Next Fix For D&O Insurers: Eight-Figure Deductibles?

"While I think its a relatively easy solution to get customers to put some skin in the game, Im not sure [coinsurance] by itself, will solve the problem," said Robert Cox, senior vice president of Chubb Specialty in Simsbury, Conn, at the recent Professional Liability Underwriting Societys D&O Symposium in New York.

The problem that he and others referred to is one in which corporations, sued in securities cases for issuing false statements (and not ultimately found to be architects of intentional fraud, which isnt covered by insurance), simply offer up the limits of their D&O insurance programs to settle claims. With market capitalizations "exploding" over the last 10 years, settlements now routinely outstrip program limits, they say.

"What needs to happen is that there truly needs to be a shift in how were thinking about D&O insurance," Mr. Cox said. For Fortune 100 companies, "if theyre going to continue to buy this and were going to continue to offer it, were not just talking about coinsurance, but retentions up into the high eight and nine-figures," he said.

"If there is going to be any economic benefit and sustainable product in the long run, those kinds of changes will need to take place," he said at a session on the future of the D&O marketplace.

Greg Flood, chief operating officer of National Union in New York, agreed that coinsurance percentages and retentions need to be meaningful enough to affect behavior. He described a situation where his company was a party to the mediation for a soon-to-be-announced mega-settlement, noting that the defendant will take a $370 million income hit, after taxes. "To see this company prepared to settle was astounding to us," he said.

At an earlier session, James ONeill, director of Aon Financial Services Group in New York, reported that buyers have not yet accepted coinsurance or retentions on their D&O programs, because insurers have not yet offered dramatic savings in return. "When youre looking at a major [premium] increase and you can get a 5 percent decrease to double your retentionthats not appealing [to] most of our clients," he said.

Chris Sparro, president of the Middle Market & Commercial Divisions for National Union, said that a buyer of a $100 million limit program was not even willing to accept 30 percent coinsurance with a 30 percent premium credit.

In an environment where corporate directors want more insurance, not less, brokers and insurers say corporate budgets really need to be strained before clients will accept coinsurance or high deductibles–or that insurers will need to stop offering the option of buying without such risk-sharing mechanisms.

As far as catching up on rates, according to Mr. Flood, 10-fold increases are needed on some D&O insurance layers to pay for known losses. "Just for 1997 and 1998, settlements over $100 million add up to $1.3 billion so far," he said, adding that resolutions of cases involving Lucent, Oxford, "and a couple of big ones" insurers are working on "will come close to doubling that easily."

In the last 10 years, he said, layers of D&O insurance above $100 million were priced at $2,200 per million. To fund losses over $100 million, just for 1997 and 1998, that rate would have to soar to $20,000 per million, he said.

In a "coming to Jesus" revelation, he said that National Unions cash flow wasnt enough to cover all its claim calls in 2001, noting it had to borrow $200 million from its parent (AIG) to cover them. "That is a scary situation," he said.

"I dont think most of us at this table realize how much we need to get," said Lance Dalzell-Piper, lead underwriter for Faraday Underwriting Ltd. in London. "I still think this industry is woefully underreserved with respect to the 700 or 800 active securities class actions outstanding."

Citing a $15 billion aggregate estimate of the ultimate cost of those actions based on historical settlement values presented a day earlier by Tower Snow, defense lawyer and partner of San Francisco-based Brobeck, Pleger & Harrison, Mr. Dalzell-Piper said he wasnt comfortable the industry is reserved at even half of that.

Asked about the outlook for new D&O insurance facilities entering the market, he said, "Its just a damn shame. Thats really all I can say," echoing the sentiments of several insurers and brokers who warned new entrants of the dangers theyll be facing.

There was also a lot of discussion about capacity that left the market in 2001–including an unquantified amount of reinsurance capacity once supplied by the London market.

"If it was a wide open market, with the potential for all sorts of profit, people would be jumping in," said David Kalainoff, senior vice president for Transatlantic Reinsurance Company in New York. Instead, "were seeing the opposite, with reinsurers, by and large, pulling back from the line."

At a session on reinsurance, he presented his view that the potential for "serious profit" in the D&O line in the next one or two years is non-existent.

"If you dont see any profit on the horizon, [then] dont we have a duty to do something different?" asked William McLaughlin, vice president of specialty casualty of Partner Reinsurance Company of the U.S. in Greenwich, Conn. "Should we take the money and invest in T-Bills if were going to just lose money by supporting reinsurance treaties?"

"The profit margins arent there, and maybe there are other places to put your money," Mr. Kalainoff said. "It could be in T-bills, other lines of professional liability, aviation, [but] I do think it is one of the duties of management to figure out what their profit margins are and, in fact, to move in that direction."

Greg Coda, marketing director for Swiss Re America in Armonk, N.Y., said such discussions are "taking place right now because the profit margins built into standard lines–property lines and normal casualty lines–have a lot more predictability [than] professional liability and D&O."

"Rational insurance and reinsurance managements will make rational allocations of capital to those lines that make the biggest returns," he said.

"The last thing we want to see, as an industry, is the transfer of capital from our shareholders to the plaintiffs bar," he added, insisting that supporting plaintiffs lawyers with "blank checks" is not the purpose of D&O insurance.

An aggressive plaintiffs bar is just one factor that participants in the two-day symposium presented by the Minneapolis-based PLUS had on a list of drivers of unprofitable D&O results. While they repeatedly referred to the multi-billion securities class action settlements for Cendant, Rite-Aid, Waste Management, and others, they also bemoaned the past sins of insurers and reinsurers as contributors to the D&O profit problem.

While Enron will help sharpen underwriters pencils going forward, multiyear programs and reinsurance treaties they wrote in the past are still impacting profitability, according to John McElroy, senior vice president of Gulf Insurance Group in New York.

"Im not going to share the number," he said, "but Im sure my competitors also have a large chunk of inforce policies still on multiyear deals that havent been reunderwritten in three years.Were getting claims on them today and theres nothing we can dobut cross our fingers."

Insurers and reinsurers, who debated questions of whether diligent underwriting could uncover a potential Enron and the effectiveness of actuarial science in the pricing process, were less concerned about the ultimate cost of Enron than its legacy.

Just days after PNC Bank and Global Crossing had also announced that accounting restatements and securities suits were filed against them, PLUS participants repeatedly referenced a report presented to them by Thomas Newkirk, associate director of the U.S. Securities & Exchange Commission, on the level of accounting restatements.

"We have 250 financial fraud and reporting cases in our inventory and theyre coming in now at a rate of one per day," he said. "We think thats going to continue [because] auditors recognize that were in a different climate than we were a year ago." He said auditors are requiring more restatements and blowing the whistle more on their clients.

During his presentation, Mr. Newkirk also discussed the SECs recent filing of charges against New York investment bank Credit Suisse First Boston Corp. for abusive practices related to initial public offerings. CSFB has agreed to pay $100 million to settle those charges and similar ones filed by the National Association of Securities Dealers.

The alleged practices of CSFB, other investment banks, and IPO issuers in a group of more than 320 cases known as "laddering cases," which late last year seemed like the biggest potential headache for D&O insurers who cover the issuers, took a back seat to Enron at the PLUS meeting. At one point, however, Mr. Snow reported that there is ongoing discussion between defendants and plaintiffs in these cases about stipulations to dismiss certain claims against all issuers, directors and officers, while staying others. (For more on these laddering cases, see NU, Nov. 12, 2001.)

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, February 25, 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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