"When will the market begin to abate?" is the question most buyers are asking today. In the past, there were clear, major events that triggered a market change. For example, in 2000-2002, the overall D&O market was responding to the tech-bubble bursting, IPO laddering claims that also implicated investment banks, the aftermath of 9/11 as well as the unprecedented accounting-related scandals that took down leading publicly traded companies like Enron and WorldCom. Another example is the financial crisis of 2007-2009 that led to the collapse of leading financial institutions and brought the Dow Jones Industrial Average below 6,500 in March of 2009, a more than 50% drop from an October 2007 high. 

Today, the turn of the D&O market seems to be the result of growing negative fundamentals. Increased claim frequency and severity, significant defense cost inflation and defense complexity, shareholder activism, and continuing M&A activity are a few examples. Also, the number of publicly-traded companies today is lower than it has been historically, which impacts the public company premium base for insurers. We don't have a major shock to the overall stock market — in fact, stocks remain near all-time highs. Therefore, to see this record number of securities class actions over a time of overall stock price appreciation feels odd. Also, the increase in complex shareholder derivative cases (shareholders suing D&Os on behalf of the company) is a relatively new phenomenon. So, the takeaway — this hardening market is a clear message from D&O carriers that the declining premiums that were being collected over the last 10 years are just not enough to pay defense and settlement costs in the current litigation environment. D&O carriers are steadfast and consistent in 2020.  

On a positive note, insurers are generally maintaining the broad levels of coverage that have become expected within most D&O policies — particularly for the individuals. As of now, we do not see that changing. The ability to expand coverage likely will be met with pushback from insurers, but insurer-imposed broad exclusions on D&O policies have not been signaled to date. That said, large private companies may be a category of insureds that faces pressure to pare back coverage for the organization itself. 

PC360: What can clients do to prepare for upcoming D&O renewals and placements?

Doherty: Highlighting all the positive risk profile qualities of a company goes without saying, as it reminds insurers that risk differentiation needs to remain a part of the underwriting analysis. That said, not all companies have positive risk profiles leading to their renewals. Therefore, other key areas of focus should be on:

• Asking brokers to improve the process and communication around securing and renewing coverage. That means, when possible, accelerating the timing of key events like underwriter meetings and application/information submissions, as well as improving the communication flow from existing underwriters to brokers to risk managers and other senior executives and key decision-makers within the organization.
• Remaining thoughtful and open-minded about the D&O program structure and terms. Buyers should ask brokers about alternative structures and compare the impact on premiums versus the change in potential coverage in the event of a claim(s).
• Budgeting conservatively. Until we see how 2020 plays out, all things are pointing to more of the same in the D&O marketplace.
• Thinking long-term by: |
  • Asking carriers for the same loyalty shown to them during the soft market. Especially if there have been no D&O claims/no payments of loss. This may not stave off premium increases, but it should mitigate them on a relative basis.
  • Showing loyalty to carriers that have handled claims well and paid significant claims. Coming to the table as a partner committed to a long-term resolution may keep carriers from "looking to recoup everything all in one year." Not all carriers think this way, but the true leading ones do.

PC360: What alternative structures are worth considering when it comes to obtaining optimal results?

Doherty: Some simple considerations include:

• Buying less overall D&O coverage based on an analytical look at the current limits and your risk profile. This requires a willingness to retain more risk going forward; or
• Raising the SIR (self-insured retention, or "retention") applicable to the company's covered loss. Important in this consideration is that the retention applicable to individual insureds (directors, officers, employees) will not be impacted and will remain at $0 for loss not being advanced or indemnified by the company. It is also important to remember that higher retention likely only impacts the primary and lower excess layers of a program, minimally (if at all) impacting layers above a certain level.

Others are slightly more complicated:

• If you buy a typical D&O program structure that has both shared coverage for the D&Os and the organization itself, as well as the usually less expensive excess (and difference in conditions) Side A only coverage for individual D&Os, consider reducing the shared coverage (the ABC coverage) while increasing the Side A only to match the reduction in the shared coverage. For example, instead of buying $30M of Side ABC + $10M of Side A DIC, buy $20M of Side ABC + $20M of Side A DIC.
• Only purchase Side A D&O protection for individual D&Os. Again, you can maintain the same level of overall D&O limits that executives and the board are accustomed to, but your costs will go down. That said, in certain cases, the cost reduction may not be as much as it would have been historically. Where Side A only costs could be estimated at substantially less than 50% of ABC coverage in years past, in today's environment, the costs may be as much as 75%+ of the cost of ABC coverage.
• Retain more risk via co-insurance. In this structure, the insured retains the risk of the retention per usual but also shares in the loss above the retention at a pre-determined percentage. 20% is typical. That 20% may be part of the limit that the insurer offers (limit-reducing), or it may dilute the loss (loss-reducing) so that the insurer still pays its full limit, but only after a larger overall loss has occurred. This can be complicated and needs clarity throughout all layers of coverage. 
• Buy limits in smaller sizes. For example, instead of buying $60M in overall limits in four blocks of $15M, buy six layers of $10M instead. The increased limit factors (ILFs) that typically discount the premium of the layer below may help save overall costs. That said, many carriers are fortifying their ILFs today so that discounts are less than they used to be. Also, in the event of a large loss ($60M or greater), claims-handling negotiations will now involve six distinct policies and likely six distinct carriers – a potentially complicating factor.

Some may be much more complicated:

• In extreme cases, consider invoking the extended reporting period options. If renewal terms are so egregious (significant increases in retention and premium, limits being cut, and/or onerous exclusions being added), putting existing coverage into "runoff" for claims alleging past acts and then securing "go-forward" coverage with different carriers for claims alleging only go-forward acts may be less expensive. It is a risky venture and not ideal, but if push comes to shove, all options should be on the table.
• Establish an indemnification trust instead of D&O insurance. This involves the company setting aside capital in the event of a D&O claim/loss. Questions remain around how this arrangement may work in the event of bankruptcy or even in response to a shareholder derivative claim settlement, as well as what legal differences may exist from state to state.
• Put D&O in a captive insurance company. Again, this also becomes very complicated as questions arise over the ability to pay Side A loss (no indemnification from company to its D&Os) via a captive insurance company.

PC360: Is the market disruption only impacting publicly traded companies?

Doherty: As noted above, this is not just a public company issue for 2020. Larger privately held companies and companies in more volatile industries and/or with more complex legal structures will also likely feel more pain in 2020.

Andrew Doherty, national D&O practice leader, USI Insurance Services.

One significant distinction in the D&O coverage for private companies versus public companies is that the coverage extended to a private (or not-for-profit) organization itself is often broader than the "securities claims only" coverage extended to most public companies. This full organization (or entity) coverage expands the D&O contract to an almost "all-risk" type policy, covering claims brought not just by shareholders, but also to claims brought by other constituents like creditors, competitors, customers, vendors and, of course, employees. Employees as potential litigants mostly stem from the fact that private companies often buy employment practices liability (EPL) for the organization in tandem with D&O coverage. Many private companies also buy D&O in tandem with other related coverages like fiduciary liability, crime, special crime (kidnap and ransom), professional liability (E&O), and even cyber or privacy coverage.  

Whether it is "true" D&O claims arising out of bankruptcy or company valuation disputes, claims falling under the extended entity coverage, or claims under the ancillary coverages mentioned above, increases in defense expenses and the costs to resolve claims are escalating for private companies as well as public companies. In 2020, larger private companies may be forced to buy the D&O contract like public companies, meaning that coverage for the entity will only be extended for shareholder claims. Mid-sized to smaller private (and not-for-profit) companies should not face this change, but they will see continued upward pressure on premiums and retentions.   

PC360: How do related exposures and lines of coverage play into this marketplace?  

Doherty: The ancillary coverages mentioned above are all under pressure, just to different degrees. 

• EPL coverage has always had some level of frequency, but the severity risk in the wake of the #MeToo movement has moved the focus from the class or mass action risk alleging systematic discrimination to the risk of high-profile, executive-suite level allegations of sexual harassment, discrimination or worse.   
• Fiduciary liability policies are digesting recent, and current "excess-fee" claims against retirement plan sponsors alleging excessive plan fees in violation of ERISA.
• Crime (bond) policies are dealing with the continued proliferation of social engineering or fraudulent inducement losses. These are losses where criminals induce employees of a company to do something that results in a loss of funds. Whether via email or over the phone, these crimes continue to plague insureds and insurers.
• The professional liability (E&O) market, in general, is more stable than D&O, but E&O exposures have always posed severity risks to insurers – certain industries more than others. Defending claims is getting more expensive in all areas of liability, so this will likely continue to pressure premiums generally.
• Cyber/privacy coverage deserves its own full analysis for 2020, but suffice it to say that, as these exposures get more complicated and losses materialize, premiums and terms will come under some pressure. USI's 2020 P&C Insurance Market Outlook predicts up to 10% in premium increases. 

What has become apparent in the last few years, and what we anticipate in 2020, is that any and all of these ancillary exposures are potential fodder for follow-on D&O claims. In other words, all roads lead to the boardroom these days.

When a major cyber breach happens, companies may not only have to deal with the breach fallout itself. If it is severe enough and disrupts the business significantly, it could result in a D&O claim, a securities claim, a derivative claim, or both. The same holds true for a high-profile EPL situation where the trust in leadership and the brand gets eroded, prompting shareholders to sue D&Os for poor management. And these threats extend to almost any event — an environmental disaster, a human healthcare-related disaster, etc. Thus, the reality of what is termed "event-driven" D&O litigation threatens all companies.

The bottom line: It is a tough time to be a director or officer of a company. Today, heavy is the head that wears the crown. But a well-thought-out strategy to proactively address issues and communicate effectively with carriers will go a long way in achieving the most optimal results available. 

Related: 

• 4 questions to identify the risk of pollution-related D&O exposure
• Social accountability drives complex D&O/EPLI market in 2019
• Why do nonprofit organizations need D&O insurance?