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early in September by Willis Group Holdings found that buyers of D&O from the London market typically enjoyed premium reductions of around five per cent from a year earlier in the second quarter of 2009. The broker expects similar conditions in the third quarter, and even companies that have been hurt by the recession or have highly-leveraged INSURANCE STRATEGIES > D&O CIR October 2009 45 www.cirmagazine.com T he market for directors’ and officers’ (D&O) liability has now been in existence for 75 years; its origins going back to the Great Depression. Lloyd’s responded to the new duties and responsibilities imposed on directors and officers with a product at a time when corporations were not permitted to provide indemnification. Two years into the latest era of credit crunch and emergency state rescues for financial institutions, the market for D&O is very much one of two halves. Commercial organisations with reasonably strong risk profiles are still able to take advantage of soft market conditions. A report issued Directors’ and officers’ liability insurance was first developed when the world economy slumped in the 1930s. Graham Buck reviews how the cover is developing now hard times have returned Full circle

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Page 1: Full circle - CIR Magazine · Full circle 45-47_directors_officers_liability_template_only.qxd 08/10/2009 17:18 Page 1. INSURANCE STRATEGIES > D&O balance sheets experienced, at worst,

early in September by Willis GroupHoldings found that buyers of D&Ofrom the London market typicallyenjoyed premium reductions of aroundfive per cent from a year earlier in thesecond quarter of 2009.

The broker expects similarconditions in the third quarter, andeven companies that have been hurt bythe recession or have highly-leveraged

INSURANCE STRATEGIES > D&O

CIR October 2009 45www.cirmagazine.com

The market for directors’ andofficers’ (D&O) liability hasnow been in existence for 75

years; its origins going back to theGreat Depression. Lloyd’sresponded to the new duties andresponsibilities imposed on directors and officers with a productat a time when corporations werenot permitted to provide

indemnification. Two years into the latest era of credit crunch and emergency state rescues forfinancial institutions, the market for D&O is very much one of two halves.

Commercial organisations withreasonably strong risk profiles arestill able to take advantage of softmarket conditions. A report issued

Directors’ and officers’ liability insurance was first developed when the worldeconomy slumped in the 1930s. Graham Buck reviews how the cover isdeveloping now hard times have returned

Full circle

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INSURANCE STRATEGIES > D&O

balance sheets experienced, atworst, no more than a slight increasein premium.

By contrast, financial institutionsworldwide have faced much hardermarket conditions with double digitrate rises of 40 per cent upwardsapplied to D&O renewals this year.Many believe that these toughermarket conditions could soon beginto extend to non-financials also.

“The financial crisis and stockmarket volatility have led to anumber of high-profile D&O claims,insolvency proceedings havemultiplied and will probably remaina feature of the unstable economicconditions for some time,”comments Emmanuelle Tardy, seniorvice-president of the financial andprofessional practice (FINPRO) at Marsh. “If these translate to multi-million losses for insurers, thenhistory tells us that the market willharden.”

Tardy cites a volatile businessenvironment, public outrage atcorporate scandals centred onboards’ remuneration, and a newlyfound, largely politically-motivatedwillingness to bring moral scruplesto the fore. These factors, coupledwith greater accountability, will fuelnew legislation and regulationaround the world, she predicts.

“Post-recession, the threat of legalactions, of legal defence costs, fines,and possible imprisonmentsentences will, rightly or wrongly, be weighting on many businessleaders’ minds.”

According to Richard Highley, a partner of law firm Davies ArnoldCooper, there also continues to beclear distinctions between the D&Omarkets of North America and thiscountry.

“The broker-client relationship isvery different in the US, where therehas been a flood of claims due tosecurities legislation,” he says. “And where there are claims, thereare also high premiums and acontinuing close relationshipbetween brokers, their clients and D&O underwriters.”

By contrast, the UK has stillwitnessed relatively few claims. Thismakes D&O more of a “hard sell”,with even many of the FTSE 350

companies still less than fullyconversant with the product. The absence of the same closerelationship means companies here often follow their brokers’recommendation when buying cover – and the absence of claimsmeans there is too often a problemwhen one does arise.

This is in marked contrast to theaccounting profession, whichregularly faces claims particularly ina recession, says Highley.

“This means there is an ongoingrelationship between auditors andinsurers. The ICAEW (Institute ofChartered Accountants in Englandand Wales) steps in to help with theprocess – and there are generally no problems.”

Reversing a trend

Until mid-2007, and the onset of thecredit crunch, D&O cover forfinancial institutions was“exceptionally broad in scope”reports Julian Martin, practiceleader for the FINEX D&O at Willis.This trend has reversed in the lastcouple of years, with insurersseeking to add restrictions such ascutting back the cover provided forinvestigation costs.

A typical D&O contractcomprises three sections: Side Aresponds to directors’ and officers’personal liability where thecompany is unable to provideindemnification, thereby protectingtheir personal assets.

Side B cover applies when thecompany can indemnify and thusprotects the company while Side C,referred to as entity cover, respondsto claims brought by shareholders.Side C has regularly been used bycompanies to provide balance sheetprotection, for which, pre-crisis, theypaid little additional premium.

Martin reports that the majorityof shareholder claims againstfinancial institutions brought in theUS both name individual directorsand also the company, so Side A, Band C are all invoked and paymentsare correspondingly much higher.

“At the moment, a great deal ofSide A cover is being purchased inthe US; indeed some insurers willonly offer Side A to financial

CIR October 200946 www.cirmagazine.com

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INSURANCE STRATEGIES > D&O

institutions. The same applies herein the UK for those institutions withUS shareholders.

“While cover continues to beavailable, underwriters are nowlooking at each application far moreclosely and D&O carriers are alsoreviewing the extent of cover theyare willing to offer.”

In particular, the Regulatory/Investigation Costs Extension hascost D&O insurers dearly. Cover isinvoked when the Securities andExchange Commission, FinancialServices Authority or similarregulatory body requires directorsand officers to justify and explaintheir conduct. The wording for thisextension has become morerestrictive and insurers are also nolonger willing to offer maximumcapacity.

“The crunch has given rise to so-called Madoff and Stanfordexclusions, which some insurershave been applying to D&O coverfor banks and other financialinstitutions – along with otherrestrictions such as the reduction, orsometimes removal, of Side Ccover,” adds Adam Barker, UKgeneral and underwriting counselfor HCC Insurance Holdings’subsidiary HCC Global FinancialProducts.

This means that companies’ ability for “building towers” on Side A, B and C has become moreconstricted, and often additionalcapacity is available only throughbuilding up Side A.

Barker adds that underwritershave mixed views on whether banksthat have been the subject ofgovernment bail-outs represent abetter or worse risk than those thathave managed to survive without a rescue.

“State intervention is, by its verynature, a red flag,” he observes. “Ifthe government is intervening, theinstitution is probably facingsignificant financial difficulties.

“This does not necessarily implywrongdoing by management; merelythat and form of state interventionwill lead to stakeholders asking thequestion ‘how did we get here?’ Onthe other hand soft intervention mayreduce the possibility of claims.”

AIG survives

The banks can at least be thankfulthat the future of AmericanInternational Group (AIG) islooking more assured than it was 12months ago. AIG has traditionallybeen the sector’s main provider ofD&O cover and, says Martin, theconsequences of the group goingunder would have been disastrous.

AIG’s survival also goes some wayto explaining why, for commercialcompanies, D&O policy wordingsremain broad with new entrantscoming into the market and newLloyd’s syndicates adding toavailable capacity. The new namesinclude Argo, a relatively recentstart-up that is competingaggressively.

Many of AIG’s competitors areclamouring to take some of its D&Obusiness, but Martin says the grouphas been pricing renewals atwhatever level is needed to retainthem. “Even where it has lostaccounts it is keen to regain them,”he adds. AIG UK has recentlymoved to put some distancebetween it and the recent troubles ofits parent, announcing that thecompany will re-brand as Chartisover the coming months.

This keen competition means thatcompanies with strong risk profilescontinue to enjoy a strongnegotiating position and can dictaterate cuts. Indeed, one major D&Oinsurer, Zurich, has commented thatwhile it regards an across the boardrate increases of six per cent toeight per cent as justified, they willnot be imposed while the currentsoft market conditions persist.

“It’s reasonable to expect thatinsurance capacity will contract ifthe global recession continues,

which may lead to more pressure onterms and conditions,” says Tardy.

“However, D&O is a profitable classof business for many insurers, and onethat has, historically, attracted newcapacity, a factor that has consistentlyfuelled competition.”

Another issue of concern for UKD&O insurers is in the field ofenvironmental liability. Althoughlegislation has been enacted thatrequires companies to clean up theiract Highley observes that theEnvironment Agency has notaggressively pursued prosecutionsagainst companies that flout theregulations.

“If the Agency was to change itsapproach and enforced the legislationmore rigorously, many more claimswould result,” he comments.

“There is, in particular, considerableimpetus for the climate change regimeto be enforced, so change could resultin more claims against directors.”

One crumb of comfort for insurers isa general absence of new legislation onthe horizon to cause serious concern,although as Barker notes with a newgovernment likely next year “thehorizon is not very wide.”

“The new Companies Act and theCorporate Manslaughter Act aresignificant, but for D&O insurers themost significant forthcoming events willbe the results of Lord Justice Jackson’sreview of UK litigation costs and anincrease in third party litigationfunding,” he suggests.

The preliminary version of theJackson report was published in Mayand his final recommendations areexpected by the end of the year. Ifthese lead to a shifting of the costburden away from the claimant, it willhave a massive impact on claims addsHighley.

“While we don’t want to end up likethe US, the absence of legal aid forcommercial actions prevents many validclaims from being pursued,” he says.

How would he sum up the likely stateof the D&O market post-downturn?

“It will look much the same, onlybetter,” he suggests. “Policies will haveto respond to claims if insurers want toretain their market share. But ratherlike the professional indemnity marketfor construction risks, it may also be amarket with fewer players.”

“Underwriters are now

looking at each

application far more

closely and D&O

carriers are also

reviewing the extent of

cover they are willing

to offer”

CIR October 2009 47www.cirmagazine.com

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