He explained that competitors trying to wrestle business away from existing (incumbent) D&O carriers traditionally charged lower prices. "That's natural," because those competing for business "would have to give something" to entice buyers, he added.

The situation is now reversed, he noted. He explained that the carriers that have for years dominated the D&O market (AIG, XL, Hartford) "are companies that have fallen on some tougher economic times"--a situation that has prompted non-incumbent markets to try to sell their better financial security rather than better pricing.

"So non-incumbents are quoting higher premiums than incumbents on the same layers of insurance. That never used to be the case," Mr. Rice said, putting the price spread between the two groups at roughly 300 basis points (3 percent).

"Those incumbent markets--the ones that have had the tougher times--are doing a pretty good job of keeping the pricing down to flat for the clients," he said, noting that the non-incumbents "are looking at claims histories and saying, 'if we're going to play on this, we need to get higher rates.'"

Mr. Rice said the spread is narrowing now because both sides are moving toward the middle--not just because incumbents are moving up or competitors are moving down.

THE PRICING INDEX

Overall, Mr. Rice said Aon's Quarterly D&O pricing index "might be flat to up" when the index is finalized and officially reported later this month, basing his assessment of year-over-year price changes (second-quarter 2009 compared to second-quarter 2008) on very preliminary figures.

Aon's D&O pricing index--which tracks D&O premiums relative to a base year of 2001--came in at 1.21 for first-quarter 2009, meaning that prices are 21 percent higher than the 2001 base year in nominal terms, not adjusted for inflation.

With the exception of a few minor quarter-to-quarter price hikes, the index has fallen fairly steadily from a high point of 2.63 in fourth-quarter 2002 to lows like the 1.21 index value recorded for first-quarter 2009. That means "about 60 percent of the rate has been taken out of the market already," according to Mr. Rice's interpretation of the numbers.

"Not even adjusting for inflation, rates are probably cheaper than they were in the year 2000. There's not a lot of rate to give back at this point in time, particularly when you look at the claims that are out there," Mr. Rice concluded.

Giving a "rough cut" of preliminary data for recent quotations that is shaping his thinking on the second-quarter index, he said there's still a possibility the index could be down slightly when all premiums are finalized for the quarter ended June 30.

"But it's certainly not going to be down like it was in the majority of [the past] 21 quarters," he said, guessing instead that the final number will settle in at something between going down 2 percent to rising 1.5 percent compared to second-quarter 2008.

Mr. Rice said widely reported price distinctions between financial institutions and other D&O buyers continued in the second quarter. During the quarter, he noted, the maximum hike Aon saw for a financial institution's (FI) D&O program was 79.6 percent, while the maximum decrease for a non-FI program was 56 percent.

Deals that are in the market now, he said, are not seeing large decreases, noting that the majority of deals fall in a range of price changes extending from a 10 percent drop to a 20 percent increase.

"Some non-FI industries continue to see a lot of competition from a lot of markets driving pricing down," he said, giving technology companies and those in the consumer staples sector as examples of industries that reaped the benefits of insurer price competition in the first quarter.

Looking into the future, Mr. Rice said he does not foresee non-FI D&O buyers facing the kinds of significant price jumps that FI buyers started to see late last year, mainly because the number of securities lawsuits (the principal drivers of D&O claims) has not increased dramatically for nonfinancial companies.

LITIGATION TRENDS

In fact, as reported by Cornerstone Research in late July, overall lawsuit frequency has started to tumble.

Tracking trends in securities class-action lawsuit filings, which historically have been a leading indicator of D&O insurance price trends, the Boston-based firm reported that 35 lawsuit filings in the second quarter of 2009 marked the lowest quarterly total since first-quarter 2007.

For the first half, federal securities class actions fell 22.3 percent to 87 from 112 during the same period in 2008.

John Gould, vice president of Cornerstone, suggested a possible explanation might be the reduced stock market volatility.

"The market was much more volatile in the second half of 2008, when filings were rising. Moving forward, greater market stability may signal a reduced number of securities class action filings," he said in a statement accompanying the report.

Does that mean increased price competition in the quarters ahead?

"One quarter doesn't make a trend," Mr. Rice responded when asked about the impact of more benign claims trends just before Cornerstone released its report. "First quarter was up slightly, second quarter was down. It really takes a string of consecutive quarters" to impact pricing, he added.

He also said there's typically a lag between stock price moves and D&O insurance price changes--a fact that has been clearly reflected in the double-digit D&O price hikes that emerged for financial institutions in the second half of 2008.

"That was about a year lag," he said. "The economic realities hit at the end of 2007, stock prices went down, lawsuits started coming in, and by the end of 2008 prices were up dramatically," he said.

Key Coleman, a certified public accountant and managing director for the insurance practice group of SMART Advisory and Business Consulting in Chicago, also noted that bifurcated loss experience--with more benign loss experience for nonfinancial firms--has translated into bifurcated rate pressures.

For financial firms, "we had scandal heaped upon debacle," he said, noting that the subprime crisis was followed by the Madoff and other Ponzi schemes, pushing up the frequency of D&O losses on the FI side, while nonfinancial firms' losses were flat to slightly down.

In addition to lawsuit trends, Mr. Coleman recommends keeping an eye on overall combined ratios and capacity levels of D&O writers to anticipate future D&O price movements.

Many of the largest D&O carriers had combined ratios under 100 in 2008, he noted. "If capacity does open up, then that's an issue that's looming out there that would break the link between the loss experience and higher rates" in the D&O line, he said.

"I think it's the same companies that are offering FI coverage as non-FI. If these companies have capacity at the end of the year, then there's going to be some rate competition in all lines. It doesn't mean that rates will come down, but it will certainly blunt the impact of the class-action lawsuits that were filed in 2008," he said.

Property and casualty insurers don't report financial information for the D&O line by itself on the annual statements they file with regulators, instead including these results in the "other liability-claims made" line. A review of top writers of other liability-claims made business reveals that six of the top-10 had overall combined ratios (across all lines) below 100.

As reported by NU in the July 20 edition, however, for just this line of business, large writers have begun to recognize worsening claims trends, as evidenced by high initial loss ratios they reported for accident year (AY) 2008.

Nine of the top-10 reported a higher AY loss ratio for 2008 at the end of 2008 than they reported for AY 2007 at the end of 2007, with three (American International Group, Zurich and ACE Ltd.) reporting these loss ratios up by 10 points or more. (See accompanying chart.)

There is, of course, the potential for such loss ratios to come down as carriers reevaluate case reserves each year if cases settle favorably or dismissal rates climb.

In fact, one D&O expert, Kevin LaCroix, author of the "D&O Diary" blog, has already begun tracking dismissals and settlements for class actions related to the subprime cases. As of July 24, Mr. LaCroix counted six settlements and 16 dismissals granted--small but growing portions of the 195 subprime class actions he's counted to date.

In addition, with lawsuit frequencies now dropping in 2009, carriers may well post their AY 2009 loss ratios below AY 2008, moving them more in line with prior accident years. But like Mr. Rice, other D&O experts who watch the litigation landscape aren't ready to extrapolate based on a single-quarter lull in lawsuit filings.

Digging more deeply into the cases filed so far in 2009, Mr. LaCroix has speculated in several blog entries (July 24, May 11) that the number of lawsuits dipped because plaintiffs' lawyers have been preoccupied with subprime and Madoff lawsuits.

Mr. LaCroix--who is a partner for Oakbridge Insurance Services, a Beachwood, Ohio-based insurance brokerage--predicts that once they've plowed through some of the complexities of these cases, the lawyers will turn their attention to a backlog of cases of firms other than financial institutions.

In fact, that's happening already, he said, citing at least a half-dozen lawsuits against firms including Bidz.com (an online auction company), Liz Clairborne (an apparel company) and Coach (a leather goods company), with class periods dating back to 2007 in the recent blog entries.

An NU article published in mid-March anticipated this trend, quoting experts--including plaintiffs' attorney Samuel Rudman, a partner with Coughlin Stoia Rudman in New York, who predicted a rash of 2007 stock drop cases would be filed later in 2009. The attorney reasoned that without a major re-inflation of the stock market, there would be no potential for stock drop cases going forward, leading law firms to dip back into pools of potential cases from the past. (See NU, March 16, page 16.)

For firms in and out of the financial institution sector, another driver of securities class-action lawsuits will be bankruptcy filings, many experts predict. For insurance companies in the D&O world, bankruptcy risks will expose Side A policies, which provide coverage for directors when corporations can't or won't indemnify them.

On the pricing side, Mr. Rice said Side A pricing has come down more dramatically than full D&O coverage in the last five years as more and more competitors entered what has been a profitable market niche.

"Side A pricing probably used to be a lot higher than it needed to be [when] there were very few carriers that would write it. We've gone from five carriers...to 40, and it's a purely supply-and-demand economic model," he said. "There's plenty of supply out there, plenty of demand, and pricing continues to come down."

Since the biggest gap in corporate indemnification is bankruptcy, the "underwriting of Side A is getting a bit more difficult," he said.

"For those companies that can prove they're not a bankruptcy risk, pricing remains very, very good. For those that either are heading toward bankruptcy or have gone into bankruptcy, Side A can be very expensive," he said.

Viewing the D&O landscape through the eyes of an accountant and with an eye on recent history, Mr. Coleman of SMART couldn't help wondering aloud about the difficult tasks ahead of D&O underwriters generally.

"I question how underwriters are going to distinguish good companies from bad companies going forward," he said, noting that "some of the financial institutions that went down in 2008 had just spent millions of dollars on Sarbanes-Oxley to set up a control environment that was appropriate."

"Still, some invested blindly with Madoff, while others invested blindly into subprime mortgages," he added.