2002 D&O Survey Finds D&O Insurance Market Continues To Harden
June 2003
The 2002 Tillinghast-Towers Perrin survey
of 2,275 U.S. and Canadian participants reveals large D&O insurance premium
increases and capacity decreases. When searching for the best D&O insurance
value for their particular situation during D&O policy renewal negotiations
in 2003 or 2004, insureds need to take a long-view perspective, keeping in mind
the financial strength and reputation of the D&O insurers with whom they negotiate,
and diligently evaluating the amount of coverage limits sought.
by Jim Swanke and Elissa Sirovatka
Tillinghast-Towers Perrin
Tillinghast-Towers Perrin's newly published 2002 Directors and Officers (D&O) Liability Survey confirms that the widespread and dramatic hardening of the D&O insurance market
which began in 2001 continued into 2002. This article highlights survey findings
on D&O insurance market conditions, and future articles will report on other
trends and issues the survey identified.
The survey is a self-selecting, nonprobability sample of D&O liability claims
and insurance purchasing patterns. It is the 25th in a series of such surveys,
and covers for-profit companies and nonprofit organizations in the United States
and Canada. The primary objectives of the survey are to help organizations assess
probable exposures to claims against their directors and officers and construct
appropriate financial protection programs.
Survey participants submitted data during the second half of 2002. For just
the second time, survey responses were accepted via the Internet in addition
to the traditional written questionnaire; responses were split about evenly
between these two methods.
Survey Participants
To put the survey results in perspective, it is helpful to understand the
demographics of the respondents. Data for U.S. participants is in U.S. dollars,
and in Canadian dollars for Canadian participants.
Among the 2,187 U.S. participants, all major industrial groups were represented.
Their median asset size was approximately $30 million and 331 organizations
with over $1 billion in assets participated in the survey. The majority (51
percent) of U.S. for-profit participants were publicly traded corporations.
About five-eighths (62 percent) of these participants reported an after-tax
loss in one or more of the past 5 years, and 39 percent experienced merger,
acquisition, or divestiture activity during the past 5 years. More than one-quarter
of U.S. for-profit survey participants were involved in an initial public offering
(IPO) within the past 5 years.
The 88 Canadian survey participants had much in common with—and some differences
from—their U.S. counterparts. A wide variety of Canadian industrial groups were
represented, with a median asset size of about $1 billion. More than four-fifths
(83 percent) of the Canadian for-profit participants were publicly traded corporations.
Most (78 percent) of these participants experienced a recent merger, acquisition,
or divestiture, and 46 percent reported an after-tax loss in one or more of
the past 5 years. More than one-fifth of Canadian for-profit survey participants
were involved in a recent IPO. Most Canadian respondent companies (51 percent)
reported having a subsidiary in the United States.
Market Conditions
D&O insurance purchasers in the United States during 2002 continued to face
the largest premium increases since the hard D&O market of the mid-1980s. Coming
on the heels of similar increases in 2001, premium increases for generally equivalent
coverage averaged more than 29 percent according to the Tillinghast D&O Premium
Index, displayed on Figure 1. A few industry niches registered level premiums
or only modest increases, but the D&O insurance marketplace was anything but
soft in 2002 for a significant majority of corporations. For-profit health services
companies, merchandisers and durable goods manufacturers, firms involved in
a recent IPO, or those exhibiting some degree of financial distress are just
a few examples of the groups that experienced very large increases in the cost
of their D&O insurance coverage. Very large organizations also felt especially
severe premium increases in 2002, as underwriters generally exercised caution,
with some becoming extremely selective.
Figure
1
These premium increases are not entirely unexpected, given the premium and
loss trends of the past several years. Five years of significant annual premium
decreases in the second half of the 1990s, coupled with the recent alarming
rise in the costs of D&O lawsuits (particularly securities litigation) have
meant that many insurers experienced adverse loss ratios and saw profits turn
to losses on this line of business. These loss trends are likely to continue,
especially when potential costs associated with the large number of so-called
IPO laddering lawsuits outstanding are considered.
Other factors have also contributed to or exacerbated recent increases in
D&O insurance costs. Many D&O carriers reinsure a significant portion of the
coverage they provide. Substantially more expensive reinsurance for many commercial
insurance lines following the events of September 11, 2001, meant that these
D&O insurers have had another important reason to seek premium increases. As
noted, the underwriting of D&O insurance became more stringent as well in 2002.
While this trend was already well underway, it gained additional momentum from
the widespread concerns about high-profile bankruptcies, corporate scandals,
and ensuing corporate governance initiatives.
Figure
2
The total amount of coverage offered in 2002 by insurers in the D&O market
retreated to its 1998 level, down from the all-time high reported in the 2000
survey. Figure 2 illustrates the trend in D&O insurer capacity available to
U.S. for-profit companies. Note that any measure of total limits capacity available
in the D&O market is bound to be imperfect, due to variations among insurers
with respect to market segment preferences and dependence upon coinsurance or
reinsurance. Nonetheless, the trend displayed in Figure 2 is an informative
portrayal of general changes in the overall D&O market capacity over the period
shown.
Many D&O insurers were increasingly selective in 2002, however, as to which
risks qualified for their full limits capacity. This meant that buyers of D&O
insurance often found it necessary to purchase smaller layers of insurance from
more carriers or employ quota share arrangements to obtain the limits they sought.
The high capacity levels were a major factor contributing to the generally
soft D&O insurance market that existed prior to 2000. Continued presence of
this capacity suggests that the firming of the D&O market—even the sharp increase
seen by some sectors—does not signal a return to crisis conditions similar to
those of the mid-1980s. There is also less dependence on a small group of reinsurers
now than was the case during that hard market.
Conclusion
Market conditions indicate that purchasers should take a longer-term view
of appropriate coverage while they seek the best D&O insurance value for their
particular situation during D&O policy renewal negotiations in 2003 or 2004.
Multiyear policies are generally unavailable for now, but purchasers should
still be mindful of the financial strength and reputation of the D&O insurers
with whom they negotiate, as well as diligently evaluating the amount of coverage
limits they purchase. Note as well that the quality of coverage based on the
wording of the individual D&O contract between insured and insurer can actually
be substantially different from one insurer to the next. This can certainly
have a profound effect on pricing, as well as future claims handling.
Questions, comments, and requests for additional information about Tillinghast-
Towers Perrin's 2002 DIrectors and Officers Liability Survey or Seminars on
Directors and Officers Liability should be directed to Jim Swanke at (952) 842-5728, Jim.Swanke@tillinghast.com or
Elissa Sirovatka at (312) 609-9812, Elissa.Sirovatka@tillinghast.com.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author’s employer or IRMI. This article does not purport
to provide legal, accounting, or other professional advice or opinion. If such advice
is needed, consult with your attorney, accountant, or other qualified adviser.