The D&O editors provide an overview of the market annually. Historical information on D&O issues is provided.
Topics covered:
"If Congress and the courts propose to hold directors hostage for corporate performance in a widening range of economic and social contexts…then the corporation should be alert to provide its directors with every reasonable protection against legislative, regulatory, and legal hazards. I have mentioned some primary steps: providing directors with improved access to the managerial information network, involving them more directly and intimately in the strategic planning and decision-making process, and accepting the need for a higher order of record keeping. Companies should supplement these with the best available insurance coverage and couple this coverage with optimum indemnity provisions in the company's by-laws."
A principal reason for the purchase of any insurance policy is to reduce uncertainty. However, in the field of D&O insurance, the varied, tortuous, and sometimes confusing language of the available policies can create considerable uncertainty about the scope of coverage. In early 1990 a federal court, citing an earlier case, made this comment about the complex structure of D&O insurance policies:
"This case presents another illustration of the dangers of the present complex structuring of insurance policies. Unfortunately, the insurance industry has become addicted to the practice of building into policies one condition or exception upon another in the shape of a linguistic Tower of Babel . . . We reiterate our plea for clarity and simplicity in policies that fulfill so important a public service. (Comments of J. Wilson in Keating v. National Union Fire Insurance Co., 754 F.Supp. 1431 [C.D. Cal. 1990.])"
Although it is easy to blame insurers for confusing insureds with hard-to-understand policy language, the laws imposing liability on officers and directors and the courts' interpretations of these laws are continually changing, sometimes in whimsical, sudden, or surprising ways. Thus, our legal system should share the blame for confusing the people who are trying to reduce uncertainty through the purchase of a contract of insurance.
To understand the full extent of the D&O coverage applicable to an insured, it is necessary to analyze and evaluate the application, the declarations page, the basic policy form, and the endorsements that the underwriter has attached. These elements of coverage then should be compared to the risks of the insured. To do this effectively, a basic knowledge of D&O liability exposures and insurance is needed.
History of Director and Officer Liability Insurance
While a crude form of errors and omissions insurance for corporate directors and officers may have been available through underwriters at Lloyd's as early as the 1930s, serious interest in insuring directors and officers against personal liability did not occur until 1939. In New York Dock Co. v. McCollom, 16 NYS 2d 844 (1939), the court held that the corporation could not reimburse its directors when they had in fact successfully defended against a shareholder derivative action. This decision caused quite a stir. The idea that the corporation's directors would be out-of- pocket when they clearly prevailed in court sent shock waves through many board rooms. The outcome of McCollom was generally credited with the enactment in 1941 of the first corporate-indemnification statutes. While this was surely good news for directors and officers, it undoubtedly was also welcomed by underwriters in London, who had developed a D&O insurance product for which no real market had previously existed.
Even so, corporate interest in D&O insurance was slow to develop. By 1960 only a small number of D&O liability policies had been written, all of which had been developed by a handful of brokers and wholesalers through placement into the London Market. Few insurance and business professionals understood D&O insurance or even knew that such coverage existed. In 1962 and 1963, two domestic insurers, the St. Paul and AIG, entered the D&O market for the first time. Several other domestic insurers also entered, and then left the market during the next few years. Most of the business, either through direct placements or as reinsurance, continued to be placed in London.
Although a lot of quoting was going on, there were still relatively few policies sold as corporate buyers grappled with the question of whether there was a real need for the coverage. Between 1967 and 1968, notable events unfolded that would solidify the demand side of the market.
Demand Soars
A major boost to demand for D&O insurance came in 1967 when Delaware passed new indemnification laws specifically authorizing the corporation to buy D&O liability insurance. By 1973, twenty-five other states had followed Delaware's lead, enacting similar statutes. Prior to this time, it was not clear whether the corporation legally could pay the cost of the individual liability coverage part. It was common prior to 1967 for the premium to be allocated between the corporation for the reimbursement coverage, and the directors and officers for the individual liability coverage part.
In 1968 two landmark cases brought to the forefront the potential personal liability faced by directors and officers. In Escott v. Bar Chris Const. Corp., 283 Supp. 683 (SD NY 1968), all but one inside director were held personally liable under Section 11 of the Securities Exchange Act of 1933 for issuing a prospectus and other SEC registration documents having omissions and misrepresentations. There was no evidence of fraud, but these directors were found to have had reason to believe the documents were incorrect. An outside director also was found liable when he did not detect the misrepresentations (he did not read the documents). Because the corporation was insolvent, the directors were forced to pay defense expenses and liability out of their own pockets without the benefit of corporate indemnification.
D&O liability became the topic of increasingly more articles in business, legal, and insurance publications. When it became well known that a sizable number of Fortune 500 firms had been buying D&O insurance for some time, many directors and officers were quick to give notice that they would not serve without the benefit of D&O insurance.
By 1968 two elements for a burgeoning D&O market were in place: potential buyers with a desire for coverage and multiple insurers competing for a piece of the pie. The primary London Market facility was underwritten by the Sturge Syndicate, using an open market form called the ALS, or Sturge Syndicate, Form. Another London facility, the Minnis Syndicate, was used by Stewart Smith (formerly Stewart, Smith, Haidinger, Inc.), for the underwriting of its SS Form. This policy was sometimes referred to as the Pacific Indemnity Form or the Leslie Dew Form (named after the lead underwriter). The other two major domestic insurers continued to be the American Home, which was considered quite aggressive, and the St. Paul, which was declining as a competitor. Other domestic insurers offering D&O liability coverage around this time included Liberty Mutual, Employers Mutual of Wausau, Lumberman's Mutual, and The Travelers. These markets, however, were little more than fronting arrangements with most of the risk passed to London underwriters. By 1975 the market for D&O insurance had significantly expanded to include the following principal underwriters and insurance companies [Directors and Officers Liability: An Analysis prepared by the Technical Development Committee of the National Association of Insurance Brokers (February 1975)]:
American Home Assurance Lloyd's of London
CNA Home Insurance Company of New York
Sequoia MGIC—Banks only
St. Paul Fire and Marine
Unigard Ins. Company
GATX Insurance Company—newly formed subsidiary of General American Transportation Bellefonte Insurance Company—subsidiary of Armco Steel International
Surplus Lines Harbor Insurance Company
Seaboard Surety
Today, the specific number of insurance companies, underwriting facilities, and alternative risk-financing mechanisms offering D&O protection is likely not known with precision.
Policy Forms
Most of the original D&O policy forms had as their basis the old London wording. Policies following this format consisted of two separate policy documents, one covering the individual liability coverage part and the other the corporate reimbursement coverage part. The overall coverage grant was difficult to understand because it was in two separate policy documents with references back and forth between the two forms. These required readers to flip back and forth between forms when evaluating coverage.
In 1976 Lloyd's introduced what it called Lydando No. 1, which was supposed to clarify some of the difficult language of the earlier policies. This form combined the separate policy format into a single contract having two insuring agreements, much in the same way some domestic insurers had been doing with their forms for some time. While this streamlined the format, the policy still had opaque language and was not very well received. By the early 1980s there were numerous new policy forms introduced that are the basis of many modern forms in existence today. By the 1990s underwriters at Lloyd's had for some time relinquished their position as market leader, with AIG, the Chubb Group, and others continuing to dominate the market.
The D&O Insurance Market – Historic
As in the infancy of the D&O marketplace, a relatively small handful of insurers still underwrite the lion's share of all D&O business. Today it is estimated that as few as ten insurers underwrite up to 70 percent or more of the entire D&O market premium worldwide. The demand for D&O insurance has been sufficient, however, to support numerous competitors. These include both small- and large-size insurers—some writing a broad range of industry risks while others concentrate on specific focused segments or niches of the market such as not-for-profit, private company, and financial services. In addition, numerous captive insurance companies and risk retention groups have made advancements in offering alternatives to the more traditional forms of D&O insurance.
The D&O insurance market has experienced much competition for more than a decade, and because loss experience was generally favorable in the D&O market during this period, underwriters aggressively pursued new business by offering an ever-expanding array of new coverage enhancements. Many brokers and insureds alike reported that coverage enhancements in addition to favorable pricing were there for the asking. This phenomenon allowed many insureds to improve the quality of their coverage and to increase limits instead of concentrating solely on price and availability. Even after nearly three years of a highly competitive and buyer-friendly market, this condition is likely to continue. Coverage terms and conditions are still flexible and negotiable and minimum premiums for excess and Side-A coverage remain soft, at least for the most desirable risks.
Between about 2010 and 2012, there was a slow but significant hardening of the primary D&O market for domestic risks, however this phenomenon was offset by widespread competition for excess layers of coverage. In 2014 and 2015, primary layer coverage renewals were experiencing premium increases in the 2-5 percent range but with overall program cost decreasing by 5 percent or more. Average rates fluctuated between +5 percent to -5 percent. Although we have been expecting the market to reach a state of equilibrium (at least temporarily), a rather soft market continued despite numerous insurer consolidations including the nearly $30 billion acquisition of Chubb by ACE in 2016. Although such consolidations should have had a stabilizing effect on premium decreases, the addition of new significant markets such as Allianz and Berkshire Hathaway increased supply and kept overall premiums down until around the end of 2018.
Many insurance brokers we surveyed, at the time, reported that favorable market conditions continued in part due to a history of easing of securities class action lawsuits and a high rate of dismissals. In 2015 and 2016 however, we saw increasing settlement values, higher levels of SEC enforcement, and increasing cyber-related claims. During 2016 the SEC filed over 800 enforcement actions. In 2017 the D&O market continued to be competitive even though class action lawsuits were filed at historically high levels. This phenomenon is partially attributable to a significant uptick in the number of federal court merger objection lawsuits (93), well above 2016 (80). The frequency of D&O claims in several key areas, and the potential for significant D&O exposure in other areas, increased with few signs of relief on the horizon. In addition, some recent case law, claims developments, a changing regulatory climate, evolving business challenges and new dynamics within the plaintiffs' bar created a potentially troubling future for directors, officers, and their insurers.
Around Q2 2019 the D&O insurance market began to enter a hardening period for some segments of public and private companies as well as healthcare. Such hardening, at least in the short-term was limited to specific areas such as California high risk exposures, for-profit education, crypto currency, cannabis related companies and companies with merger and acquisition exposures. In the short-term overall renewal rates remained flat for the most desirable classes with modest increases of up to 10% or higher for other sectors. The latter part of 2019 and continuing throughout Q1-Q2 of 2021 marked a continuing and widespread hardening of D&O rate escalation across the board as evidenced by the following:
The Council of insurance Agents and Brokers' Commercial/Casualty Market Survey found that in Q2 of 2020, the average D&O rate increased 17% over the prior quarter with 93% of respondents reporting an increase. Aon reported Q2 2020 D&O rate increases up over 70%, and in Q3 2020 Marsh & McLennan Companies reported an astonishing 50% increase with over 90% of clients experiencing some form of rate increase.
In 2021, many insurers aggressively forced companies to accept higher retentions by either not offering expiring terms and conditions or through premium incentives to accept higher retention amounts. Many insurers scaled back on primary limits capacity and breadth of coverage offered. These changes were particularly acute for high-risk and hard to place risks.