The latest trends in D&O insurance are examined and it is found that despite a slew of litigation driving demand higher, there might be some light at the end of the tunnel.
In the wake of a wave of corporate scandals and bankruptcies, litigation targeting directors and executives at US companies has increased dramatically. With courts appearing to lean on the side of litigants, directors and officers are rushing to protect their financial assets through a range of new and varied D&O insurance policies, according to brokers and underwriters.
The good news is that, due to a large influx of capacity creating a more competitive environment for underwriters and brokers, directors are paying significantly lower premiums than two years ago, although that trend appears to be leveling.
A study by Stanford University finds that 214 federal securities class action suits were filed in 2003, up from 171 in 2001. According to a separate study by National Economic Research Associates, roughly 80 percent of these suits were settled out of court. NERA goes on to claim that almost 3 percent of public companies had class action suits brought against them in 2004.
A significant increase in the number of financial restatements appears to be driving the current wave of civil litigation. Between 2000 and 2004, the average number of restatements equaled 314 per year, according to Huron Consulting Group. The total number in 2004 came to 414, and the 2005 figure is predicted to be significantly higher.
With the liability landscape becoming increasingly complicated, many directors are losing faith in traditional insurance policies and are looking to improve their protection.
‘The baseline is that directors and offi-cers are looking at the exposure,’ says Steve Schappell, managing director at broking giant Aon’s financial services group. ‘The severity of these claims is skyrocketing.’
Ignoring the outlying blockbuster settle-ments, the average settlement in 2004 was $33 million per issuer, Schappell says. This compares to an average of $10-11 million in 1995-1996 (when the insurance reform act came into effect).
This atmosphere is forcing companies to buy higher limits on traditional D&O policies, and to layer on side-A policies that solely benefit the independent directors as well as entity insurance for the company overall. Traditional D&O insurance, or side-B, is a company reimbursement policy. This pays the defense costs and settlements for individual directors and officers when the company indemnifies them.
Side-A is becoming more popular as it insures the individual when the company can-not indemnify him or her. This is particularly useful for derivative action suits or, in the case of bankruptcy, when the traditional side-B policy may not be available. Entity insurance covers the company and board as a whole, but the problem is, in the event of expensive, drawn-out trials, the proceeds may be exhausted before the directors come to court.
One of the main issues driving directors – independent directors, in particular – to think more seriously about insurance is the fear that they won’t be indemnified against claims, according to ACE senior vice president and counsel Carol Zacharias.
More complicated and expensive insurance is not just affecting existing board members. Companies are now coming under greater pressure from prospective directors in terms of the type and level of available insurance.
Roger Kenny, managing partner at Boardroom Consultants, a recruiting firm that specializes in placing executives and directors at the board level, advises recruits to engage an independent consultant to get advice. ‘There’s a cautionary feeling out there,’ he says.
Ralph Cemararo, senior vice president and chief operating officer at Nasdaq Insurance, says, ‘Directors are obviously taking a more active look at D&O policies. In the past, directors were just asking to see if there was a policy in place. Now they are saying, How much do you have? Who is your insurer? And fax the policy over to my attorney.’
‘The issuers have consistently gone out and bought more limits, at the insistence of directors,’ says Schappell. Zacharias agrees, ‘Directors are now asking, Do I have enough, what are the elements of my insurance, do I have the right co-insured and do I really want my fortunes to go to the entity?’
Companies and directors are also taking a look at the financial position of the insurer. Many directors and officers were left without coverage when Kemper and Reliance became insolvent.
More risk, less premium
One surprising aspect to the marketplace is that as underwriters cover more apparent and expected risk, premiums have come down sharply in recent years. In fact, brokers and underwriters estimate that premi ums have fallen 10-15 percent in each of the last two years.
Even amid a backdrop of increased litigation, larger settlements, higher bankruptcy rates and increased restatements, capacity that came on line, particularly after the upward price adjustment of several years ago, has kept the market competitive and premiums declining.
‘There was a huge price correction in 2001-2002,’ Cemararo says. ‘Because rates came up, a lot of capacity came into the market.’ According to the Tillinghast survey, from 2002 to 2003 D&O coverage costs rose 33 percent on average.
And some of these companies have very large books. A joint ven ture of several large underwriters and an investment bank based in ?Bermuda ‘wrote almost $1 billion of premium in the first 12 months,’ says John Schwonke, senior vice president and manager of the financial services group at ADD.
This should keep the market competitive for some time, but companies will not likely continue to see the deep discounts of the last two years. ‘We’re seeing the pricing level out,’ says Cemararo.
Size matters
Not all companies are equal when it comes to insuring directors.
Larger cap Fortune 500 companies that may have a traditional D&O policy with a $30 million limit might now have a $20 million side-A policy as well, in addition to entity insurance. While it’s been around a long time, Schwonke notes that ‘the A side has really exploded over the last three or four years.’
Smaller companies are more likely to have traditional D&O policies with lower lim its around $10 million. But as companies grow, that tends to change. ‘As they grow, they may feel they need to get different board members,’ says Schwonke, adding that a company making an acquisition or recruit ing more prominent board members may raise its coverage by 50 percent. ‘And they might say, I would not have done that with current management.’
So corporate secretaries and others involved in establishing D&O insurance now have more to consider. The wrong decision will affect your ability not only to retain directors, but to find new ones as well.
