Increasing underwriting challenges in D&O insurance
Although representing about 1% of the insurance market, D&O liability insurance claims can cost a company millions of dollars.
A highly competitive market pricing environment along with a shifting claims landscape is having an adverse effect for many professional liability underwriters, particularly in Directors & Officers (D&O) liability insurance.
Though representing only 1% of total industry direct premiums, D&O insurance comes with a notoriety that belies its size. Sizeable D&O claims arise from events such as corporate insolvencies, large stock price declines, financial reporting irregularities or regulatory investigations. D&O insurance is intended to cover the directors and officers of an organization against allegations of negligence, misleading statements or wrongful acts that lead to litigation. Leading underwriters in the D&O insurance segment include AIG, Chubb Limited and XL Group Ltd.
D&O specific direct underwriting results are reported by insurers in statutory supplemental filings since 2011. Following initial years of steady growth, unyielding market competition has stalled premium growth over the last four consecutive years. Industry direct written premium volume held at approximately $6.4 billion in 2017.
Related: D&O liability trends
Underwriting results have shown a more pronounced deteriorating trend. D&O insurers saw their direct underwriting results take a sizeable hit last year by posting a 77% direct incurred loss and defense and cost containment (DCC) ratio in 2017, 11 points higher than the prior year. This figure represents the worst-ever results since D&O supplemental data was first recorded in 2011. A closer look shows larger players like AIG and Zurich American Insurance Group reporting much higher 2017 direct loss ratios and many other market participants reporting deteriorating results.
This movement is not altogether surprising because D&O insurance is by its nature a more volatile product line than many other P&C products. However, premium rates in the D&O space do not appear to be responding to weaker results as revealed by insurance broker reports and other market surveys. Aon plc’s fourth-quarter 2017 D&O Pricing Index indicates that D&O primary policy renewal rates have fallen steadily since 2Q15. Willis Towers Watson’s Marketplace Realities 2018 report predicts that D&O pricing overall is likely to see flat to 7% lower rate changes in 2018.
Related: 5 things to know about Side A D&O coverage
Increasing number of D&O class action suits
Several recent claims trends also point to D&O underwriting challenges going forward. Federal securities class action lawsuits increased dramatically in 2017 and were a pivotal factor behind the growth in incurred losses for D&O insurers. A recent NERA Economic Consulting report reveals that class action filings increased by 44% in 2017 to 432, representing the highest level since 2001, which in and of itself saw a tremendous litigation spike from IPO laddering claims.
Securities class action filing growth is largely attributable to the expansion of merger
These claims are typically not subject to lengthy court proceedings and tend to settle quickly without large payments. Still, in past years, merger objection claims represented a source of claims frequency that can generate significant expenses for defense and settlement costs.
The NERA report also notes that the number of publicly traded U.S. firms declined by more than 40% since 1995. Combining this phenomenon with the spike in filing activity raises class action suit frequency to 8.2% of all public companies in 2017, highlighting the omnipresent risk publicly held firms have of litigation.
The NERA report does note, however, that case dismissals and closures are occurring at a more rapid pace. What’s more, the recent lull in the number of larger class action settlements is likely an offsetting positive influence on recent D&O underwriting performance. Recent analysis by Cornerstone Research indicates that the total value of class action settlements last year was $1.5 billion (the second lowest number in a decade) with no individual settlement exceeding $250 million. This result may be attributable to smaller class sizes and settlement time frames for the specific cases settled in 2017 and may not reflect an enduring trend.
Related: Directors, officers, creditors beware: D&O coverage narrowed in bankruptcy cases
More employment-discrimination claims
Public company executives’ liability exposure continues to evolve broadly. A greater inclination for courts to seek to hold executives individually accountable for corporate misconduct following the 2015 “Yates Memorandum” from the Department of Justice adds to this personal exposure, spurring demand for coverage.
Boards and management are facing more liability exposure in several employment-related areas, including discrimination and sexual harassment claims that could fall under an employment practices liability (EPLI) coverage, but more frequently include allegations of a lack of board and management oversight of employee training or organizational culture. These exposures are meaningful for private companies and nonprofit organizations as well.
Cyber risk represents another growing risk exposure for the D&O space. Increasing dependence on interconnected information systems is leading to a greater incidence of hackers breaking into an organization’s computer networks to disrupt operations or steal sensitive personal or financial information as evidenced by numerous high-profile 2017 ransomware attacks.
The expanding chance for cyber events that impinge corporate reputations or generate financial or share value losses could lead to D&O liability allegations that ineffective or negligent risk management practices, corporate governance and board oversight were contributing factors behind inadequate systems defenses and breaches. More cyber incidents and the subsequent increase in cyber insurance coverage that addresses D&O risk will create more potential for cyber-related D&O claims going forward.
Not much improvement on the horizon
Continued weak pricing trends suggest that underwriting results are unlikely to improve for the D&O insurance segment in the near term. Market underwriting capacity remains abundant and there are few signs of any individual insurers retreating from the D&O space. Potential remains for further profit deterioration hinging largely on how the influx of recent claims settle. Larger settlement trends are difficult to predict and can hinge on changes in judicial norms, juror sentiment and other unforeseen factors.
James B. Auden, CFA, is managing director, Insurance, for Fitch Ratings. He can be reached at jim.auden@fitchratings.com. For more information about the 2017 D&O liability insurance underwriting results, check out the full report, “U.S. Director and Officers Liability Market Update,” available at www.fitchratings.com.