The gap between attractive prices being charged by incumbentdirectors and officers liability insurance carriers and higherpremiums that have been charged by competitors in recent quartershas started to narrow, according to a broker executive.

Michael Rice, chief executive officer of Aon's FinancialServices Group in Denver, Colo., also predicted that D&Oinsurance prices could show an uptick for only the second time in22 quarters when Aon publishes its second-quarter D&O priceindex this month.

He stopped short of linking thetwo trends together, however, attributing the overall pricereversal instead to the simple fact that prices have nowhere to gobut up at this point.

Giving some background on the development of Aon's quarterlyD&O pricing index, Mr. Rice said Aon separately tracks whatincumbent and non-incumbent carriers quote on D&O programlayers, and what non-incumbents charge, noting that the traditionalrelationship would have incumbents quoting higher.

He explained that competitors trying to wrestle business awayfrom existing (incumbent) D&O carriers traditionally chargedlower prices. "That's natural," because those competing forbusiness "would have to give something" to entice buyers, headded.

The situation is now reversed, he noted. He explained that thecarriers that have for years dominated the D&O market (AIG, XL,Hartford) "are companies that have fallen on some tougher economictimes"--a situation that has prompted non-incumbent markets to tryto sell their better financial security rather than betterpricing.

"So non-incumbents are quoting higher premiums than incumbentson the same layers of insurance. That never used to be the case,"Mr. Rice said, putting the price spread between the two groups atroughly 300 basis points (3 percent).

"Those incumbent markets--the ones that have had the toughertimes--are doing a pretty good job of keeping the pricing down toflat for the clients," he said, noting that the non-incumbents "arelooking at claims histories and saying, 'if we're going to play onthis, we need to get higher rates.'"

Mr. Rice said the spread is narrowing now because both sides aremoving toward the middle--not just because incumbents are moving upor competitors are moving down.

THE PRICING INDEX

Overall, Mr. Rice said Aon's Quarterly D&O pricing index"might be flat to up" when the index is finalized and officiallyreported later this month, basing his assessment of year-over-yearprice changes (second-quarter 2009 compared to second-quarter 2008)on very preliminary figures.

Aon's D&O pricing index--which tracks D&O premiumsrelative to a base year of 2001--came in at 1.21 for first-quarter2009, meaning that prices are 21 percent higher than the 2001 baseyear in nominal terms, not adjusted for inflation.

With the exception of a few minor quarter-to-quarter pricehikes, the index has fallen fairly steadily from a high point of2.63 in fourth-quarter 2002 to lows like the 1.21 index valuerecorded for first-quarter 2009. That means "about 60 percent ofthe rate has been taken out of the market already," according toMr. Rice's interpretation of the numbers.

"Not even adjusting for inflation, rates are probably cheaperthan they were in the year 2000. There's not a lot of rate to giveback at this point in time, particularly when you look at theclaims that are out there," Mr. Rice concluded.

Giving a "rough cut" of preliminary data for recent quotationsthat is shaping his thinking on the second-quarter index, he saidthere's still a possibility the index could be down slightly whenall premiums are finalized for the quarter ended June 30.

"But it's certainly not going to be down like it was in themajority of [the past] 21 quarters," he said, guessing instead thatthe final number will settle in at something between going down 2percent to rising 1.5 percent compared to second-quarter 2008.

Mr. Rice said widely reported price distinctions betweenfinancial institutions and other D&O buyers continued in thesecond quarter. During the quarter, he noted, the maximum hike Aonsaw for a financial institution's (FI) D&O program was 79.6percent, while the maximum decrease for a non-FI program was 56percent.

Deals that are in the market now, he said, are not seeing largedecreases, noting that the majority of deals fall in a range ofprice changes extending from a 10 percent drop to a 20 percentincrease.

"Some non-FI industries continue to see a lot of competitionfrom a lot of markets driving pricing down," he said, givingtechnology companies and those in the consumer staples sector asexamples of industries that reaped the benefits of insurer pricecompetition in the first quarter.

Looking into the future, Mr. Rice said he does not foreseenon-FI D&O buyers facing the kinds of significant price jumpsthat FI buyers started to see late last year, mainly because thenumber of securities lawsuits (the principal drivers of D&Oclaims) has not increased dramatically for nonfinancialcompanies.

LITIGATION TRENDS

In fact, as reported by Cornerstone Research in late July,overall lawsuit frequency has started to tumble.

Tracking trends in securities class-action lawsuit filings,which historically have been a leading indicator of D&Oinsurance price trends, the Boston-based firm reported that 35lawsuit filings in the second quarter of 2009 marked the lowestquarterly total since first-quarter 2007.

For the first half, federal securities class actions fell 22.3percent to 87 from 112 during the same period in 2008.

John Gould, vice president of Cornerstone, suggested a possibleexplanation might be the reduced stock market volatility.

"The market was much more volatile in the second half of 2008,when filings were rising. Moving forward, greater market stabilitymay signal a reduced number of securities class action filings," hesaid in a statement accompanying the report.

Does that mean increased price competition in the quartersahead?

"One quarter doesn't make a trend," Mr. Rice responded whenasked about the impact of more benign claims trends just beforeCornerstone released its report. "First quarter was up slightly,second quarter was down. It really takes a string of consecutivequarters" to impact pricing, he added.

He also said there's typically a lag between stock price movesand D&O insurance price changes--a fact that has been clearlyreflected in the double-digit D&O price hikes that emerged forfinancial institutions in the second half of 2008.

"That was about a year lag," he said. "The economic realitieshit at the end of 2007, stock prices went down, lawsuits startedcoming in, and by the end of 2008 prices were up dramatically," hesaid.

Key Coleman, a certified public accountant and managing directorfor the insurance practice group of SMART Advisory and BusinessConsulting in Chicago, also noted that bifurcated lossexperience--with more benign loss experience for nonfinancialfirms--has translated into bifurcated rate pressures.

For financial firms, "we had scandal heaped upon debacle," hesaid, noting that the subprime crisis was followed by the Madoffand other Ponzi schemes, pushing up the frequency of D&O losseson the FI side, while nonfinancial firms' losses were flat toslightly down.

In addition to lawsuit trends, Mr. Coleman recommends keeping aneye on overall combined ratios and capacity levels of D&Owriters to anticipate future D&O price movements.

Many of the largest D&O carriers had combined ratios under100 in 2008, he noted. "If capacity does open up, then that's anissue that's looming out there that would break the link betweenthe loss experience and higher rates" in the D&O line, hesaid.

"I think it's the same companies that are offering FI coverageas non-FI. If these companies have capacity at the end of the year,then there's going to be some rate competition in all lines. Itdoesn't mean that rates will come down, but it will certainly bluntthe impact of the class-action lawsuits that were filed in 2008,"he said.

Property and casualty insurers don't report financialinformation for the D&O line by itself on the annual statementsthey file with regulators, instead including these results in the"other liability-claims made" line. A review of top writers ofother liability-claims made business reveals that six of the top-10had overall combined ratios (across all lines) below 100.

As reported by NU in theJuly 20 edition, however, for just this line of business, largewriters have begun to recognize worsening claims trends, asevidenced by high initial loss ratios they reported for accidentyear (AY) 2008.

Nine of the top-10 reported a higher AY loss ratio for 2008 atthe end of 2008 than they reported for AY 2007 at the end of 2007,with three (American International Group, Zurich and ACE Ltd.)reporting these loss ratios up by 10 points or more. (Seeaccompanying chart.)

There is, of course, the potential for such loss ratios to comedown as carriers reevaluate case reserves each year if cases settlefavorably or dismissal rates climb.

In fact, one D&O expert, Kevin LaCroix, author of the"D&O Diary" blog, has already begun tracking dismissals andsettlements for class actions related to the subprime cases. As ofJuly 24, Mr. LaCroix counted six settlements and 16 dismissalsgranted--small but growing portions of the 195 subprime classactions he's counted to date.

In addition, with lawsuit frequencies now dropping in 2009,carriers may well post their AY 2009 loss ratios below AY 2008,moving them more in line with prior accident years. But like Mr.Rice, other D&O experts who watch the litigation landscapearen't ready to extrapolate based on a single-quarter lull inlawsuit filings.

Digging more deeply into the cases filed so far in 2009, Mr.LaCroix has speculated in several blog entries (July 24, May 11)that the number of lawsuits dipped because plaintiffs' lawyers havebeen preoccupied with subprime and Madoff lawsuits.

Mr. LaCroix--who is a partner for Oakbridge Insurance Services,a Beachwood, Ohio-based insurance brokerage--predicts that oncethey've plowed through some of the complexities of these cases, thelawyers will turn their attention to a backlog of cases of firmsother than financial institutions.

In fact, that's happening already, he said, citing at least ahalf-dozen lawsuits against firms including Bidz.com (an onlineauction company), Liz Clairborne (an apparel company) and Coach (aleather goods company), with class periods dating back to 2007 inthe recent blog entries.

An NU article published in mid-March anticipated thistrend, quoting experts--including plaintiffs' attorney SamuelRudman, a partner with Coughlin Stoia Rudman in New York, whopredicted a rash of 2007 stock drop cases would be filed later in2009. The attorney reasoned that without a major re-inflation ofthe stock market, there would be no potential for stock drop casesgoing forward, leading law firms to dip back into pools ofpotential cases from the past. (See NU, March 16, page16.)

For firms in and out of the financial institution sector,another driver of securities class-action lawsuits will bebankruptcy filings, many experts predict. For insurance companiesin the D&O world, bankruptcy risks will expose Side A policies,which provide coverage for directors when corporations can't orwon't indemnify them.

On the pricing side, Mr. Rice said Side A pricing has come downmore dramatically than full D&O coverage in the last five yearsas more and more competitors entered what has been a profitablemarket niche.

"Side A pricing probably used to be a lot higher than it neededto be [when] there were very few carriers that would write it.We've gone from five carriers...to 40, and it's a purelysupply-and-demand economic model," he said. "There's plenty ofsupply out there, plenty of demand, and pricing continues to comedown."

Since the biggest gap in corporate indemnification isbankruptcy, the "underwriting of Side A is getting a bit moredifficult," he said.

"For those companies that can prove they're not a bankruptcyrisk, pricing remains very, very good. For those that either areheading toward bankruptcy or have gone into bankruptcy, Side A canbe very expensive," he said.

Viewing the D&O landscape through the eyes of an accountantand with an eye on recent history, Mr. Coleman of SMART couldn'thelp wondering aloud about the difficult tasks ahead of D&Ounderwriters generally.

"I question how underwriters are going to distinguish goodcompanies from bad companies going forward," he said, noting that"some of the financial institutions that went down in 2008 had justspent millions of dollars on Sarbanes-Oxley to set up a controlenvironment that was appropriate."

"Still, some invested blindly with Madoff, while others investedblindly into subprime mortgages," he added.