RISKVUE ARCHIVE | INDUSTRY WATCH >DIRECTORS & OFFICERS LIABILITY (D&O)

Directors & Officers Insurance:
Summer 2002 Market Update

By Fred T. Podolsky and Susanne Murray, Esq.

Over the past year, director and officer (D&O) insurers have been hit hard with claims, particularly those related to securities and employment matters, and are no longer willing to rely on investment income to offset the financial impact of such claims. Instead, insurers are taking measures now to recoup losses quickly and to reduce the potential for adverse future losses by increasing prices, rethinking their target markets, and by reducing limits and coverage.

According to Securities Class Action Alert, class action settlements during the year 2000 totaled nearly $4.4 billion and the number of securities class actions filed in 2001 reached an all-time high. For D&O insurers, this is bad news, because coverage for securities class actions is one of the primary purposes businesses buy D&O insurance. In addition, the increasing demand for entity coverage provides little or no opportunity for insurers to share losses with the insureds via allocation.

Legislation effecting directors’ and officers’ duties and responsibilities are usually seen as similarly affecting their potential for liability. As an example, the passage of new audit committee rules, the new Securities and Exchange Act Rule 10b-5-1, and Regulation FD (Fair Disclosure) increase the potential for liability. Equally important are older rules with new interpretations. The Federal Sentencing Guidelines came to the attention of directors and officers in connection with the Caremark litigation. Today, those same guidelines will be considered by prosecutors of Arthur Andersen in determining whether to bring individual criminal actions against certain of the firm’s partners.

Current Market Conditions

Capacity

While there is plenty of capacity, insurers are taking closer looks at just how much limit they will offer on a given risk. Insurers that once offered limits of $50-$100 million for a single risk are now finding their comfort zone may be as low as $10 or $15 million. As a consequence, more insurers may be needed to fill out a high-limit insurance program.

Underwriting Trends

Insurers also are taking a closer look at the business they write and renew. Today’s underwriting trends include:

• More stringent use of long form D&O applications (with warranties)
• The return to underwriting basics, including close examination of all open and potential claims
• Detailed review of the applicant’s financials and industry-specific matters
• Quoting on more restrictive prior forms

Even the most desirable accounts are now subjected to this new underwriting regimen.

Coverage Trends

Insurers are also taking a hard look at the terms and conditions of coverage they are willing to provide. Some of the current coverage restrictions seen are:

• Deletion of Retention Waivers for successful defense
• Reintroduction of “Hammer” clauses
• Co-insurance requirements
• Increased self-insured retentions
• Failure to Maintain Insurance Exclusions
• Limiting of Outside Directorship Liability Coverage
• Limited availability of Pollution Coverage
• Elimination of entity coverage in favor of pre-agreed allocations that will be less than 100%
• Restricted use of severability provisions
• Lack of pre-set pricing or elimination of Extended Reporting Periods
• Removal of insurer non-cancellation provisions

Pricing

In the past, insurers considered the primary $5-$10 million coverage limit to be the “burn layer,” the layer most likely to be hit if there was a claim. Pricing for limits in excess of the burn layer would be available at significant discounts. Today, the burn layer for a large public company is viewed by some insurers to be as much as $100 million. As a result, discounts on excess layers for some insureds may have all but disappeared.

For insureds with healthy balance sheets and favorable claims experience, premium increases are ranging from 50-75% for public companies. Smaller or private companies are seeing lesser increases, with the exception of insureds in certain industry sectors such as telecommunications, healthcare, high technology and biotechnology. For insureds with less robust financials or with significant claims experience, premium increases are in some cases exceeding 100%. Companies suffering financial dislocations are experiencing increases in the 200-400% or higher range.

Conclusion

Regardless of current insurance market conditions, the foundation of a successful D&O placement consists of determining each client’s unique needs, strengths, and risk profile. For the second half of 2002, such a foundation has never been more important. Program placement is part of an integrated whole that includes risk identification, loss control, risk transfer and claims management. The underwriting case presented to the marketplace needs to demonstrate a clear understanding of exposures and a committed process to contain or mitigate them. The best advice is to start early with a clear understanding of placement and negotiation strategy, yet show flexibility as the program develops.

ABOUT THE AUTHOR

The above is excerpted from “June 2002 Market Update: Directors and Officers Liability” by Fred T. Podolsky, Executive Vice President, and Susanne Murray, Esq., National D&O Practice Leader, of Willis. Mr. Podolsky can be reached at 212-837-0608 or Podolsky_ft@willis.com. Ms. Murray can be reached at 212-804-0518 or murray_sm@willis.com.

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August 2002