How Long Will D&O Prices Defy Gravity?

New York

Speakers at a New York symposium expressed surprise at thedownward trend that directors and officers insurance price changesare taking, but litigation trends could prompt a second hardmarket, some warned.

“Defying gravity” is how David Bradford, executive vicepresident of Advisen, a New York-based information provider,referred to price trends during his statistical presentation at the2004 D&O Symposium of the Minneapolis-based ProfessionalLiability Underwriting Society last month in New York.

Prices arent actually declining yet, according to figurespresented graphically by Mr. Bradford. But the year-over-yearchange in rate hikes fell from 180 percent for the first-quarter of2003 to 120 percent in the second quarter, then to 60 percent, andfinally to 20 percent in the fourth quarter, creating a straightsteep line that experts on a panel likened to a double-blackdiamond (extremely difficult) ski slope.

A line graph, which Mr. Bradford used to illustrate his point,was based on the Risk and Insurance Management Society Cost of RiskSurvey that Advisen administers, putting together survey responsesfrom 1,000 risk managers. He presented his risk manager surveyresults alongside similar results from a survey of underwriters puttogether by panel moderator Phil Norton, president of theprofessional liability division of Arthur J. Gallagher in Itasca,Ill. Mr. Nortons figures indicated year-over-year rate hikes of 135percent, 115 percent, 50 percent and 25 percent for publiccompanies for the successive quarters of 2003.

“The good news is that we are still in a hard market–but justbarely,” Mr. Bradford said. “Rates are close to plateauing and ourprojection is that they will go negative within the next 12months.”

“Will they bounce back or are we going to see continueddeterioration?” he asked. “Theres nothing to suggest that the trendhas any brakes built into it.”

“Right now, my view is that were in the eye of a hurricane,”said John Kuhn, executive vice president of Axis FinancialInsurance Solutions in Berkeley Heights, N.J. “I dont think we arethrough with a hard market. I think we may be heading into thatcalm period for a period of time. But I think there are going to bethings that will be coming down that will make it a hard marketagain.”

What is coming down the road, Mr. Kuhn said, are losses fromyet-to-be-settled securities class actions and a new crop ofprivate actions described by a panel of legal experts.

In the earlier panel of legal experts, Tower Snow, a defenseattorney and partner with Clifford Chance US, LLP, in SanFrancisco, noted that there are over 1,000 federal securities classactions that are still unresolved since the passage of the PrivateSecurities Litigation Reform Act in 1995. The Reform Act raisedprocedural hurdles for federal securities class-action filings.

Although there were three settlements that topped $200 millionin 2003 (Oxford-Health, Daimler Chrysler, and Lucent Technologies),not a single mega-case has been settled, he noted, referring to alonger list that includes Enron, MCI, Adelphia, Global Crossing andTyco, which he suggested would settle for much bigger bucks.

In addition, he said, less than one-half (48 percent) of allcases are settled within five years. (Statistics on cases filed andsettled are regularly published by PricewaterhouseCoopers andCornerstone Research. Mr. Snows statistics are consistent withthese sources.)

While Mr. Snow noted that average settlement values actuallydipped in 2003, falling to $19.8 million from $23.3 million in2002, he suggested that the trend may simply mean that lessvaluable cases are being settled earlier. Indeed, he said that somecommentators have put a $75 billion potential cost on the amountneeded to settle 1,000 outstanding “standard” cases together with“mega-cases,” IPO laddering cases (a unique subset of class actionsfiled in 2001 dealing with allocations of initial publicofferings), analyst cases and mutual fund cases, withoutattributing the figure to a particular source.

Although Mr. Kuhn raised the question about how much of the $75billion is really going to be insured, plaintiffs lawyershighlighted emerging trends that could add to D&O insurerpayouts.

“It may be deceptive trying to forecast” ultimate losses fromthose numbers, said William Lerach, partner for Milberg WeissBershad Hynes & Lerach in San Diego. (The firm, according toMr. Snow, holds the distinction for filing the most securitiesclass actions.) “One clear mega-trend” that is taking hold is thewillingness of institutions to opt out of class actions and to fileindividual cases that are not class actions.

For example, he said, in addition to class actions, there areindividual private claims filed by institutional investors, such aspublic retirement funds, against Enron, Adelphia and Qwest. “Andthese are not small claims. Many of these private claims standingon their own would have been considered [the equivalent] of asignificant class action three-to-five years ago, he said, notingthat they each involve $300-to-$500 million in damages.

Mr. Lerach said the reason institutions are opting out of classactions is that they are dissatisfied with the size of theirclass-action recoveries.

“You cannot expect an institution with a $100-, $200-, $400million loss to sit back and await a proof-of-claim form and acheck where if the class-action recovery is $1 billion, they getthree or four cents on the dollar.”

D&O underwriters expressed concern over the attorneysobservations.

“Theres a significant wave of issues that statistics dont bearout yet,” said Keith Thomas, senior vice president, commercialmarket management solutions group of Zurich Insurance Company inNew York. The real issue is “how we respond,” he said. “Willunderwriters look at the signs and really assess riskappropriately?”

“We [the insurance industry] cant really go sliding down the skislopes that far, can we?” Mr. Norton asked.

Unfortunately, “we went down the double-black diamond beforewithout knowing how to ski,” Mr. Kuhn said. “We really have tounderstand and manage our loss costs,” which are constantlychanging and increasing.

“Its concerning where were heading Everyone says it shouldnt begoing the way it is, but we are heading in that direction.”

“Some carriers will be facing some difficult decisions,” Mr.Kuhn continued, likening the pricing process to a “game of chicken.Are you willing to walk away and not focus on market share?” heasked.

“What this shows is that we really dont know how to price thisbusiness,” said Zurichs Mr. Thomas, referring to pricing trendslides presented by Mr. Bradford. “Were following market trends[and] using an overall portfolio pricing approach,” he said, notingthat while such an approach can produce long-term profits, thebetter approach is for the industry to figure out “the real driversof claims activityto find better metrics.” Otherwise, he said,“were going to quickly repeat the same cycle with worse dynamicsthan we had before.”

Mr. Kuhn pointed out that as the magnitude of insurer rate hikestumbled in recent months, exposures rose, with stock values ofpublic companies approaching 52-week highs.

“Are we at break-even or do we still need additional rate to getus there?” he asked.

Giving some history earlier in the session, Mr. Kuhn noted thatindustry premiums fell somewhere between 38 and 50 percent from1995 to 1999, while insurers enhanced coverage at the sametime.

“That shows you where we need to get to as an industry. Somecompetitors have said the industry is still 30 percent deficientright now. Thats probably not a bad number for where we sit today,”he said.

Mr. Thomas said the Dow Jones average was at 4000 or 5000 wheninsurers cut their prices in half in the mid-1990s. And while thestock valuations of public companies soon doubled, “we went in anddecided to triple the policy period,” he said, referring to thefact that insureds were able to lock in low rates with three-yearpolicies. “Thats some pretty bad math. Im not an actuary, but thatswell north of 100 percent on a decrease basis.”

“It seems painful for you who are broking the business for yourcustomers. But hopefully youre expressing that sort of math,because thats the reality that were experiencing on theunderwriting side,” Mr. Thomas said.

Conference Chair Michael Cavallaro, managing director of ARCExcess & Surplus, a New York-based wholesale broker, who spoketo lead off the two-day conferences, urged underwriters not toreturn to past behavior patterns.

“We appear to be headed back where we came from in the late1990s a lot sooner than anyone expected,” he said, lamenting: “Idont want to see another Reliance. I dont want to see anotherRoyal. I dont want to see another Kemper. And I dont think myinsureds do either.”

Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, February 27, 2004.Copyright 2004 by The National Underwriter Company in the serialpublication. All rights reserved. Copyright in this article as anindependent work may be held by the author.

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