Expert Commentary

1999 D&O Survey Reports Rising Costs of Claims from Shareholders and Employees

The 1999 Directors and Officers Liability Survey found rising average costs of claims against directors and officers from shareholders and employees, the two most frequent sources of D&O claims. These increasing trends in claims costs occurred while overall pricing for D&O liability insurance declined for the fourth consecutive year.

Professional, D&O, and Fiduciary Liability
June 2000

The 1999 Directors and Officers Liability Survey found rising average costs of claims against directors and officers from shareholders and employees, the two most frequent sources of D&O claims. These increasing trends in claims costs occurred while overall pricing for D&O liability insurance declined for the fourth consecutive year. (For further details on D&O insurance pricing trends, as well as background on the survey and its participants, see our previous article.)

Approximately 25 percent of U.S. survey participants and 13 percent of those from Canada reported one or more claims against their directors or officers over a 10-year experience period. The 1999 survey results confirm the increasing claims frequency trend we have seen develop over the last 5 years for organizations in many size groups. Claims severity was higher for most claimant groups in this year's survey, although average payments to claimants and average defense costs were down somewhat overall because of a continuing increase in the frequency of (lower cost) claims from employees.

Companies with a history of merger, acquisition, or divestiture activity were more than twice as likely to experience a claim against their directors or officers. Firms with fewer than 500 shareholders were less than half as likely to experience a D&O claim as their more widely owned or publicly traded counterparts. Educational and health care organizations and large banks reported the highest claims frequency of the U.S. business groups analyzed in this survey. The transportation and communications business class was next, with communications firms reporting a large number of claims per company. Note that the transportation and communications group reported the highest frequency of D&O claims among our Canadian survey participants.

The following graph illustrates the differences in claimant distribution between the publicly traded, privately owned, and nonprofit groups of U.S. survey respondents. Shareholders are the most frequent source of D&O claims against publicly traded companies, while employee claims are most frequent for private companies and nonprofit organizations. The continuing high number of claims from employees reported in our survey reaffirms that the most significant increase in the incidence of claims made against directors and officers and their organizations in recent years has been because of employment practices liability (EPL).

CLAIMANT DISTRIBUTION BY OWNERSHIP, U.S. Claimant Distribution by Ownership - U.S. Bar Graph

Discrimination in employment was the most frequently cited D&O claim issue (27 percent) among U.S. participants in this year's survey, followed closely by claims involving wrongful termination, financial disclosures, or related to mergers and acquisitions. Mergers, acquisitions, and divestitures were the most frequent general issue generating D&O claims for many years. They were cited as the main claimant issue in 4 percent of the claims reported in this survey, less than one-fifth of our survey result from 1990, when more than 20 percent of the claims reported in that survey were principally related to mergers, acquisitions, and divestitures.

Our survey results reflect the impact of recent legal developments in the United States that are affecting employers' exposures to EPL claims and drawing increased attention from corporate risk managers. These include the following.

  • The Older Workers Benefit Protection Act of 1990 and The Age Discrimination in Employment Act of 1967
  • The Civil Rights Act of 1991
  • The Americans with Disabilities Act of 1990 (effective 1992)
  • The Family and Medical Leave Act (1993)
  • The U.S. Supreme Court decision in Harris v Forklift Systems, Inc. (November 9, 1993)

Of these, we believe that the Civil Rights Act of 1991 has had the most significant impact on the liability of employers. While this law did place some caps on compensatory and punitive damages, it did not limit such traditional damages as back pay or interest thereon. Moreover, the caps on damages do not apply to cases alleging discrimination under the Civil Rights Act of 1866, which allowed potentially unlimited compensatory and punitive damages for racial and ethnic discrimination, according to existing interpretation of the 1866 Act.

Punitive damages were made possible by the 1991 Act. Another important first—the right to trial by jury—also was provided, clearly creating a new level of volatility and increased exposure for employers. Not surprisingly, this jury trial/punitive damages combination already has led to several large and disquieting case results.

Inadequate or inaccurate disclosure, including financial reporting, was cited as the single most important issue in 6 percent of claims, compared to 10 percent last year and 8 percent in 1990. Disclosure and financial reporting replaced mergers and acquisitions as the most frequently cited general D&O claim issue in our survey results 6 years ago and remained the leading cause of D&O claims until 3 years ago. If we include claims related to stock offerings as well, more than 7 percent of all D&O claims were reported because of disclosure issues in general. Many of these newer disclosure claims are because of alleged violations of Section 10(b) of the 1934 Act and SEC Rule 10b‑5 promulgated thereunder. Such claims relate to securities trading decisions made on the basis of allegedly inadequate or inaccurate disclosure by the corporation that led to financial loss.

Of the 972 claims reported as closed by U.S. participants, 203 were dropped by the claimant, and the majority of those not dropped were closed without an indemnity payment being made. The average defense cost on all closed claims reported by U.S. participants (excluding those in which no defense costs were given) was about $0.7 million, down from $0.8 million last year. The comparable result for Canadian participants was $0.4 million, as was the case in last year's survey. Recall that all data for U.S. participants is in U.S. dollars, and in Canadian dollars for Canadian participants.

In the case of closed claims where third-party indemnity payment was made, the indemnity paid to the claimant by U.S. survey participants averaged $2.74 million, down 15 percent from our prior survey. This reduction is attributable to significant increases in the number of participants with smaller asset sizes and the number of (lower cost) employee claims. We believe the trend in shareholder claims costs as reported by U.S. participants is more representative: Average indemnity paid to such claimants in this survey was at an all-time high of $8.67 million, compared with $7.16 million last year and $7.51 million 2 years ago. A similar trend was reported for claims from employees, which saw the average indemnity paid climb to $306,000 from $287,000 in the prior survey.

The average nonzero indemnity payment among Canadian survey participants was about $0.7 million. This is down from about $0.9 million in last year's survey but still more than double the comparable result from our 1991 Canadian survey.

Note that these amounts for indemnity paid to claimants and defense costs have not been trended or adjusted to current economic conditions. Our average (as reported) closed claim indemnity payment of $2.74 million for 1999 survey respondents, adjusted for trends and closed claim bias, translates into an expected future loss of more than $10 million for claims made in 1999, especially if we add defense costs to these nonzero indemnities.

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