D&O Insurance Trends Move Toward A New Equilibrium

The directors and officers liability insurance market has changed dramatically during the past couple of years, and further changes are likely in the near future. This article examines recent D&O insurance pricing, coverage and loss trends, and looks at where the D&O insurance market might be headed.

The markedly higher premiums currently faced by many D&O insurance purchasers come in the wake of a prolonged “soft” market of the recent past. During the latter half of the 1990s, the overall D&O insurance market experienced sharply falling prices and ever-broadening coverage.

To see the trends in D&O insurance premiums, consider Tillinghast-Towers Perrins D&O Premium Index. Established and standardized at a value of 100 for the average in 1974, the index tracks the experience of U.S. for-profit respondents to Tillinghast-Towers Perrins annual Directors and Officers Liability Survey. The D&O Premium Index measures relative D&O insurance premium after accounting for important demographics (e.g., ownership, size, etc.), as well as policy limit, entity/reimbursement deductible and other important coverage features.

As the accompanying graph shows, the median and average values of the D&O Premium Index fell more than 35 percent between mid-1994 and mid-1999 (survey responses are generally submitted in the third quarter of each year). This general softness in the D&O insurance marketplace was consistent with individual premium changes during this period, as significant majorities of companies surveyed each year reported either no change or a decrease in their D&O insurance premium.

This same period saw entity coverage for securities claims become commonplace. More than 90 percent of publicly-traded companies responding to the 1999 Directors and Officers Liability Survey reported that their D&O insurance included entity coverage for securities claims, up from less than 30 percent in 1996. As well, coverage broadened for a majority of those surveyed over this period to include claims from employees against non-officer defendants and/or the entity itself; such changes significantly broadened the D&O coverage available to private companies.

While fierce competition raged in the D&O insurance market in the second half of the 1990s, adverse loss trends were developing.

The volatile U.S. stock market of recent years–notable for mergers and acquisitions using stock as currency, financial restatements and questionable insider activity–has provided ample opportunity for shareholder lawsuits against directors and officers. Suits from shareholders have historically been the most costly class of D&O claims, and the severe market capitalization swings of certain stock market sectors during this period only served to make such claims much more costly.

Other factors have also contributed to an increase in the severity of D&O claims. Although the Private Securities Litigation Reform Act of 1995 helped to reduce the number of shareholder suits that might be viewed by many as frivolous or having little merit, its effect on the severity of shareholder claims was quite the opposite.

Shareholder suits which survive a motion for dismissal since 1995 are arguably those that have more substance than before, and such suits certainly have considerably more time and expense invested by the plaintiffs.

Since nearly all D&O claims from shareholders are settled rather than tried to a verdict, settlement discussions following PSLRA have generally featured plaintiffs with stronger cases demanding commensurately higher settlement values.

These claim trends combined with the high prevalence of entity coverage to find D&O insurers paying dramatically higher loss costs than they had envisioned when their policies were sold. Many insurers have seen adverse loss ratios and shrinking (or vanishing) profit margins for several years.

As a result, the D&O insurance market firmed overall in 2000–and for some segments, it turned sharply.

Premiums increased by about 11 percent on average through mid-2000 for generally equivalent D&O coverage, according to the D&O Premium Index.

Since most market segments saw little or no increase through mid-2000 (as evidenced by the nearly flat median value of the D&O Premium Index), it is clear that those segments that did see an increase in 2000 saw a substantial one. During this period, technology and biotechnology companies, firms involved in recent IPOs or those exhibiting some degree of financial distress were likely to see increases of 25 to 50 percent or more in their D&O insurance premium.

Underwriters also clearly began to exercise caution, with some becoming quite selective. Multi-year policies began to disappear. These developments were not entirely unexpected, given the premium and loss trends of previous years.

Further sharp premium increases have occurred since mid-2000, as falling stock prices eroded insurers investment income while simultaneously increasing the exposure of many of their insureds to shareholder suits. While final results for the 2001 Directors and Officers Liability Survey are not yet available, preliminary results indicate that, for the first time in many years, a majority of insured respondents experienced an increase in premium.

Prior to Sept. 11, 2001, D&O insurers were earnestly seeking additional real premium increases of 20 to 50 percent, depending upon market segment, often through a combination of premium increases and coverage restrictions. Perhaps the most significant coverage restriction in 2001 is coinsurance, introduced by some D&O insurers and reintroduced by others. Coinsurance is in most meaningful respects similar to the pre-determined allocation offered as an alternative to entity coverage in the mid-1990s.

Since Sept. 11, D&O insurers have responded to increasing pressure from their reinsurers to return to profitability by seeking even larger premium increases. The terrorist attacks on Sept. 11 have had and are expected to have only limited direct effect on the D&O insurance line of business. There are, however, some important indirect effects.

Some reinsurers have suggested that without the events of Sept. 11, the most significant topic of discussion between insurers and reinsurers during this renewal season would be the losses in the D&O line.

Certainly Sept. 11 has raised reinsurers awareness regarding profitable use of their capacity, and even at the current higher D&O insurance premium levels, other lines of insurance may represent more profitable business for many reinsurers.

What then does the future hold for the D&O insurance market?

In the near term, probably more of the same: further premium increases, stricter underwriting standards, and additional tightening of coverage terms and conditions.

But it wont go on forever; a new equilibrium will be found, if only for a little while.

Further out into the future, prices will stabilize and competition between current insurers or from new entrants to the D&O insurance market will mean that the cycle has begun again.

Mark W. Larsen is a consultant in the Chicago office of Tillinghast-Towers Perrin. He is also the director of the firms annual D&O Liability Survey.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, December 3, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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D&O Insurance Trends Move Toward A New Equilibrium

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