Travelers Companies based in Cincinnati,agrees that the market is competitive.

Many carriers have shied away from what he terms the "mega-caps"(publicly trading companies with large market capitalization)because of their potential exposure. They have competed for thesmaller companies, creating a softer market there, he said.

Rather than worrying about any particular price, Mr. Nestheidesaid that tying the rate to the exposure is a priority at St. PaulTravelers.

"There are accounts that probably warrant decreases in pricebecause of their risk characteristics," he said.

Technology, pharmaceuticals and biotechnology warrant higherprices because of their past experience, he said.

The London Market shows similar pricing trends, according to the2005 third-quarter Willis Index. All of the insurers surveyedreported rate reductions, but more than half put them in the singledigits.

"Comparing these results with those given by issuers in theprevious quarter, we see that these rate reductions were less thanpreviously anticipated," the Index report stated.

Keith Thomas, New York-based senior vice president in Zurich'sManagement Solutions Group, said the D&O line "has given backin the past 18 months a considerable amount of the rate increase itgot following 9/11."

"But we think that is almost stopping," he said. "In fact, wethink we will see, by the end of the year, rate trends declining inthe low-single digits, and then actually some rate increase."

The larger, Fortune 500 risks have seen some price stability."Smaller cap companies, depending on their situations, may see morerate relief than that larger group," Mr. Thomas said.

Companies with "earnings issues" will always face morevulnerability to events that give D&O underwriters heartburn."So, we watch that very carefully, along with companies that have alot of activist shareholders--and that could be anybody," hesaid.

And even major product liability events such as Merck's Vioxxissues will eventually transform themselves into D&O suitsthrough their effect on the stock price, Mr. Thomas said. He wasreferring to product lawsuits that the Whitehouse Station,N.J.-based drug maker now faces after it decided to pull anarthritis drug from the market because of studies that link Vioxxto increased heart attack risk.

"The issue would be that you didn't disclose that you had issueswith this one drug, or that you over-hyped that it was sosuccessful," Mr. Thomas said.

"Stock price is the trigger for the plaintiffs' bar. And that isthe way we look at the business. While it is insurance, it is likea semi-financial product, and we are asked to mitigate market caplosses in an industry group," Mr. Thomas said. "So, we price it tothat, almost like an option."

For D&O underwriters, the better mousetrap will be theunderwriting methodology that best captures a company's lawsuitexposure.

"I have been doing this since 1983, and it has become a lot morescientific," Mr. Nestheide said.

Mr. Thomas said that Zurich's D&O methodologies offercustomers transparency. "We can sit down with customers and tellthem where their prices are derived from in terms of what theirmarket caps have done, and in terms of risk factors that aren'tquantitative yet but are in the process of getting there."

Class action securities litigation trends top the list ofD&O insurers' concerns. The Stanford Law School SecuritiesClass Action Clearinghouse reported the number of companiestargeted by securities class action suits in 2004 rose to 212 from181 the previous year. But the decline in stock marketcapitalization corresponding to these actions approached the levelsseen in the aftermath of the 2000 stock market downturn, theClearinghouse reported in cooperation with CornerstoneResearch.

Elaine Buckberg, New York-based vice president for NERA EconomicConsulting, in a report published in July wrote that 2005 "willlikely bring new highs in both mean and median settlements." In thefirst six months of the year, the mean settlement value reached$25.8 million, compared to $23.5 million in 2002, excludingWorldCom and Enron (the two largest settlements in 2005).

Federal legislation crucial to the D&O line includes the1995 Private Securities Litigation Reform Act, which aimed to curbthe plaintiffs' bar, and the 2002 Sarbanes-Oxley Act. Passed in theaftermath of the Enron and WorldCom corporate governance scandals,D&O writers are now just starting to measure the impact of thelatter.

Mr. Nestheide said the PSLRA brought only a temporary respite inthe mid-90s. "The plaintiffs' bar figured out what the Reform Actdid, and so you had a temporary lull in the filing of class actionsuits. But then the numbers picked back up to historical levels andthen higher."

While some have feared that the reporting requirements of theSarbanes-Oxley Act could be a lure to plaintiffs' attorneys,fueling more suits, Mr. Bradford said about the only impact so farhas been fewer lawsuit dismissals. "The more intense reportingrequirements provide plaintiff attorneys with more data to build acase to survive the initial challenge," he said.

Mr. Nestheide said he was concerned that the first company thatclaimed to be in compliance with Sarbanes-Oxley, but was found tobe otherwise, would not be defendable.

Mr. Thomas said that Sarbanes-Oxley has led to more engagedboards and better corporate governance. "But on the flip side, itcan provide a road map for the plaintiffs," he said.

Buyers today are not only worried about the fervor of plaintiffsfrom a D&O perspective but also in terms of personal liabilityexposures--as some institutional investors seek to ensure directorsof errant companies feel the investors' pain in their ownpocketbooks.

Mr. Thomas said he recently participated in a New York StockExchange Summit where the trend of out-of-pocket director paymentsto "send a message" was a matter of increasing concern.

"Whether that changes the rules of the game from what we saw inthe past, it is probably likely. But I think that will be reservedfor the more egregious type of fraud accounting cases," hesaid.

D&O pricing has generally followed general commercial linestrends, which saw pricing shoot up after the 9/11 attacks. Butthose events were quickly followed by the Enron-WorldCom scandalwhich had its own unique D&O impact, sending rates up.

Mr. Thomas expressed concern that the subsequent decline inrates did not match the environment in which they fell. "If youlook at what our marketplace did over the past 18 months, one wouldsay 'why would you give back that much rate when you have data thatsays you have the same number of lawsuits and severity?'"

Primary D&O insurers are also keeping an eye of reinsurers,with some speculating that losses unrelated to D&Oliability--from Hurricane Katrina--may increase reinsurer warinessto play in the D&O market. That, in turn, may reinforce anytrend toward D&O market stability by those companies who relyon reinsurance, and who will think twice before cutting prices tograb market share, they say.

"When something happens on the scale of what happened in thepast couple of months, it is going to impact us," said Mr.Nestheide, referring to primary D&O writers. "We, however, arealso such a small part of it that we will be affected by our ownthings--such as PSLRA," he said. "But mostly what is going toaffect us is reinsurance."

From his perspective, Mr. Nestheide sees reinsurers being moreparticular about the primary companies they want to do businesswith. "They will look at which carriers have the correct appetite,and which ones have the predicting models and strategies that areconducive to long-term success," he said.

Midsized companies, with revenues between $100 million and $1billion, benefited most from the price competition for theirD&O coverage.

David Bradford, Executive V.P.,Advisen Inc.

"There are accounts that probably warrant a decrease in pricebecause of their risk characteristics."

Jim Nestheide, V.P., St. Paul Travelers Companies

"We think we will see, by the end of the year, rate trendsdeclining in the low-single digits, and then actually some rateincrease."

Keith Thomas, Senior V.P., Zurich Management Solutions Group

Art Caption:

The future direction of the D&O pricing seesaw is anythingbut certain, but after 18 months of declines that seemedinconsistent with loss experience, market participants are startingto see price drops fall to the single-digit range, and expect pricehikes to emerge by year-end.

Big Numbers Chart

Flag: Suit Statistics

Head: WorldCom Eclipses Cendant

Year-to-date Suits in 2005

150

'Classic' Suits in 2004

212

Issuers Named Post-PSLRA

2,149

Highest Mega-Settlements

$7.2 Billion

Enron

$6.1 Billion

WorldCom

$3.5 Billion

Cendant

Mean Settlement Six-Months '05

$25.8 Million

Excluding WorldCom, Enron

Source: Suit figures from Stanford Law School Securities ClassAction Clearinghouse/Cornerstone Research as of Oct. 17. 'Classic'Suits exclude 21 analyst and mutual fund cases in 2004. Meansettlement from NERA Economic Consulting