DIRECTORS AND OFFICERS-TAKING A HARD LOOK AT THE HARD MARKET

Rough Notes, Apr 2004 by Zinkewicz, Phil

Employment practices and merger activity are leading drivers of claims

One of the more volatile of the professional liability lines of insurance in the property/casualty business is directors and officers (D&O) coverage. The terrorist attack of September 11, 2001, has often been used as a guidepost for the beginning of today's overall hardening of the property/casualty marketplace, and small wonder. But even before September 11, the P-C arena was experiencing a slight hardening, especially in the D&O area. Rate increases in the area of directors and officers liability have persisted during the last three years, but there are signs that the market may be stabilizing a bit, according to a recent survey.

Directors and officers (D&O) liability insurance premiums increased approximately 33% on average from 2002 to 2003, according to the Tillinghast business of Towers Perrin's 2003 Directors & Officers Liability Survey. While employee lawsuits were significant for all types of respondents, entities with more than 500 shareholders saw most of their claims come from some of those shareholders. Despite record premium increases during the year, the 2003 D&O Premium Index indicates that the market started stabilizing toward the end of 2003 with premium increases beginning to level off, according to Tillinghast's survey, which included 2,139 participants.

The 2003 D&O Premium Index median and average premiums were the highest ever reported by survey participants (see accompanying graph), with 70% of U.S. respondents reporting an increase in premiums from a prior policy and only 19% reporting a decrease. Signs of stabilization occurred toward the end of the year, however, with 62% of U.S. participants with renewals reporting a premium increase in the third quarter, compared with 76% in the third quarter of 2002, according to Tillinghast.

"While many companies are still seeing increases in D&O premiums, the proportion of participants reporting increases declined in the last half of our survey period," says survey leader Elissa Sirovatka.

Other key findings from the survey include:

* Coverage is available despite decreased capacity levels. According to information provided by D&O insurance carriers, $1.35 billion in full limits capacity was available during 2003, which is the lowest capacity level since 1997. Yet few survey participants cited availability problems.

* The year 2003 was the 11 consecutive year that less than 5% of all U.S. participants not purchasing D&O coverage made their decision because coverage was completely unavailable to them. "Though 2003 capacity was low, we believe it has reached a bottom and will increase in 2004," says Sirovatka.

* Employment practices liability (EPL) saw the most significant increase in incidence of D&O claims. "Employment-related claims have become a driving force behind D&O liability losses, increasing the perceived need for coverage among public and private companies alike," says Sirovatka. During 2003, 91% of D&O claims against nonprofit organizations were brought by employees. At forprofit companies with fewer than 500 shareholders, 50% of D&O claims were brought by employees, compared with 24% at companies with more than 500 shareholders. Employment discrimination (40%) was the most frequently cited employment-related claim, followed by wrongful termination (24%).

* Though there was a dip in the frequency of D&O claims, severity-excluding shareholder claims-increased by 40%. Severity of shareholder claims, however, was down, averaging $14.2 million per claim award in 2003, compared to $23.4 million in 2002. "We were surprised to find a drop in the average claim award; however, these claim trends are highly volatile and vary by category," says Sirovatka. "The drop in shareholder claims could be good news for the D&O insurance market."

* M&A activity more than doubled odds of D&O claims. Twenty-seven percent of U.S. respondents were involved in a merger, acquisition or divestiture during 2003, and these companies were more than twice as likely to have at least one D&O claim. On average, they also had three times as many D&O claims as their counterparts that did not undergo such reorganization.

Tillinghast predicts the D&O market will take the following shape in 2004:

* Capacity will increase. After bottoming in 2003, capacity should bounce back this year with new entrants coming into the market.

* Market will remain hard. In spite of the increase in capacity, the market will not begin to soften. Though premium increases will stabilize overall, some industry sectors will still experience increases of 30% or more.

* Narrowing of coverage. There will be some continued narrowing of coverage by virtue of more restrictive coverage forms and carriers imposing more exclusions. However, most of this is expected to occur in the first half of 2004 with coverage stabilization likely during the second half of the year.

* Sarbanes-Oxley creates an interesting dynamic. Regulation from Sarbanes-Oxley will likely make buyers more concerned about having enough coverage limits. However, insurers will be concerned about claim frequency increasing and may become more selective in offering coverage limits.