D&O: One Reinsurers Drink, Anothers Poison
With its business representing just 1 percent of the reinsurance market for directors and officers liability, Hamilton, Bermuda-based Trenwick Groups recent announcement that it non-renewed most of its U.S. D&O liability business may not have shaken too many primary insurers that write that coverage or other related specialties.
But a general contraction of the reinsurance market for such business–that began in January and continued at July 1–might be having a broader impact, experts say. "I wouldnt be surprised if we see more [reinsurance] markets pull out" next year, said Sean Whelan, managing director of Guy Carpenter & Company in New York.
Mr. Whelan and other experts, however, arent predicting a mass exodus of reinsurers that provide coverage for specialty lines like D&O, employment practices liability and professional liability. "On the one hand, there are more reinsurers entering the so-called professional liability lines. At the same time, you have reinsurers using their maximum capacity less," he said. Right now, "there is probably the same amount of capacity for D&O overall. [But] its harder to get."
For some reinsurers, upward trends in primary and reinsurance prices together with tighter policy terms and more favorable treaty structures are making management liability lines like D&O and employment practices liability, as well as some professional specialty areas attractive.
"We have non-renewed some [D&O treaties] but not a huge part of our portfolio by any means," said Bonnie Boccitto, senior vice president in charge of the specialty lines department of American Reinsurance in Princeton, N.J. "We actually feel that with the improvements going on this is a pretty good time to be in the D&O market."
"Last January was really the beginning of the hardening market, but reinsurers didnt have a good understanding of what prices and terms would stick," Mr. Whelan said. He noted, however, that most of the business had been through the renewal cycle by July 1 and insurers and reinsurers are more comfortable and are moving toward "a meeting of the minds." He predicted further contraction for Jan. 1.
"There are still a couple of deals out there that have not yet renewed, that will be coming up [on Jan. 1, 2002]," said Marcia Munn, executive vice president of CNA Re, headquartered in Chicago, observing that many D&O multiyear treaties came up in 2001. "People tried to lock in capacity going into year 2000. Well see continued tightening of capacity on the reinsurance side through the first of the year."
Richard Betterley, president of Betterley Risk Consultants in Sterling, Mass., said that "a delay in completing treaties is the really big news" coming out of the July 1 renewals of treaties covering D&O and EPL business.
Referring to observations he made during a February interview about EPL, Mr. Betterley said that before July 1, "we saw some tightening up, with reinsurers getting some higher prices and also redirecting some capital in the direction of other more profitable lines of insurance," such as errors and omissions coverage.
Since then, "Ive seen more of that, but instead of a little tightening up, it seems like quite a bit," he said, adding that hes heard reports "that some significant insurers in the professional EPL, D&O area are having a lot of trouble renewing their reinsurance treaties."
"And some of them are not finished yet," he said in mid-August. "Its not unusual that a little while after July 1, they havent finished their treaties, but this late is really quite late."
At CNA Re, American Re, Trenwick and Guy Carpenter, experts agree that D&O loss trends have worsened–and they point to the Private Securities Litigation Reform Act of 1995 as the main driver of an ever-increasing number of larger and larger D&O settlements and judgments. Larger market capitalizations of publicly traded companies (which mean larger potential damages from suits brought by shareholders who stand to lose greater amounts of money), and an overall recession are compounding the severity problem, they say.
Explaining some Reform Act basics, Ms. Boccitto said that before 1995 it was "pretty easy" for shareholders to bring D&O suits. "As a matter of fact, one shareholder who had one share of stock could bring a suit," she said, noting that, as a result, cases were smaller and many were frivolous.
The 1995 federal act heightened the standards for bringing a D&O suit. "Now, any suit thatactually makes it to court is probably quite a well-founded suit. And well-founded often means larger," she said, explaining that more larger losses started showing up on insurers and reinsurers books in 1997, 1998 and 1999.
While the potential for increased severity was talked about right after the act passed, "unfortunately, I think most reinsurers are reacting to it now as opposed to reacting to it back in 1995 or 1996. A few reinsurers might claim that they took some measures [then], but truthfully, when I look at our competitors I think most of them are having experience very similar to ours," she said.
Coleman Ross, executive vice president and chief financial officer of Trenwick, recently referred to the combination of 50 percent declines in primary pricing for D&O between 1995 and 2000, progressively broadening coverage grants, and the potential for a greater number of severe claims as a "Perfect Storm scenario."
Even now, Trenwick "may be acting sooner" than other reinsurers, he said during an Aug. 1 conference call discussing the companys non-renewals and action to boost reserves on U.S. D&O business by $11.3 million.
"We employ outside counsel to evaluate potentially serious D&O cases," he said. "Our current assessment of these cases may not correlate with other reinsurers on the same syndicate transactions, [which] project reserves by relying solely on the bulk values reported to them by their clients."
Because worsening D&O loss experience is a severity issue, excess-of-loss reinsurers feel more of the brunt of loss trends than primary insurers, experts say.
Mr. Whelan also noted that the D&O results reported by primary companies like Chubb, Hartford, CNA and AIG include private company D&O middle-market business. The private company business, which has been profitable by and large, falls below typical treaty retentions and is not reinsured, he said.
Explaining the factors contributing to a bad situation for excess reinsurers in particular, Ms. Munn noted that not only were D&O rates low overall, but the higher up one gets on a program, the less expensive it is. "With larger settlements happening, more limits are exposed. And the more limits that are exposed, the higher up they are, the cheaper they are," she said, so the rates are lower and the settlements are bigger.
"The average attachment point on excess business, the safe harbor area, is becoming higher and higher," Ms. Munn said. She noted that in addition to requiring higher retentions, reinsurers are lowering ceding commissions, restricting capacity for certain classes such as technology or telecommunications, and putting annual aggregate deductibles and "loss corridors" into treaty structures.
(When a loss corridor is in place, the ceding company comes back in for a certain amount–either a number of loss ratio points or a dollar amount–and then the reinsurance kicks back in.)
Ceding commissions, which were up towards 32.5-35 percent, are coming down to a flat 30 percent or being replaced by sliding-scale commissions, Ms. Munn said.
Mr. Whelan cited more dramatic reductions, reporting that his firm had seen ceding commissions drop 20-30 percent over the last 12 months, across the board, referring to treaties covering any of the management liability lines (such as D&O, EPL and fiduciary).
"Reinsurers are also asking for a reduction or elimination in multiyear deals. And theyre asking if an underwriter is starting to do more underwriting," Ms. Munn said. "There are new exposures that have developed over the last couple of years, like claims for merger and acquisition activity. So theyre asking, How is the company looking at M&A activity?" she continued.
Ms. Boccitto said reinsurers are "watching and monitoring the increased pricing that ceding companies are getting [and] really looking at increased limits factors," or factors that indicate how much of the premium goes into excess layers.
Based on American Res audits of ceding companies, she reported that on commercial D&O (for Fortune 1000 companies), ceding companies are getting increases around 15-25 percent. On tougher nonstandard risks, theyre getting in excess of 25 percent hikes, and on financial institution D&O (for banks, for example), increases are in the 10-15 percent range, Ms. Boccitto said.
She also said that some primary insurers are seeking co-insurance participations from their insureds. "Heretofore, without 5-10 percent co-participations, insureds have had little incentive to try to keep the size of the D&O losses in check or to settle for less than total policy limits," she added.
"Were absolutely looking to see if ceding companies are pressing [for co-insurance]," she said. "Its something that is fairly new. We have not insisted on it from any of our insurance companies, but it is certainly something that we look favorably upon when we evaluate a submission for a reinsurance treaty," she said.
As for the rate increases that reinsurers are getting, Mr. Whelan said that while they depend on the results of the book of business, "some companies that have handed reinsurers substantial losses are seeing increases upward of 50 percent." For those ceding companies whose results have not been disastrous, 15-25 percent reinsurance rate increases are more typical, he said.
Reinsurers are seeking more partnership roles than in the past, roles that will put their results more in line with insurers results, he said. That doesnt mean that reinsurers are necessarily writing more pro-rata treaties, he added. "London still prefers to see excess contracts."
Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, September 10, 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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