It is the question that always gets asked. While the intent of the question is to gain specific knowledge, the answer will typically be too vague
 to be useful.
"What is the state of the market?” or in this case, “What is the state of the Directors and Officers (D&O) Liability market?” The typical vague response is “stable, plus or minus a few percentage points."
The correct answer depends on the perspective of those asking the question. The question needs to be more specific as the answer will vary depending upon whether one wants to know about a publicly traded financial institution, a publicly traded commercial entity, or a privately held firm. Even identifying one of those three general D&O sectors will still result in a somewhat vague response. The reality is that “the D&O market” is dynamic, with current results and future outlook driven by many factors. In fact, there are many D&O markets.
If the goal is to get an idea of the D&O market for a renewal several months out, the more detail the better. For instance, what is the state of the D&O market for a manufacturing firm with a market cap of $5 billion, profitable, that is conservatively leveraged with no debt maturities until 2013, currently paying $30,000 per million for the primary layer, and the program has not been marketed in three years? The answer to that question will differ from a similar company that is paying $18,000 per million and was recently marketed.
Once you dig below the three general D&O sectors (publicly traded financial institution, a publicly traded commercial entity, or a privately held firm), the state of any particular market segment is driven by three key factors: the segment within a sector (industry and market cap), the insurer supply and demand within that segment, and company-specific issues (e.g., profitability, amount of debt and timing of debt maturities, and potential for accounting irregularities). Think of this in terms of a risk spectrum that on one end has a well-capitalized small, privately held company, and on the other end a highly leveraged, large, publicly traded financial institution. Publicly traded commercial entities will fall somewhere in between.
The average pricing for companies closer to the privately held end of the spectrum will always be significantly less than companies near the public financial institution end. Since the privately held end of the spectrum is consistently more profitable than the other end, there is an abundant supply of capital from the insurers, which has resulted in a very stable market.
On the other end, insurers in the publicly traded financial institution segment are always prepared to pull capacity and adjust pricing given the volatile nature of that regulated industry as evidenced by a very difficult hard market over the past two and a half years. It is also true that companies in the same segment can experience dramatically different results from the D&O market. A company with little or no debt and conservative accounting practices will always benefit from much more insurer competition than a company that is highly leveraged, has no clear plans for refinancing maturing debt, and pushes the boundaries on accounting.
So there really is not one "D&O market." There are literally dozens, or even hundreds, of D&O markets whose performance and outlook are as diverse as the risk spectrum. You can be certain that:
- The D&O market for public companies is less stable than it is for private companies;
- The market for large-cap firms is less stable than for small-cap firms;
- The market for high-tech firms is less stable than for manufacturing firms; and
- The market for financial institutions is less stable than for nonfinancial institution companies.
While there is not enough space here to give an actual update on all of the D&O markets, we will just say that the average of all D&O markets is "stable, plus or minus a few percentage points."
Underwriting Capacity
Underscoring all of this is the fact that overall capacity for D&O insurance, as well as other Executive Liability lines, such as Fiduciary Liability and Employment Practices Liability, is remarkably high. The supply/demand factor is, for the most part, keeping prices down. While there have not been a lot of truly new market entrants in the past year, several “newer” markets have continued to expand and grow their D&O presence, including Everest Re, Berkley Pro, Ironshore, CV Starr, and Freedom Specialty. Other markets such as Catlin, Hiscox, and Endurance have continued to expand their U.S. presence.
Litigation Trends
It is worth a pause here to briefly discuss the D&O litigation landscape. Depending on which study you review, D&O litigation either increased, decreased, or stayed the same in 2009 versus 2008. Clear as mud? The difference lies in how each study counts the litigation. According to Cornerstone, there was a dramatic drop in securities claims in 2009; however, Cornerstone only counts securities class actions and does not take into account things like “state actions” or “breach of fiduciary duty”-type claims.
The decrease in class actions is due largely to an improved and less-volatile stock market as well as fewer claims against financial institutions.
NERA and Advisen, two other publications that track D&O litigation, show a higher number of claims than Cornerstone (i.e., NERA shows 235 filings in 2009 versus 169 for Cornerstone). With these differing numbers, it is difficult to completely understand the D&O litigation landscape. What is certain is that while claims continue to be expensive (with defense cost escalation and the escalation in derivative settlements), the market is not factoring this into their pricing at this time. In addition, while the credit crisis waned in 2009, there are still many subprime/credit-related lawsuits that are slowly making their way through the system. This could lead to greater costs of litigation down the road.
An additional trend seen in the D&O litigation landscape is “lagging” D&O claims, which are lawsuits brought long after the proposed class action period cut-off date, sometimes as long as two years, which is the limitation period. This phenomenon appears to be the result of a backlog of suits at some of the law firms that had been focused on the credit crisis.
Conclusion
As we move into the second quarter of 2010, the D&O, EPL, and Fiduciary markets show no signs of hardening. As referenced above, there are exceptions and differences depending on public versus private, large versus small, financial institutions versus commercial risk, but the theme for most risks, with the exception of some financial institutions, is general stability and softness.
Could this change? Could proposed financial regulatory changes, such as those proposed by Senator Arlen Specter, change the securities litigation landscape and hence lead to a harder market? Will the subprime, credit crisis, and Ponzi scheme cases begin to impact some carriers? What about claims against failed commercial banks? How might the new carbon disclosure regulations impact the D&O landscape? At Lockton, we will continue to stay on top of these issues and many others for our executive lines clients.
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Please contact your Lockton Representative for further information regarding any information contained in this
market update.
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Gary Phillips
Senior Vice President
Financial Services Practice Leader
New York, NY
Tel: 646.572.3940
E-mail: gphillips@lockton.com |
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Rodger Laurite
Senior Vice President
Financial Services Practice Leader
Atlanta, GA
Tel: 404.460.0770
E-mail: rlaurite@lockton.com |
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