What’s Going on With D&O?
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Transcript of What’s Going on With D&O?
Tammi Dulberger John LewandowskiFrançois MorinBoston, MANovember 11-13, 2002
What’s Going on With D&O?
2002 CAS Annual Meeting
2
Agenda
Background
Market Overview
Drivers of D&O
Summary
Questions
Background
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What does a Directors and Officers liability policy cover?
Original Intent
Cover the Directors and Officers of the organization Provides coverage for claims arising from the “wrongful acts” of
insured persons while serving in their capacity as Directors or Officers
Typical D&O policy consists of two sections Personal coverage (Side A) Corporate reimbursement coverage (Side B)
Until late 1995, allocation of loss between the Directors and Officers and the entity itself Allocation was either negotiated or predetermined Insurance contract covers only the loss allocable to the Directors and
Officers; Insured covers the loss allocable to the entity
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What does a Directors and Officers liability policy cover?
Broadened Coverage Beginning in 1995
Cover extended to include the entity in addition to the Directors and Officers (Side C) Directors & Officers share the policy limit with the entity Insurance contract covers 100% of losses; insured pays 0% after
retention Additional coverages granted such as Employment Practices Liability,
Fiduciary Liability, Errors and Omissions Broader coverage terms
— Lower merger and acquisition thresholds— Waiver of applications and signed warranty statements— Multi-year contracts— Extended reporting period
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What does a Directors and Officers liability policy cover?
Move Toward Coverage Changes Beginning in 2001
Reintroduce allocation Control insurers’ cost Restore contract to original intent of coverage for Directors and
Officers
Pull back additional coverage grants for lines like Employment Practices and Errors and Omissions by unbundling contracts
Restriction in coverage terms (cease multi-years, raise M&A thresholds, tighten notice provisions, require signed applications and warranty statements etc.)
Increased demand for A-side only cover
Market Overview
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8
4.7 4.75.0
6.0
7.5
0
1
2
3
4
5
6
7
8
9
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1998 1999 2000 2001 2002
The U.S. D&O market is growing toward $7.5 billion
Growth DriversGrowth Drivers
Increasing rates, particularly significant in some segments among publicly traded insureds
Increased penetration among private companies through 2000, potentially reduced in hard market going forward
Broadening and contracting coverage
Increasing rates, particularly significant in some segments among publicly traded insureds
Increased penetration among private companies through 2000, potentially reduced in hard market going forward
Broadening and contracting coverage
Estimated Direct Written Premiums
Source: A.M. Best; industry press, Tillinghast estimates. Note: These are midpoints of a rangeof estimates, e.g., 2000 base range is $4 billion to $6 billion. As D&O financial results are combined with other liability coverages in the Annual Statement, precise figures are not available.
$ Billions
0%6%
20%
25%
10
5
Assumed % change in Price -5 +6 +20 +30Assumed % change in Exposure +5 0 0 -5
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Public insureds represent the largest share of the market
Distribution of Premium by Segment
Source: Tillinghast D&O Survey, Tillinghast estimates.
Not for Profit10%For Profit
Private10%
For Profit-Public80%
By Ownership Type
EPL28%
D&O60%
Fiduciary12%
By Coverage Type
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Very Large20%
Large25% Mid-
Market30%
Small25%
Merch/Real Est/Oth
14%Util/Petrol/Mine/Ag
10%
Fin Svcs/Commun
12%
Mfg/Trans/Const
19%
Tech/Pharm/Health45%
For Profit by Account SizeFor Profit by Industry
Source: Tillinghast D&O Survey, Tillinghast estimates.
Distribution of Premium by Segment
Technology, pharmaceutical and health sectorsrepresent a disproportionate share of the for-profit market
Small: Assets < $100MMid: $100M < Assets < $1BLarge: $1B < Assets < $10BVery Large: Assets >10B
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The D&O market is highly concentrated, with 2 players writing over half the business
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
AIG
Chubb
Lloyd’s
Hartford
CNA
ACE
Admiral
Old Republic
Zurich
Genesis
Rock River
XL
Gulf
Great American
AEGIS
CompanyEstimated 2000 D&O
($ Millions)
All other
Total
Share of Market
Source: Tillinghast D&O Survey, Tillinghast estimates.
100%
$1,000
1,000
600
190
180
150
140
140
130
130
120
110
100
90
60
860
$5,000
20.0%
20.0%
12.0%
3.8%
3.6%
3.0%
2.8%
2.8%
2.6%
2.6%
2.4%
2.2%
2.0%
1.8%
1.2%
17.2%
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Growing D&O loss levels have caused certain players to exit the market and others to strengthen reserves
7/99 - Chubb acquires Executive Risk
9/00 - Hartford acquires Reliance’s D&O staff and book
10/00 - Kemper enters D&O market
11/00 - Fireman’s Fund acquires ERC’s not-for-profit D&O book
7/01 - AIG reintroduces coinsurance
7/01 - ACE D&O Report headline, “Size of D&O Settlements Exploding”
7/01 - Trenwick announces D&O reserve strengthening
8/01 - SVB Syndicates (Lloyds) announce significant losses due in part to “a sharp increase in lawsuits against US company directors”
Continued exit by smaller, less profitable writers may result in a further concentration of business among
larger players
Continued exit by smaller, less profitable writers may result in a further concentration of business among
larger players
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Roughly 20% of D&O business is reinsured with non-affiliated entities
Top Buyers of Reinsurance (Estimated 2000 Ceded
Premium)
Top Buyers of Reinsurance (Estimated 2000 Ceded
Premium)
AIG 300
Lloyd’s 150
Hartford 100
Zurich 60
Great American 50
Gulf 50
CNA 35
Admiral 35
RSA 25
Chubb 25
AIG 300
Lloyd’s 150
Hartford 100
Zurich 60
Great American 50
Gulf 50
CNA 35
Admiral 35
RSA 25
Chubb 25
*Based on total other liability claims-made premiums reinsured with non-affiliates. Source: A.M. Best, Tillinghast calculations.
Reinsurance of D&O Premiums
2000 DWP: $5 Billion
Retained:$4.0 Billion
Reinsured:$1.0 Billion
Drivers of D&O
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Timeline of significant milestones in the D&O Market:1933/34 Securities Acts
Securities Act of 1933, Section 11: Directors and Officers are liable for misrepresentations and omissions in a public offering registration statement filed with the SEC
Securities Act of 1933, Section 12: Directors and Officers are liable for material misrepresentations and omissions in written materials or oral communications in the sale of securities
Securities Exchange Act of 1934, Section 10b: Directors and Officers are liable for any misrepresentation or omission in connection with any purchase or sale of securities. This includes both public offering sales and after market sales.
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Timeline of significant milestones in the D&O Market:1995 PSLRA
Intended to prevent abuses of securities class action lawsuits
Not intended to eliminate all litigation, only frivolous
Safe Harbor provision to protect Forward-Looking Statements
Heightened Pleading Standard Pleading must include specific details of materially false and
misleading statements or failure to disclose statements that would constitute a fraud
Stay of Discovery while a Motion to Dismiss is Pending
Lead Plaintiff - Largest financial interest
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Timeline of significant milestones in the D&O Market:2002 Sarbanes-Oxley
Black-out trading barred Directors and Officers cannot trade securities received for their work,
where the trades take place during black-out periods in which employees cannot also trade the company stock.
CEO and CFO certifications
Executive loans prohibited/Freeze on extraordinary executive funds or payments.
Executive pay forfeited for restatements For the 12-month period following the first filing with the SEC of a
restatement required due to misconduct relating to material noncompliance with financial reporting requirements
Faster insider trading disclosure Securities transactions by directors, officers and owners of more than
10% of the company securities must be revealed to the SEC and the public within 2 business days of the transaction, instead of the current time frame of 10 days after the first month in which in the transaction occurred
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Timeline of significant milestones in the D&O Market:2002 Sarbanes-Oxley (cont.)
Closer auditor management Public companies may not use their outside auditor for specifically
listed non-audit services, unless de minimus The lead audit partner of the public company accounting firm must be
rotated off the audit after auditing the company for five consecutive years
Liability ensues for any officer, director or representative thereof who fraudulently influences, coerces, manipulates or misleads the company’s outside auditors
Increased Audit Committee duties
Increased financial disclosures
Increased SEC review
More time to sue
More criminal penalties and fines
Increased Accountants and Lawyers’ responsibilities
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Starting in the mid-1990’s, the D&O industry entered into a soft market
Expanded capacity/larger limits offered
Expanded coverage, entity coverage eliminated pre-set allocation
Blended programs including D&O and E&O, with significant discounts
Broker forms and lack of applications
Free/automatic reinstatements
Bilateral discovery - under-priced ERP’s
Multi-year contracts, significant discounts and no ability to re-underwrite
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The stock market bubble of the late 1990’s had profound effects on the D&O market
Stock volatility/Earnings pressure to compete
Increased number of IPOs, mostly Internet stocks
Increased market capitalization, many times earnings
New entrants, naïve capacity
Readily available reinsurance capital
Top-line focus
Increased M&A activity
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The current landscape of the D&O market has changed significantly over the last 12 to 24 months
Increased claim frequency and severity
Significant increase in frequency and severity of large securitiesclaims (delayed impact of PSLRA ’95) and EPL claims. Severityincreases will hit XS reinsurers hardest.
Slowdown in economy Will reduce investment income and may further increase claimfrequency (securities and EPL).
Significant rate increases Market in “Payback” mode. Many insureds seeing 10% to 50% (or more) rate increases in 2001
and 2002. Focus on underwriting discipline Stricter underwriting necessary to restore profitability to a line hit by
a recent surge in claim costs (coverage restrictions, terms andconditions, unilateral discovery).
Move back to underwriter forms, away from broker forms. Pricing more transactional than relationship driven.
Increasing capacity limitations Some market withdrawals. Limited capacity for technology,biotechnology and healthcare industries.
Many players on each program.
Reintroduction of coinsurance Retreat from full to 80% entity coverage limits exposure; givesinsured stake in settlement negotiations.
Single year policies 3-year policies, prevalent from 1997 to 1999, are now rare. Increased price responsiveness. No reinstatements.
Description/D&O Market ImplicationsDescription/D&O Market ImplicationsTrend/DevelopmentTrend/Development
Source: Tillinghast – Towers Perrin analysis; industry press
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“Best practice” companies are most likely to remain profitable in a rising cost environment
Underwriters that understand their insureds Close/frequent monitoring of insureds’ financial results Significant information disclosure required during application/underwriting
process
Active loss mitigation/risk management programs Ability to manage both securities and human resources claims
Corporate Governance reviews by outside parties
Active retention management on EPL
Strong broker relations
Active actuarial participation Understand drivers of loss costs - size and segment key drivers Create architecture around the pricing of a risk vs. market pricing
— Reevaluate the expense base used in rating— Update Increased Limit Factors and Deductible Factors— Ensure data integrity— Keep pace with trend
Understand company’s case reserving philosophy Regular open dialogue between claims, actuarial and underwriting
Summary
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Key takeaways
Results vary significantly across market segments Not-for-profit and private, for-profit business present a different type
of D&O exposure than public for-profit companies Public exposures, however, show mixed results, with larger insureds
looking unprofitable Previously clean segments now looking much different (utilities)
D&O premiums are in a rapid growth phase Fueled by significant price increases (estimated 20% in 2001; 30% or
more in 2002)
Rapidly rising claim costs have also been a prominent feature of the D&O landscape Historical average increase approximately 10% through 1999 Rate of increase may have doubled since then Hard data not available
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Key takeaways
The implications of primary insurers’ lack of profitability are Weaker players will continue to exit the business, possibly resulting in
increased industry concentration The most profitable players will be those embracing loss mitigation/risk
management programs and disciplined, data-driven underwriting approaches
Implications for reinsurance partners Excess reinsurance will require extra care in underwriting, as will
reinsurance of books with heavy concentrations of large public risks Leveraged effects of inflation on excess positions present unique
challenges Profitable reinsurance opportunities may exist in the market -- the
challenge is finding the right cedents— Mix of exposures (I.e. size and industry of insureds)— “Best practice” underwriting, pricing and loss
mitigation/management… and the right reinsurance structure and terms