Seventeen billion — that’s “billion” with a “B” — is a number that’s difficult to truly comprehend.
In 2014, that’s the amount Bank of America agreed to pay in response to a government investigation into the design of the bank’s mortgage-backed securities and its purchases of Merrill Lynch & Co. and Countrywide Financial Corp., making it the largest civil settlement in U.S. history. (The second-largest settlement last year was Citigroup’s $7 billion deal that also centered on mortgage-backed securities.)
How much insurance played a part in those settlements is unknown. The exact details of directors and officers (D&O) liability insurance claims are seldom made public. What is known is that the severity of claims has been increasing, with apparently no end in sight. “The statistics are alarming,” says Phil Norton, Ph.D., managing director in Arthur J. Gallagher’s management liability practice.
Norton keeps a running tally of the 50 largest D&O claims incurred in the past eight years by publicly traded companies. The dollar amount of those claims continues to climb: The 50th largest D&O claim on the 2014 list was more than double that of the same slot in 2006. Average claim severity over that same time period has also doubled — to $58 million, according to NERA Economic Consulting. Part of the increase in claim value is because of increased regulatory scrutiny of public companies.
“Agencies that regulate publicly traded companies are better funded, are more visible, and are more comfortable sharing and publicizing the value of the success of their actions,” says Anthony Galban, senior vice president and global D&O product manager, Chubb Specialty Insurance.
They are also more willing to pursue action against individual directors and officers. In early September, the U.S. Department of Justice issued a directive that emphasizes the prosecution of individual employees. Additionally, a company will not be able to obtain credit for cooperating with an investigation unless it identifies and turns over evidence against individuals to the government.
“Both the DOJ and SEC are on the move, and have taken a more aggressive posture in the aftermath of the credit crisis,” says Robert Wolfe, executive vice president, professional risk, ACE Group.
In addition to regulatory claims, publicly traded companies face increased loss severity from securities-related class actions and merger objections. In 2014, the vast majority (more than 90%) of merger and acquisition deals valued above $100 million were litigated, with plaintiffs’ attorneys typically alleging that the board of directors breached its duties by conducting a flawed sales process that failed to achieve maximum sale value to shareholders. The likelihood that a publicly traded company is sued is also running above historical levels, according to a 2015 midyear assessment of class-action filings by Cornerstone Research.
One of the largest nonregulatory cases last year was a $275 million settlement that mass media company Vivendi paid to resolve a shareholder derivative lawsuit related to its sale of a stake in Activision Blizzard Inc. According to Activision, the settlement was paid by “multiple insurance companies, along with various defendants.”
Raymond Hannan, senior vice president and U.S. underwriting manager for management liability at Aspen Insurance, has seen a spike in D&O claims against biotech companies in particular. “If there’s a setback around the development of a drug that impacts a company’s stock price, investors typically react with a vengeance,” he says. “We have to pick our insureds very carefully.”
The dollar value of settlements tells only part of the story. “As you read the headline news, keep in mind those larger amounts take longer to settle, so more defense costs were spent,” says Louis Lucullo, chief underwriting officer/financial lines, North America, for AIG. “Defense costs tend to be around 30% [of settlement amounts], so policy limits are getting eaten up even faster.”
Although small, privately held companies are generally spared from the regulatory and shareholder action that publicly traded and large private companies face, they are not immune from D&O claims. “The areas that have been troublesome in D&O on the private side are theft of intellectual property and breach of noncompete clauses,” says David A. Schooler, partner and trial attorney specializing in professional liability at Minneapolis law firm Briggs and Morgan.
Although these types of claims are not new, the growth of electronic information has been a game-changer in both the cause and defense of claims. “The battleground is over electronic data,” Schooler says. “No matter how sophisticated people are, you invariably end up taking something, putting it on a thumb drive or sending it to your home e-mail, and putting companies at risk. Computer forensics involved in defending against claims are complicated and expensive, which is just one reason why private companies need D&O.”
Technology is also playing a role in claims through Cyber liability covered by D&O forms. “Cyber is becoming one of the biggest D&O exposures out there, mainly because shareholders and regulators are going to hold the board of directors as the primary party responsible for the security of a company. I don’t think anyone expected that a few years ago,” says Lucullo.
Hannan feels that the ultimate impact of Cyber claims on the D&O market is difficult to predict at the moment because “the situation is playing out in real time,” he adds. “There have been some D&O suits that have attached to a cyber event or resulted from a cyber event, but those cases are so new that they haven’t had a chance to work their way through the court process. It is a real exposure, but still relatively undeveloped.”
Excess capacity leads to counterintuitive pricing
Although claim severity is on the increase, pricing on excess layers of D&O has remained competitive, with high-single-digit decreases seen on average accounts and even stronger competition for the best risks.
“Buyers are currently very fortunate to have an overflow of excess D&O capacity,” Norton says. “There can be 30 or 40 potential writers out there for a particular account.”
In the primary market, carriers are still trying to get increases but are able to achieve only low single-digit price bumps. “If anything, that pricing line is trending downward toward a zero increase on primary-attachment renewals,” says Norton.
D&O coverage has also trended in a direction counterintuitive to increased severity. “There has been steady pressure on carriers to make terms and conditions more expansive,” Galban adds.
At Aspen, Hannan has been watching derivative settlements closely. A key area of concern is the potential impact of these settlements on Side-A D&O coverage, which protects executives against claims that a company cannot legally or financially cover. A derivative suit settlement is typically not indemnifiable, because if it were to be indemnified, the company would make payment to itself.
In addition to obtaining competitive pricing, brokers have steadily chipped away at carrier exclusions, including insured-versus-insured, pollution and conduct-related limitations. Side-A D&O coverage has been broadened with no-exclusion language and difference-in-condition excess forms that cover gaps in primary policies.
However, even though broad coverage is available, brokers have to know how to get it. “Complexity is a barrier to breaking into this market,” says Norton. “Doing business in D&O almost requires you to know a secret code. If you know what to ask for, carriers will generally say yes and may not even charge for it—but you have to know what to ask.”
Complexity also comes in the form of non-standard coverage. Although D&O forms share the same basic building blocks of Side-A, -B and -C coverage (see “D&O Coverage Basics” graphic above), each insurer has its unique coverage wrinkles. The insurance cycle itself also challenges brokers: “It’s not unusual for publicly traded companies to request dozens of wording changes to their policy each year. There is a lot of activity on a typical D&O policy,” says Galban.
Brokers determined to break into the market can make use of the services provided by insurers. “Most carriers are good about providing material that can help you through a basic conversation on D&O with a business owner,” Galban continues. “In advising a business of any scale, it does you no harm to at least present the idea of D&O.”
Brokers can also explore the relatively untapped market of privately held companies, which have been less likely to purchase the coverage than publicly traded counterparts. “We are a long way from saturating the market for D&O purchases by private companies,” Galban adds.
One Chubb survey notes that only 28% of privately held companies purchase D&O insurance. That low number exists in part because business owners mistakenly believe that they are protected by their GL policy, and in part because they think their exposure to loss is small. The challenge for brokers is to convince business owners otherwise.
“There’s a strong feeling on the part of smaller, family-run companies that they don’t need this coverage. They say, ‘My customers love me, my employees love me, so I don’t need D&O.’ Unfortunately, for many companies, learning about the risks comes from experience,” says Galban.
In its survey, Chubb found that D&O suits cost private companies an average of nearly $700,000, including judgments, settlements, fines and legal fees.
“Agents need to educate the customer as to the risks they’re facing,” says Schooler. Those risks include allegations of breach of fiduciary duty, false adverting and other claims that attempt to “pierce the corporate veil” by targeting directors and officers, as well as disputes among business owners and family members.
“Professional services and financial firms, architects, engineers — they have no idea that a single claim will put them out of business just from defense costs alone,” he adds. “A couple thousand dollars a year in premium for a policy is peanuts compared to having to absorb the cost of one lawsuit.”