While the U.S. recession is said to be over, economic challenges remain. Unemployment is approaching 10 percent. Median residential real estate prices are off their 2006 peak by 25 percent, and 10 percent of prime loans are either delinquent or in foreclosure. Despite a recovery from their March 2009 lows, the major U.S.
equity markets are still well off their 2007 highs, resulting in sustained losses in 401(k), pension, college savings, and other related accounts. And, while the federal government has pumped trillions of dollars into the economy, consumers are saving more and purchasing less, suggesting the recovery will unfold slowly.
Despite the recession and volatility in the equities markets, securities class actions have actually declined to 87 filings in the first half of 2009 as reported by Cornerstone Research. This compares to 112 filings during the same period in 2008, reflecting a 22 percent decline in frequency. Further, 57 of the 87 filings
(66 percent) arose from the financial sector, leaving only 30 filings from commercial organizations, reflecting a level well below what we have seen over the past several years. While the recession has impacted the ability of all companies to grow earnings, it is somewhat surprising to see a decrease in frequency, particularly outside of the financial sector.
Buyers of Directors and Officers Liability (D&O) insurance will ask two questions:
1. What does this mean for me, and
2. What will the environment be like in 2010?
Current Events, Trends, and Developments
In order to address these questions, we review current events, trends, and developments that are driving underwriting behavior.
Though claim frequency and severity are important issues, there are other considerations that factor into the current and future
direction of the D&O market. This Market Update will discuss the key considerations shaping the D&O market in 2009 and into 2010.
Sub-prime/Credit Crisis Overhang on Loss Severity
As originators, issuers, lenders, investors, and service providers in mortgages and debt, the many varieties of financial institutions—banks,
insurance companies, mutual funds, alternative investment funds, mortgage originators and broker dealers—have been most directly impacted by the
sub-prime meltdown and credit crisis. National Economic Research Associates reports median loss settlements during the first half of 2009 remain in
the $10 million range, which is consistent with prior years. However, there has been a fairly meaningful increase in median investor losses for cases filed in 2008 and
2009, suggesting future median loss settlements will be on the rise. The overwhelming majority of these filings have been in the financial institutions sector, where we expect loss
severity to correlate.
Ponzi Schemes
The meltdown that occurred in the capital markets last year exposed businesses that were built on fraudulent Ponzi scheme models. Bernard Madoff alone caused
investors to lose $65 billion. As investors seek recovery of their losses, they are turning to fund managers, bankers, accounting firms, law firms, and anyone
else involved in the investment chain. Investment advisors and feeder funds are particularly vulnerable, including deep-pocketed broker dealers, as allegations of
failure or inadequate due diligence are asserted. These organizations, in turn, will be looking to management and professional liability policies for protection.
Regulatory Implications
Gaps and weaknesses in the financial regulatory system have been exposed. The Obama Administration and the Treasury Department have outlined a framework for comprehensive regulatory
reform aimed at reforming and modernizing our financial regulatory system with the goal of stronger tools to prevent future crises and rebuilding confidence in the basic
integrity of our financial system. This will undoubtedly create concern for D&O underwriters as they attempt to understand and assess the new regulatory framework and its impact
on potential litigation.
Bank Failures and Bankruptcy Proceedings
Both are occurring at alarming rates. The FDIC’s most recent Quarterly Banking Profile (Q2 2009) reports 416 banks are on its “Problem List”—this is a 15-year high. This number could go
higher by the end of the year as credit card and commercial/residential losses mount faster than the lenders’ ability to reserve. The deteriorating economy is also taking a toll on companies
in the commercial sector. According to the American Bankruptcy Institute, business bankruptcy filings for the six-month period ending June 30, 2009, are up 64 percent over the first half of 2008.
Many believe corporate bankruptcy trends will continue due to the ailing economy and tight credit markets. Given the financial losses shareholders and creditors will experience, bank failures, and
bankruptcies remain high on underwriters’ concerns as these events have historically correlated to high frequency.
Liquidity and Debt
With equity valuations impaired across most industries, traditional measurements of risk, such as stock volatility, are currently out of favor. Underwriters are looking more closely at income statements
and balance sheets to assess and prioritize liquidity and default risk. Companies with insufficient cash (or access to it) and/or high levels of debt, particularly with maturities in 2009, 2010,
and 2011, are looked at with a conservative eye and some degree of skepticism. As a result, companies with liquidity and/or debt issues can expect to face renewal challenges marked by reduction in
capacity, higher premiums, and increase retention levels. Attempts at coverage restrictions, particularly connected to creditor claims, can be averted through focused and skilled negotiating.
Ever-growing Landscape of New Capacity
The current D&O market environment is characterized by an ever-growing landscape of new capacity for commercial organizations. Despite the issues and concerns discussed above, an oversupply of
capacity for both public and private organizations has prevented a hardening of the market in 2009 in the commercial sector. Further, we see the powerful dynamic of supply exceeding demand as
a prevailing trend into the first half of 2010 due to:
- Reinvigorated desire to maintain market share by most, if not all, of the leading D&O insurers.
- Personnel shifts in the D&O community where seasoned underwriters are moving to insurers that are looking to opportunistically capitalize on market dislocation, which has been caused by ratings downgrades and credit watches.
For those commercial organizations with liquidity and debt issues squared away, we expect the D&O market to behave competitively on price and terms. Favorably profiled risks will enjoy flat
to modest decreases as incumbents compete to retain business, and new/reinvigorated capacity seeks to expand primary market share. Those troubled by claim experience and/or liquidity and debt
issues will likely experience higher premiums, and perhaps reductions in capacity, though there is ample replacement capacity to fulfill program needs.
Financial Institutions
The D&O and Professional Liability/E&O environment for financial institutions has deteriorated over the past several
years, as underwriters have reacted to a material increase in filing frequency and expectations that losses will be severe.
By 2008, underwriters were reacting with reductions in capacity, nonrenewals, coverage restrictions, and increased premiums
(50 to 100 percent, sometimes more). By mid 2009, underwriters settled down and returned to a discipline of risk differentiation. Asset managers, advisers,
real estate companies, and private equity (unlinked to Ponzi schemes) firms should now expect less volatility at renewal. Tougher classes of business tied
to toxic assets, TARP funds, and Ponzi schemes will continue to be challenges in 2010. Depository institutions, leveraged real estate companies, mortgage companies,
and hedge funds remain difficult classes of business as regulatory, lender/creditor, and shareholder exposures present underwriters with high-risk scenarios.
Lack of additional capacity is causing the “supply/demand” equation to work against financial institution buyers, though we do expect to experience more of a
leveling off in 2010.
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Please contact your Lockton Representative for further information regarding any information contained in this
market update.
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Chris DiLullo
Senior Vice President
Unit Manager
Washington, D.C.
Tel: 202.414.2660
E-mail: cdilullo@lockton.com |
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Tom Wronski
Senior Vice President
Account Executive
Houston, TX
Tel: 713.458.5347
E-mail: twronski@lockton.com |
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