The market for Directors & Officers coverage continues to be competitive, despite a concerning trend of increased frequency in litigation — in particular, securities class action suits.
Lawsuits resulting from mergers and acquisitions have been ramping up, and such legal actions can result in high-severity loss settlements.
Pricing, however, continues to trend downward and major players are joining this already soft market. All taken together, it begs the question: Is the current D&O market environment sustainable?
So far, 2017 is one for the record books in the number of federal securities class action suits filed.
According to Cornerstone Research's “Securities Class Action Filings Q1 Update,” the increase of securities class actions in 2016 has only continued into 2017. Plaintiffs filed a record 127 federal class action securities cases in the first quarter of this year — almost twice the number filed in the first quarter of 2016 (64), and nearly half of the total number filed for the entire year of 2016 (270).
“We finished 2016 at record-high levels, and right now, 2017 is trending to surpass that,” says Laura Coppola, regional head of commercial management liability, North America at Allianz Global Corporate & Specialty (AGCS).
“We continue to closely monitor the elevated level of federal securities class action filings,” adds Thor Beveridge, the head of executive liability commercial at The Hartford. “Generally, securities class action settlement statistics for 2016 indicated an unfavorable movement in total settlement dollars, the average settlement size and the median settlement value.”
The rise in filings is concerning, considering the total value of the 10 largest securities class action settlements is $30 billion, according to the AGCS report “D&O Insurance Insights — Management Liability Today: What Executives Need to Know.” But what's driving the growing number of suits?
“The increase [in securities class actions] has in part been driven by the increase in the number of merger-objection lawsuits filed in federal courts following the Delaware Chancery Court's decision in the Trulia case,” Beveridge explains.
In the case In re Trulia Inc. Stockholder Litigation, the court rejected a disclosure-only settlement, shifting several merger-objection lawsuits from state to federal courts. Since that decision there has been an increase in M&A filings, says Dr. John Gould, a senior vice president at Cornerstone Research.
Mike Sisk, assistant vice president of underwriting, professional liability, at Philadelphia Insurance Cos., adds: “If you’re looking solely at the D&O line, bankruptcy and M&A activity continue to be the leading cause of claims.”
So far this year is one for the record books in the number of federal securities class action suits filed. According to Cornerstone Research, plaintiffs filed a record 127 federal class action securities cases in the first quarter of this year — almost twice the number filed in the first quarter of 2016 (64), and nearly half of the total number filed for the entire year of 2016 (270).
Costly settlements from poaching
Janet Haverkampf, private company Directors & Officers liability project manager at Travelers Cos., notes the insurer is seeing an increase in claims from businesses hiring competitors’ former employees.
“What we’re seeing most is the continuation of a trend we refer to as ‘You took my people, and you took my stuff,’” she explains. “These claims typically involve companies suing their competitors and an ex-employee after that employee is hired by a competitor. The allegations often include misappropriation of proprietary information, tortious interference with business, copyright/patent infringement and violations of non-compete agreements.”
However, hiring experienced employees from other companies is a reality for all businesses, Haverkampf notes. “It is not an exposure that can easily be underwritten,” she says. “We are beginning to see the resolution of several cases, and can know their ultimate severity cost.”
Regulatory liability a factor
Along with the increase in securities class actions, regulatory liability is also driving losses in D&O. According to the AGCS report, the top cause of D&O claims by number and value is non-compliance with laws and regulations, and claims severity is rising due to higher legal costs, increasing complexity, expanding regulatory investigations and cross-border actions.
The new administration may play a part in reducing those losses. “We’ve got a lot of discussion around eliminating or mitigating some of the regulatory hurdles that we’ve had as a market,” says Coppola. “Our president has certainly not been quiet or shy about his views on what needs to be changed, and I think that time will tell how those changes will affect our industry. It could indicate good things for our business, in terms of litigation trends.”
Though Coppola notes that changes to the regulatory environment wouldn't be immediate, on June 8 the U.S. House of Representatives approved the Financial Choice Act, which would erase several provisions in the Dodd-Frank Act and eliminate some key financial regulations enacted during Barack Obama's presidency.
Ned Kirk, a partner at Clyde & Co.'s New York City office, believes that in the near future we may see a significant change in the U.S. regulatory and litigation environment. Less-aggressive regulators with fewer powers may bring fewer regulatory investigations and actions, he says, and the conservative judges Trump is putting on federal benches will likely issue more pro-business decisions that make it harder for shareholders to pursue litigation.
“This could be good news for insurers of financial institutions and D&Os in the short term, as they may see fewer claims,” says Kirk.
He does add that in the long term, however, “loosening regulation of financial institutions ultimately could have some dire consequences, as we saw in the years leading up to the last financial crisis.”
The D&O market is seeing new entrants, even though it’s highly competitive. (Photo: Thinkstock)
Soft market discourages few
As the frequency of litigation and cost of settlements continue their upward trend, pricing in the D&O coverage market is continuing on its own downward trend — and there's an abundance of capacity.
“There is definitely downward pressure on rates for private-company D&O,” says Sisk. “The market continues to be pretty soft, with carriers fighting hard to retain their renewal books and getting ultra-aggressive in their pursuit of new business accounts.”
“Rates are the softest that I have ever seen them in my career,” says Chad Berberich, vice president of RLI Executive Products Group. Primary carriers tend to see some firming, he notes, but the excess space remains competitive — with low- to mid-single-digit decreases being the norm.
“While a primary carrier may get a flat renewal, or in rare cases an increase, excess carriers are routinely being asked to give back significant premium,” Berberich adds.
Meanwhile, loss trends have impacted the way Travelers rates private D&O, says Haverkampf. “Private D&O continues to be impacted by increasing and evolving exposures, an expanding breadth of coverage and economic factors, resulting in gradual margin compression,” she explains. “Frequency and severity have been on the rise, leading us to anticipate greater prospective loss costs in the future.
“The cost of severity claims in private D&O is running about five times the severity in certain other core management liability coverage for privately held organizations,” she adds.
Even though the D&O market is highly competitive, new entrants have recently thrown their hats into the ring. M&A activity has also added to the pool of carriers, with the ACE/Chubb merger “leading the charge within the D&O space,” says Sisk.
“We have continued to see some new entrants in the space over the last couple of years,” adds Berberich. “There is plenty of capacity available, and nobody is leaving the market.”
“Right now, in the U.S. especially, we are at an abundance of capital available in D&O and management liability,” adds Coppola. “There are unique opportunities for global players to capitalize on and leverage our capabilities, which is why we entered into the U.S. marketplace despite the softening environment.”
However, Coppola does see the dynamic of more litigation (with increased severity in claims) in a soft market as an issue in the long term.
“I think that something’s going to give,” she explains. “This is not a sustainable environment for D&O. We can't continue to see coverage evolve and broaden with pricing going down and litigation trends increasing.
“We’ve lived through it for the last several years, but eventually something will break and give on that dynamic in today's marketplace.”
What about cyber?
Looking ahead, cyber exposure seems to be top of mind for insurers in the space. “The potential implications of network security and privacy liability on D&O coverage continues to be a hot-button topic as we see an increase in the frequency of cyber liability claims,” says Sisk.
“I think that cyber exposure will continue to evolve in respect to D&O coverage,” adds Berberich. In particular, the derivative exposure or the exposure to individual directors and officers, he says, is a trend to watch.