2002 Casualty Actuaries in Reinsurance:D&O Liability Session - 9/19/02

• Paul N. Brodeur, Vice President D&O Product Manager, Travelers Bond

• Douglas S. Colosky, Esq., Vice President, Executive Liability Claims, Travelers Bond

• Michael F. Mc Manus, FCAS, MAAA, Senior Vice President and Actuary, Chubb Group of Insurance Companies

Session Outline

• Evolution of D&O Insurance Coverage• Private Securities Litigation Reform Act of 1995• Soft Market• Stock Market• Corporate Governance Crisis• Current Market Reaction• What does the Future Hold

Evolution of D&O Insurance Coverage

• Original Intent – provides coverage to D&O’s for non-indemnified claims.

• Addition of coverage for corporate indemnification in the early 1980’s.

• Throughout Late 80’s and early 90’s evolution of allocation language.

• Best Efforts

• Nordstrom Case – end of Best Efforts

• Pre-set allocation with Relative Legal and Financial Exposures Language.

• Entity Securities Coverage (1995)

The Private Securities Litigation Reform Act of 1995 (PSLRA-95): Intent

• Institute procedural changes in securities litigation.

• Provide safe-harbor for forward looking statements by public companies.

• Restrict joint and several liability, heighten loss/causation requirements, modify damage calculations.

PSLRA-95: Procedural Changes

• Allegations of fraud must be plead “with particularity” and demonstrate facts that give a “strong inference” of fraudulent conduct.

• Appointment of lead plaintiff.• Appointment of lead plaintiff class counsel.• Prohibition of referral fees.• Settlement disclosure.

PSLRA-95: Procedural Changes (cont’d)

• Sanctions for frivolous pleadings.• Discovery reform.• Safe harbor for forward looking statements.• Proportionate liability.• Loss causation.• Damages.

The Post-Reform Era(In 2001 312 IPO allocation/laddering lawsuits were filed)

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100

200

300

400

500

1991

1993

1995

1997

1999

2001

Number of Filings

Source: Stanford Law School Securities Class Action Clearinghouse

The Post-Reform Era

• Stock drop – automatic causation. • Policy final adjudication language.• Inadequate retentions relative to alleged loss.• Importance of motion to dismiss.• Pressure on issuer to settle within limits of the

policy.

Evolution of D&O Insurance Coverage – Soft Market

• Reduction in Retentions• Waiver of retention for a finding of no liability• Elimination of co-insurance• Reinstatement of limits• Bilateral Discovery• Severability of application and some exclusions• Final adjudication language in fraud exclusion

Evolution of D&O Insurance Coverage – Soft Market (Con’t)

• Deletion or reduction in scope of exclusions, including management carve-backs on key exclusions

• Non-entity Employment Practices Liability coverage• Multi-year policies with no cancellation• Blended programs• Back-dated Prior and Pending Litigation dates• Waiver of warranties

D&O Insurance Premium Trends

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200

300

400

500

600

700

800

900

Tillinghast-Towers Perrin D&O Premium Index Trends 2001

D&O Insurance Capacity

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Tillinghast-Towers Perrin Full Limits Capacity (in millions) 2001

D&O Insurance Coverage – Soft Market

• New Entrants

• Increased Capacity

• Reinsurance readily available

• Increased Competition

• Scope of coverage dramatically expanded

• Decreasing pricing

Impact of Bull Stock Market

• Unprecedented stock market runup in late 1990’s kept shareholders generally happy

• Fueled by technology and telecom stocks

• Internet stock IPO’s created massive market caps that were largely speculative and ripe for disappointment and failure

LADDERING

• Claims involve 300+ companies that went public in 1998-2000 during height of bull market

• Allege that underwriters colluded with their customers to artificially drive up stock prices by allocating shares at cheap, premarket prices in exchange for promise to buy more shares in aftermarket at higher prices (“laddering”)

• Also allege that underwriters solicited excessive and undisclosed commissions in exchange for allocations of “hot” IPO shares

• Liability exposure appears greater for underwriters than issuing companies

Class Action Frequency Trend

# Class # of Class % Change in Class Period Actions Actions # Class Actions

End Year Filed ex Laddering ex Laddering1991 164 1641992 202 202 23%1993 163 163 -19%1994 231 231 42%1995 188 188 -19%1996 109 109 -42%1997 175 175 61%1998 234 234 34%1999 204 204 -13%2000 214 214 5%2001 486 317 48%

YTD Aug 2002 182 182 15%

Source: Stanford Law School Securities Class Action Clearinghouse

1. Frequency of class actions has increased an average of 23% annually from 2000 through 2002.2. Cumulative change in frequency from 2000 through 2002 is 78%.

Class Action Severity Trend

SettlementClass Period # of (Millions) Average Smoothed % Change

End Year Settlements Dollars Settlement Average in Severity1991 15 248.7 16,577,080 12,740,596 1992 21 489.8 23,326,008 17,821,681 40%1993 40 276.2 6,905,393 13,351,554 -25%1994 93 703.4 7,563,949 9,542,267 -29%1995 131 1,237.0 9,442,838 8,396,495 -12%1996 99 1,032.2 10,426,190 9,203,256 10%1997 105 1,401.4 13,346,869 10,957,092 19%1998 128 2,205.3 17,228,562 13,972,500 28%1999 78 1,482.0 18,999,508 16,362,183 17%2000 44 995.0 22,614,531 18,729,028 14%2001 8 108.9 13,616,762

YTD Aug 2002 2 165.0 82,512,500

Source: Stanford Law School Securities Class Action Clearinghouse

1. Average settlement values have been increasing an average of 20% annually from 1997 thorugh 20002. Combined frequency severity trend is running at 48%.3. Cumulative change in severity from 1997 through 2000 is over 100%

Securities Fraud Mega-Settlements:(> $100 million dollars)

• Cendant

• Bank of America

• Waste Management II

• 3 Com

• Waste Management I

• Rite Aid

• Microstrategy

• Informix

• Sunbeam

• Conseco

• Ikon

• Prison Realty

$ 3.527 Billion

$ 490 million

$ 457 million

$ 259 million

$ 220 million

$ 193 million

$ 192.5 million

$ 136.5 million

$ 125 million

$ 120 million

$ 111 million

$ 104.1 million

Source: Stanford Law School Securities Class Action Clearinghouse

Corporate Governance Crisis

• Enron• Worldcom• Tyco• Adelphia• Imclone• Lucent• etc.

D&O Insurance Market Reaction

• Prices on primary increasing by a minimum of 25% with many accounts seeing 100% increases

• Accounts with claims or in tough industries are seeing 100% + increases and in some cases can not fill out their program

• Increases in Retentions • Contract Restrictions and use of co-insurance• Return to underwriting as opposed to writing “deals”

D&O Insurance Market Reaction (Con’t)

• Cut back in limits extended on one risk. More selective use of capacity.

• Reinsurance- price increasing, coverage restrictions, restrictions in capacity. January 1 renewals will set the tone for 2003.

• Return of A-side only towers.• Potential elimination of Securities Entity Coverage

Sarbanes-Oxley Act - July 2002

• Requires CEO and CFO certification of financial information for the 947 largest companies

• Increased penalties for violation of securities law• Increase Statute of Limitations – claim can be

brought within 2 years of discovery or 5 year of the event.

• Requires further study of enhanced financial disclosure of off-balance sheet transactions and use of SPE’s, analysts conflicts of interest, and lawyers responsibility to report violations.

What Does the Future Hold?