Alls Fair In Love, War, And D&O Markets

With news of sky-high rate hikes, attempted policy rescissions and coverage restrictions dominating headlines about directors and officers liability insurance, it's easy for risk managers to get the idea that carriers have the upper hand in the current D&O market.

But as buyers rightfully seek more protection for directors and officers in a world of heightened accounting scrutiny following the Enron collapse, the market remains competitive and coverage deals can be worked out, experts say.

No one disagrees that D&O premium rates are up considerablyat least in the 25-to-50 percent range for most public companies. (See related story, page 24.) But the sense “that either there's no insurance or that buyers must accept whatever is offered, because there's nothing else” is not an accurate perception for most insureds, according to Carolyn Rosenberg, an attorney with Sachnoff & Weaver in Chicago.

In spite of all the “gloom and doom, sky is falling rhetoric,” Ms. Rosenberg, who advises companies on D&O coverage, said her clients continue to find opportunities to tailor policiesby shopping the market and through thoughtful negotiation with carriers.

News about the bankruptcies of dot-coms, and giant companies like Kmart and Enron, is making them understandably more sensitive to D&O coverage issues. As they look for the maximum protections possible, one option theyre considering involves buying additional “Side A” coverage beyond what is offered in a traditional D&O policy, she said.

Explaining the coverage parts, she noted that the corporate reimbursement section of the policy, also known as “Side B” coverage, comes into play more often than “Side A” coverage.

Typically, when a securities case is brought against a director or officer, and the company is also sued, the company advances defense costs and hires lawyers to defend everyone. Once the D&O policy deductible is met, bills are forwarded to the insurer, which responds under the corporate reimbursement section.

But there are situations where the company cannot indemnify directors and officers for defense, judgment or settlement amounts. Examples are when a company is bankrupt and can't pay its bills, and situations where it would be against public policy to do so. “Side A” responds to those non-indemnifiable claims, often with no retention.

“That's the ultimate protection for the directors and officers,” she said, suggesting that directors and officers might want to seek additional “Side A”-only limits of coverage. Because corporate reimbursement claims account for 99.9 percent of claims, the more rarely triggered “Side A” coverage is typically cheaper, she said.

Fred Podolsky, chief executive officer of the Global Financial and Executive Risks Practice of Willis Group in New York, agrees that there's a “definite trend” among buyers to seek towers of “Side A” coverage limits on top of existing D&O programs.

Mr. Podolsky recently co-authored a “D&O Market Forecast,” proclaiming the market to be “in disarray” as carriers look “to recoup yesterday's losses as soon as possible.” But he also noted the market is still competitive.

Indeed, brokers have described some situations where continued competition among carriers, combined with the aftereffects of one particular soft market coverage provision, are giving some buyers bargaining power that carriers hadn't figured on.

Carriers have been “ERPed,” said Jeffrey Lattman, managing director of Marsh's FINPRO Group in New York, referring to situations where buyers use extended reporting provisions (also called discovery or tail provisions) of expiring D&O policies to their advantage as conditions tighten.

Brokers explain that such provisions were originally designed to protect insureds in situations where an insurer cancelled or non-renewed a policy, by allowing them to buy coverage for claims that came in during a limited time period after the policy terminated, such as 60 days, for a preset amount. The claims, however, have to relate alleged wrongful acts that occurred before the policy terminated.

During the soft market, these provisions were expanded in two ways.

First, they allowed for “bilateral discovery.” In other words, the tail could be purchased if the insured decided to nonrenew, not just if the carrier made such a decision. In addition, policies came with options for one, two and three-year discovery periods that could be purchased for 75 percent, 150 percent and 250 percent of the expiring premium, respectively.

As the market hardens, “if an insurer puts forth a proposal that a client doesn't likenot enough limits, too much premium, or some other provision they dont likethe client can elect the extended reporting period, 'ERP' the existing carrier, for a preset low cost,” Mr. Lattman said. In addition, a new carrier can price the policy more cheaply since it won't have to cover any prior acts, he said.

Mr. Podolsky noted that even in a situation where the insurer decides to nonrenew a bad risk, the insured can buy a one-year tail and have a year “to back the garbage truck up to the old company,” dumping any litigation that comes in on the non-renewing carrier.

Michael Cavallaro, a broker with ARC Excess and Surplus in Mineola, N.Y., gave a simplified numerical example to explain why some insureds are electing discovery.

Assuming that a $500,000 renewal premium is proposed for an insured that was previously paying $100,000, if the insured had a one-year tail that it could buy at 75 percent, it would cost $75,000. Assuming further that another insurer might be willing to give no prior acts coverage for $100,000, the total cost is $175,000, as opposed to $500,000.

“I'm not saying that's always the right thing to do. But some insureds are definitely doing that [electing discovery],” he said. “It's not a lot of insureds, but on some very big accountswhere the premium might go from several hundred thousand to several million, that may be one of the things that they're going to do.”

Brokers say buyers need to consider the risks of such strategies. If a carrier is ERPed, “then you roll the dice on claims,” said James O'Neill, director of Aon Financial Services Group in New York, during the Professional Liability Underwriting Society's D&O Symposium in February.

He explained that each insurance policy is different with respect to the definition of a claim and how the reporting period works. “You can't just buy the extended reporting period and hope that any claim that comes up in the next 12 months will be covered by the last guy,” he said.

Indeed, while Ms. Rosenberg told NU that she looks to the opportunity to report “not only claims, but potential claims” when she reviews extended reporting provisions, a carrier representative at the PLUS meeting pointed out some ugly ramifications of such wording.

Greg Flood, chief operating officer of National Union in New York, described a situation where his company decided to nonrenew a layer of a D&O program. The company then received a claims “laundry list” in the form of a letter from a law firm, including a one-line item that said, “We did business with Enron. As such there might be a risk to us in the future. That's the groundwork for a legal dispute between the incumbent carrier and the new carrier,” he said. “And it's like a nuclear holocaust in a sense.”

He continued that, “the reason we're at that juncture is because that client didn't want to pay what some of the carriers on this program thought the risk was worth. In trying to save somebody premium dollars, they've set the groundwork for a [future] legal battle.”

During the PLUS Symposium, ERPs were the topic of heated discussion, with insurers and brokers raising various questions about fairness.

Is it fair for clients of ERP carriers? Is it fair for competitors to take business by offering lower rates without prior acts? Above all, brokers questioned the fairnessand even the legalityof one carrier's response to ERPs that it believes are going too far.

Brokers said they had little problem with most carrier responses to “being ERPed,” including making discovery provisions “unilateral,” raising the cost, and limiting the time period. But one responsea provision that says discovery premiums are “to be determined”was met with raised voices and angry words.

“I don't see where it's legal and I don't see where it's right,” said Christopher Cavallaro, managing director of ARC E&S, at a PLUS session, later suggesting that carriers that did this would find themselves in front of insurance regulators to defend such practices.

In an interview, ARC's Michael Cavallaro said, “I can't have a 'to be determined,'” noting that his $100,000 account could potentially be hit with a $1 million discovery cost with such a provision.

“That puts me in a spot. What if I've got an insured that's looking badthat doesn't have an alternative. I need defined discovery terms,” he said, noting that even a 200 percent ceiling on a one-year provision is more acceptable.

At the PLUS meeting, the brokers and insurers debated the issue back and forth. Some insurer representatives pointed out that carriers have been burned by bad risks that decided to nonrenew when they were offered “responsible” premium hikes. Such carriers, left to foot the bill for claims yet to be made or already in the door, can potentially recoup some of the losses with “to-be-determined” tails.

At the heart of this debate is the entire issue of the psychology of the marketplace, the respectful handling of claims, and offers of responsible renewal terms, said David Elroy, executive vice president of Hartford Financial Products in New York, whose firm has not put forth the “to-be-determined” provision.

He added that while competitors, with obligations to shareholders, have every right to take business from carriers that are ERPed, “at the same time, there's probably an obligation to the industry to make sure that we can return en masse to profitability.”

(Next week: Part 2 of this story describes more hard market coverage changes.)

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, April 15, 2002. Copyright 2002 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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Alls Fair In Love, War, And D&O Markets

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