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D&O GOOD TIMES ENDING?

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The softening directors and officers liability insurance market may not be able to withstand deteriorating claim costs after next year, even with the recent enactment of a federal tort reform law, the author of a new study warns.

Several insurers entered the D&O market last year, which helped boost market capacity, drive down premiums and allow most study participants to renew their policies with improved or unchanged coverage, according to study author Phillip N. Norton.

But, the cost of claims that were paid last year stabilized at more than $4.5 million on average, indicating that a significant increase in claim costs in 1994 was not a fluke, said Mr. Norton, a Chicago-based consultant responsible for the national D&O practice at Watson Wyatt Worldwide.

On top of that, defense costs and the percentage of survey respondents that face D&O claims continue to grow, according to the study, which is scheduled to be released this week.

If those trends continue, they likely will force the D&O market to harden after 1997, though any constriction probably will not match the market turn of the mid-1980s, Mr. Norton predicted.

The Securities Litigation Reform Act-designed to protect companies and their officers from frivolous claims-may not help curb claim costs much, he said. While the new law likely will lead to fewer claims, it also probably will prompt costlier settlements and judgments, he said, a view that many D&O market experts share (BI, Jan. 8).

Trending out current indemnity and defense costs, which totaled nearly $5.9 million last year, a D&O claim that is filed in 1995 and is not later dropped or dismissed will cost $11 million on average, Mr. Norton estimated.

D&O defendants also are disposing of officers liability claims in three years-two years sooner than they had been. That gives insurers less time to earn investment income off of their D&O premiums.

"It will take a while for some insurance companies to realize they're losing money on this product," Mr. Norton said. But, when they do realize it, some insurers will exit the market, which will reduce capacity and allow those that remain to raise prices and still retain their business, he said.

Given those trends, D&O policyholders should consider trying to negotiate multiyear policies, Mr. Norton suggested.

Many likely will be able to lock in three years of coverage with new aggregates each year and pay no more than they currently pay, he said. Those that select a single aggregate over a three-year period likely would be able to cut their premiums further, he said.

Policyholders with multiyear policies may miss another round of premium cuts, but their premiums in the long run likely will be cheaper, he said. "I think this pricing is close to the bottom."

The greater concern for D&O policyholders should be negotiating terms and conditions of coverage that they would want for several years, Mr. Norton said.

For the 1995 Directors and Officers Liability Survey, Wyatt and the Risk & Insurance Management Society Inc. mailed questionnaires to 7,000 companies. By late summer, 1,157, or 16.5%, responded.

D&O capacity reached a record high at $895 million in December, up 7.2% from $835 million a year earlier. The 1995 increase marked the 10th consecutive year D&O capacity has grown.

Part of the increase was attributable to five insurers that boosted their capacity. But, new market entrants also brought in significant new capacity.

Competition led to lower premiums for many risk managers and to far more modest increases for those who had seen their coverage costs soar in recent years.

Thirty-six percent of respondents reported lower premiums, and 29% said their premiums were unchanged.

On average, premiums dropped 1.6%, according to Watson Wyatt. That figure is based on the cost of coverage that is renewed with little or no change.

The news was not all bad even for some of the 35% of survey respondents who reported they paid higher premiums last year.

High-technology firms were saddled with the highest premium increases: more than 10% on average. But, that was a far lighter load than the 50% hikes that have been common for high-tech firms in recent years.

In addition, while 38% of high-tech firms had to pay more for D&O coverage, 42% paid less and 20% paid the same on renewal.

Merchandisers, the industry group in which the greatest percentage of respondents paid higher premiums, were the only other group for which D&O insurers noticeably raised premiums, according to the study. Premiums rose for 49% of the surveyed merchandisers.

Large banks fared best, with premiums dropping for 52% of those respondents and remaining unchanged for 28%.

Mr. Norton also noted that "a significant segment" of policyholders renewed their coverages with higher limits and improved terms and conditions.

For example, limits increased on average more than $1 million to $32.5 million. Limits for companies with more than $2 billion of assets jumped the most-$5 million-to $65.2 million on average.

Overall, 20% increased their limits, and 77% retained the same limits. Only companies with between $100 million and $400 million of assets purchased less coverage: $10.9 million in 1995, down more than $1 million from $12.1 million the year before.

And, largely because of policyholder victories in three federal appellate courts last year, 20% of the participants purchased coverage that either covered the entity against a securities-related D&O claim or established preset allocations of coverage in those cases.

A few insurance companies began offering this coverage in late 1993, but most D&O insurers extended it to policyholders as an option only this past summer because of the rulings (BI, Nov. 13, 1995).

Deductibles largely were unchanged for corporate reimbursement coverage, which remunerates an organization for its responsibilities to indemnify its directors and officers.

On average, they dropped about $27,000 to $1.13 million. But, companies with at least $2 billion of assets hiked their deductibles about $79,000 to $2.6 million.

Companies, though, increasingly are opting for no deductible for personal D&O insurance, which directly indemnifies company officials if corporate indemnification is precluded by corporate bylaws or state statutes. Eighty-four percent did not have a personal coverage deductible in 1995, compared with 80% in 1994 and 74% a year earlier.

The soft D&O market does not reflect insurers' results.

Excluding claims that either plaintiffs dropped or policyholders closed without drawing on their coverage, the cost of claims paid in 1995 exceeded $4.5 million, a marginal decrease from $4.6 million in 1994.

However, the cost of claims paid during the past two years reflects a more than 39% increase since 1993 and 1992, when that cost hovered around $3.25 million.

"It says that jump is a real jump. Severity has increased," Mr. Norton observed.

That trend has been evident throughout the decade. The cost of claims paid has more than doubled from $1.94 million in 1990, according to Mr. Norton. The greatest increase was in 1991, when claim costs surged 56% to more than $3 million.

Shareholders commanded the highest indemnity payment in 1995, nearly $6.8 million, followed by: governmental shareholders, $4.6 million; customers, $3.4 million; employees, $1.2 million; and competing companies, $521,000.

Defense costs also continue to soar. For both open and closed claims, but excluding claims that did not incur any litigation expenses, defense costs jumped about 50% to more than $1.3 million from nearly $886,000 a year earlier.

Claim susceptibility, or the percentage of survey respondents who reported one or more claims, reached a record high of 27%, up one point from 1994.

Claim frequency, or the number of claims on average per survey respondent, was largely unchanged-0.68 in 1995, compared with 0.69 in 1994. But, claim frequency was 36% greater than in 1992, when each respondent reported 0.5 claims on average.

Alleged inadequate or inaccurate financial reporting disclosures, cited by 16% of D&O claimants, remain the leading complaint among plaintiffs. Claims for wrongful employee terminations, 11.3%, and discrimination, 4.7%, were the next most common complaints.

American International Group Inc., Chubb Corp. and Lloyd's of London remain the three leading D&O markets. But, CNA Financial Corp. jumped three notches to No. 4, and The St. Paul Cos. Inc. moved into the top 10.

Based on the number of D&O policies they place, brokers Marsh & McLennan Cos. Inc. and Johnson & Higgins remain the leading D&O market brokers. However, M&M gained ground, increasing its market share by two points to 18.3%, while J&H's market share dropped nominally to 15.6% from 15.8%.

Market share among the other top 10 D&O market brokers changed most for fifth-ranked Sedgwick Group P.L.C., which doubled its share to 8.6%.

Copies of the 1995 D&O liability report can be obtained from Mary Maze at Watson Wyatt Worldwide-D&O Services, 303 W. Madison St., Suite 2400, Chicago, Ill. 60606. The price is $300, $235 for non-participant RIMS members and $150 for 1995 survey participants.