Current Trends in

Directors & Officers Liability

Current Trends in

Directors & Officers Liability

February 27, 2006February 27, 2006

AgendaAgenda

The D&O Market: Back to the Future

Claim Trends: The Best of Times, The Worst of Times

D&O Grows Up: The Day After Tomorrow

D&O Crisis Management Planning: Preparing for Barbarians at the Gate

The D&O Market: Back to the FutureThe D&O Market: Back to the Future

Determining market capacity: what’s available ($1.4 billion) versus what’s really available ($400 million to $800 million)

What factors are driving the pricing of capacity?

How is the reinsurance market affecting pricing, capacity and coverage?

What is the impact of reserve changes upon the D&O market?

Why have CLASH events taken on new meaning for D&O insurers?

How are D&O insurers evaluating their exposure to attachment point?

How does the structure (layered, quota share, size of blocks) impact pricing and claims handling?

The D&O Market: Back to the FutureThe D&O Market: Back to the Future

Key terms and conditions: severability; the dishonesty/fraud and other conduct exclusions; and rescission

The rapid growth of A-Side coverage in its various forms

If the underwriting of D&O coverage has not changed, then is the current market really less volatile than it was in 1986?

The D&O Market: Back to the FutureThe D&O Market: Back to the Future

Schedule P – “Other Liability” Claims MadeLeading D&O Liability Insurers Statutory Gross Accident Year Combined Ratio

(Assumes 23% Expense Ratio for All Companies) Source: A.M. Best, CFRA

Schedule P – “Other Liability” Claims MadeLeading D&O Liability Insurers Statutory Gross Accident Year Combined Ratio

(Assumes 23% Expense Ratio for All Companies) Source: A.M. Best, CFRA

91.687.2

117.2

142.1137.6

149.7

129.5

96.9

79.775.9

0

20

40

60

80

100

120

140

160

2004200320022001200019991998199719961995

Mature Immature

Claim Trends: The Best of TimesClaim Trends: The Best of Times

Number of Securities Lawsuits fell 17% in 2005 (from 213 in 2004 to 176 in 2005)

Market capitalization losses plummeted 33% (from $147 billion in 2004 to $99 billion in 2005)

The impact of Sarbanes-Oxley and lower stock market volatility are cited as explanatory factors for these results

The Dura Pharmaceuticals, Inc. v. Broudo decision: The U.S. Supreme Court weighs in on “loss causation” in securities claims

In re: Walt Disney Company Derivative Litigation: The Delaware Chancery Court reaffirms the Business Judgment rule

Claim Trends: The Best of TimesClaim Trends: The Best of Times

Big is big more often: the number of settlements over $100 million increased from 2.4% before Enron to 3.9% after Enron collapses

The average settlement increased from $26.4 million in 2004 to $28.5 million in 2005 (Cornerstone Research) – these figures exclude Enron and WorldCom settlements

Claim Trends: The Worst of TimesClaim Trends: The Worst of Times

The median settlement increased from $6.3 million in 2004 to $7.5 million in 2005 (Cornerstone Research)

Financial restatement cases nearly doubled to account for 40% of all cases in 2005

Institutional plaintiffs led 35% of all settlements in 2005 – this compares to only 20% in 2004

Claim Trends: The Worst of TimesClaim Trends: The Worst of Times

Companies paid more than $9.6 billion in settlements with shareholders in 2005

The rise of the individual, opt-out institutional shareholder makes a global settlement that much more difficult to accomplish

Claim Trends: The Worst of TimesClaim Trends: The Worst of Times

D&O Grows Up: The Day After TomorrowD&O Grows Up: The Day After Tomorrow

The insurance industry is entering a period of transformation

Volatility in the D&O market frustrates policyholders, underwriters, reinsurers and brokers

The lack of differentiation in the commercial market

frustrates many policyholders

Approximately 2% of publicly-traded companies are sued for securities-related claims in any given year

Why do so many companies have to pay for the sins of so few?

We know a lot about what causes D&O shareholder litigation

Risk modeling and predictive analytics require sufficient quantities of financial, governance and loss data

The data is available

The challenge is figuring out how to use the data to answer the right questions about D&O liability risk prevention, mitigation and transfer

D&O Grows Up: The Day After TomorrowD&O Grows Up: The Day After Tomorrow

Risk ModelingRisk Modeling

Business Effectiveness

Governance Practices

Accrual Practices

Firm Descriptors

Regulatory Forces (e.g., Sarbanes-Oxley)

Market Forces (e.g., premium levels)

Fir

m-C

ontr

olla

ble

Fac

tors

Risk ProfileClass Action

Litigation Likelihood

Expected Loss

Risk Quantification: Likelihood & SeverityRisk Quantification: Likelihood & Severity

Firm-specific class action likelihood will be quantified as a step toward risk assessment

Firm-specific probabilities will be computed relative to industry giving rise to likelihood level groupings defined vis-à-vis industry average

Not actual results--for illustrative purposes only

Likelihood Estimation

• 0% - 100%

• Size-adjusted for cross-company contrasts

• Standardized for longitudinal tracking

1 2 3 4 5 6 7 8 9 10

Above average probability Below average probability

Average Probability

1 2 3 4 5 6 7 8 9 10

Above average probability Below average probability

Average Probability

1 2 3 4 5 6 7 8 9 10

Above average probability Below average probability

Average Probability

1 2 3 4 5 6 7 8 9 10

Above average probability Below average probability

Average Probability

Next, the severity of loss will be estimated, also in a larger competitive context

The estimate will support firms’ classification in an appropriate damage level group, as illustrated below

Above average expected loss Below average expected loss

Average Loss Index

1 2 3 4 5 6 7 8 9 10

Above average expected loss Below average expected loss

Average Loss Index

Above average expected loss Below average expected loss

Average Loss Index

1 2 3 4 5 6 7 8 9 10

Above average expected loss Below average expected loss

Average Loss Index

Severity Estimation

• $0 - $upper limit

• Size-adjusted for cross-company contrasts

• Standardized for longitudinal tracking

Likelihood of Class Action Litigation Expected Severity of Loss

Risk Categorization: Likelihood x SeverityRisk Categorization: Likelihood x Severity

Risk = Class Action Likelihood + Estimated Severity of Loss

High

High

Low

Low

Hig

h

Hig

h

Lo

w

Lo

w

Overall largest likelihood &

severity

Overall smallest likelihood &

severity

MARA: Firm-Level Likelihood x Severity Tallying

Overall moderate likelihood &

severity

Overall moderate likelihood &

severity

LIKELIHOODS

EV

ER

ITY

RISK TAKERSNORMATIVES

NORMATIVESRISK AVOIDERS

Beecher Carlson’s Multivariate Algorithm for Risk Analysis—MARA—amalgamates the separately derived likelihood and severity profiles into a single risk categorization schema, as illustrated below:

User Benefits: Enterprise Risk ManagementUser Benefits: Enterprise Risk Management

Risk Characterization

Available DataMethodological Considerations

Risk Quantification

Risk Likelihood Estimation

Risk Severity Estimation

Risk Tallying & Categorization

On-Going Risk Management

Risk Transference

Drivers of Risk Delineation

What-If Decision Planning

Premium Differentiation

Terms Determination

On-Going Enterprise Risk ManagementOn-Going Enterprise Risk Management

Decision Scenario 1

What—if? Decision Scenario 2

Decision Scenario n

Sce

nario

-attrib

uta

ble im

pac

t in

cremen

tality q

uan

tificatio

n

Baselin

e

Scenario 1 Lift

Scenario 2 Lift

Scenario n Lift

The risk management advisory is supported by a quantitative scenario evaluation tool, the goal of which is to provide objective side-by-side comparisons of the expected risk impact of contemplated courses of action.

D&O Crisis Management Planning:D&O Crisis Management Planning:

Terrorist Attack

Business Interruption attributable to weather-related events

Disruption of IT and Communication systems by hackers or other causes

Avian flu

Major D&O claim emanating from securities-related issues

Preparing for Barbarians at the Gate

Which of these events is likely to be the most cataclysmic for your company?

How come very few companies have a crisis management plan for a D&O meltdown?

D&O Crisis Management Planning:D&O Crisis Management Planning:Preparing for Barbarians at the Gate

What are you looking to accomplish in structuring a D&O program?

How do you balance the interests of the individuals with those of the company?

How much coverage is enough? What does enough mean?

What is your crisis management plan in the event of a major D&O claim?

D&O Crisis Management Planning:D&O Crisis Management Planning:Preparing for Barbarians at the Gate

Developing a Crisis Management PlanDeveloping a Crisis Management Plan

D&O underwriters Shareholders Banks and other

Creditors Rating agencies Regulatory authorities Customers Suppliers Employees

The first 24 hours Financial issues Restructuring the

Board and replacing Executive Officers

Dislocation among employees

Brand restoration The damage created

by email Moving forward

Questions & AnswersQuestions & Answers