The directors and officers liability insurance market appears to be going through a transition.

Rates are holding steady or, in some cases, increasing. Coverage terms are rarely being broadened, and insurers are more frequently restricting the amount of capacity they are willing to grant problematic accounts.

It is still too early to call the D&O market "hard," but many of the signs are pointing that way, brokers and insurers say.

And the huge increase in exposures and losses over the past several years make rate increases justifiable, insurers say, noting that the run-up in the market capitalization of many companies and the increasing number of securities-related lawsuits has not been reflected in the rates charged for D&O coverage.

"We are definitely seeing a hardening in pricing and coverage terms," said Paul Schiavone, vp and chief underwriting officer of National Union Fire Insurance Co. of Pittsburgh, Pa., a New York-based unit of American International Group Inc.

At the beginning of 2000, D&O rates stopped falling and the number of new coverages being offered slowed, Mr. Schiavone said.

Now, insurers are imposing rate hikes on many policyholders, particularly those conducting initial public offerings as well as companies that are involved in telecommunications, other technology companies and health care, he said.

"They have definitely seen an increase in rates and a status quo on coverage," Mr. Schiavone said.

"We are seeing things beginning to tighten....Some accounts may see 10% to 15% (hikes), and others may have larger increases, so it depends on the account; but we are not really seeing anything staying the same or going down," said John Kuhn, president of Kemper Insurance Cos.' Financial Insurance Solutions unit in Berkeley Heights, N.J.

Kemper entered the directors and officers liability insurance market on Nov. 1 last year. Mr. Kuhn, who previously was chief underwriting officer at Chubb Executive Risk, brought Greg Tully and Michael Ferguson with him to Kemper from Chubb Executive Risk to set up the unit, he said. The insurer offers $50 million in limits for primary and excess D&O coverage.

"The market is in the midst of a correction," said Steven Anderson, a managing director at Marsh Inc. in New York.

Insurers are sitting on a backlog of claims, which makes D&O business marginally profitable at best, he said.

Many policyholders are being quoted single-digit increases, while those with poor loss experience or those involved in high-tech or health care business are being quoted increases of up to 35%, Mr. Anderson said.

Rates have to increase, said David McElroy, senior vp at Hartford Specialty, a New York-based unit of the Hartford Financial Services Group Inc.

The losses from 1997, 1998 and 1999 are making those years far less profitable than D&O business was in the early 1990s, he said.

Technology companies, which are particularly volatile risks due to shareholder actions, should expect 10% to 15% rate increases when they renew, and large public companies should expect no further rate decreases and, perhaps, some modest increases, Mr. McElroy said.

"It's still competitive, but we are managing to get some rating increases," said Giles Stockton, the active underwriter for Janson Green Ltd. syndicate 79 at Lloyd's of London.

The increases were first seen at high-tech and IPO risks, but now they are being imposed on most publicly traded corporations, he said.

Lloyd's underwriters are generally seeking 10% to 25% increases for publicly traded policyholders, Mr. Stockton said.

"But there are still a lot of competitors in the U.S.," he said.

But D&O reinsurers everywhere are seeking rate increases, and that will, in turn, lead to even more pressure on insurers to increase rates, Mr. Stockton said.

There is increased pressure on the part of insurers to raise rates across the board, particularly insurers in London, said Fred Podolsky, a senior vp at Willis North America Inc. in New York.

London underwriters are looking for increases of up to 20% for most risks and are pushing for hikes of up to 40% for accounts that have suffered losses or have had suits filed against directors and officers, he said.

"They are not being completely successful, and there have been a number of accounts that have left London," Mr. Podolsky said.

London-based underwriters were particularly aggressive in the pursuit of high-tech accounts in the mid-1990s and they have now suffered large losses on that portfolio, so they are under more pressure to raise rates now, he said.

"In the U.S., there is still healthy competition for good or even marginal accounts," Mr. Podolsky said.

Large public companies with unexceptional losses are seeing unchanged D&O rates, or at most 3% to 6% increases. And a few accounts are still seeing some decreases, he said.

Companies with management or structural problems are seeing demands for 5% to 10% rate increases but insurers are not always successful in making those increases stick, Mr. Podolsky said.

But companies going through initial public offerings are seeing some dramatic increases, particularly for multi-year deals, he said.

Two years ago, IPO policyholders would have been charged 2.1 times the annual premium for D&O coverage, whereas now, the premium is between 2.8 and 2.95 times the annual premium, and many IPOs are not able to obtain multi-year deals, Mr. Podolsky said.

And reinstatements on those deals that have been agreed upon also have increased dramatically, he said. A year ago, a reinstatement premium would be about 150% of the annual premium, whereas as today, it is between 250% and 275%.

Policyholders will likely find it hard to find attractively priced multi-year policies, agreed Mr. McElroy of the Hartford.

Up until last year, multi-year deals had been popular among policyholders as they wanted their coverage to span the transition from 1999 to 2000 to avoid coverage issues related to Year 2000 losses, Mr. McElroy said.

"Now underwriters are looking at multi-year deals and saying 'How can I assess a dynamic corporation over three years?' so they want to get back to annual deals," he said.

Last year, the D&O book now handled by The Hartford consisted of about 35% multi-year deals, but that likely will fall to 20%, Mr. McElroy said.

The Hartford greatly expanded its involvement in the D&O market through the purchase of the renewal rights to the D&O business of Reliance Insurance Co. Also, Mr. McElroy and about 160 other former Reliance staff joined The Hartford.

The Hartford has renewed about $250 million of the Reliance portfolio and has a total $450 million of former Reliance business in force due to multi-year deals, Mr. McElroy said.

Three-year single aggregate policies with reinstatements have become more difficult to place, said Mr. Anderson of Marsh.

And those multi-year policies that can be obtained are experiencing significant rate increases, he said.

Whereas prior to the hardening, multi-year premiums were in the range of 2.25 to 2.5 times the annual premium, now they are 2.7 times the annual premium and more, Mr. Anderson said.

"Insurers believe that losses will continue to trend upwards and they don't want to underwrite out for two to three years without being able to underwrite each year," he said.

Insurers are particularly keen to increase rates for publicly quoted companies due to the significant increase in the size of settlements and claims in that sector over the past several years, said Tony Galban, vp and D&O underwriting manager at Chubb Executive Risk, a Simsbury, Conn.-based unit of Chubb Corp.

The run-up in the stock market in the mid- to late 1990s led to a huge increase in the market capitalizations, which in turn led to larger claims and settlements due to larger swings in share prices, he said.

"Companies can lose billions of dollars in value in a day and that has led to larger settlements," Mr. Galban said.

In addition to increasing rates, insurers are limiting the amount of capacity they are willing to offer policyholders with a poor loss history, he said.

"We are seeing increases now. We've gone through the time when we just talked about them," Mr. Galban said.

But the hardening market will not be like the last hard market for D&O in the mid-1980s, when much of the capacity dried up and rates increased sharply, he said.

"I don't think it will be the same. It'll be much more gradual this time," Mr. Galban said

"We are not going to see another meltdown. Most of the companies in the D&O market now are less dependent on reinsurance, so a loss of the reinsurance market would not mean that they would have to slash their capacity," said Mr. Anderson of Marsh.

Insurers are restricting the limits they are writing for problematic accounts, but the hardening market will likely not be a repeat of the market of the mid-1980s, agreed Mr. Schiavone of National Union.

"There are a lot of carriers today and a decent amount of capacity in the market place," he said.

But the rate increases likely will continue for the rest of the year and into next year as the rates no longer reflect the risks that they are covering, Mr. Schiavone said. Over the past several years, loss ratios have increased due to increases in coverage, said Mr. Schiavone of National Union.

In 1995, D&O insurers started offering comprehensive entity or corporate coverage for securities claims and that led to an increase in losses in 1996 and 1997, he said.

The Private Securities Litigation Reform Act of 1995, which was intended to reduce the number of frivolous lawsuits, has had little impact on the number of D&O-related suits filed and the amount of damages that plaintiffs are seeking is growing due to the huge increase in market capitalizations and market volatility, Mr. McElroy.

Contrary to expectations, the Private Securities Litigation Reform Act did not permanently reduce the number of lawsuits, agreed Mr. Schiavone of National Union.

The legislation does help prolong some cases, however, as it did create an obstacle for plaintiff lawsuits, he said. "But that just means that they look for a bigger payback," when the case goes to trial or is settled, Mr. Schiavone said.

In 1995, the average settlement was 10 cents for every dollar of damage estimates whereas today it is more like 15 cents to 20 cents, he said.

A lawsuit which three or four years ago might have sought $25 million to $30 million in damages would now seek about $80 million for the same alleged violations, Mr. McElroy said.

"And I don't see it letting up," he said.

The number of federal securities class actions increased by about 75% between 1995 and 1998, said Mr. Stockton of Janson Green.

"So we are seeing an increase in the frequency of claims and an increase in severity due to the vagaries of the stock market," he said.

Insurers are looking to increase policyholder retentions in response to the increased frequency and size of claims, Mr. Stockton said.

"Companies with market caps of hundreds of millions of dollars will have to take more than a $250,000 retention to be in any way reflective of the exposure," he said.

In particular, insurers will start to look for some degree of co-insurance within the coverage for shareholder claims arising out of alleged securities law violations, said Mr. Anderson of Marsh.

"They want there to be a financial incentive above the retention for policyholders to manage and fight claims a bit harder," he said.

And as exposures increase, some policyholders are seeking to increase their limits, said Mr. Anderson.

"A few years ago, no one wanted more than $150 million, but a lot of companies are looking for capacity well beyond that now and in some situations, they have run into difficulties with excess carriers not willing to write for a rate that conforms with the rest of the program," he said.

As the market hardens, insurers are offering little new coverage. But one new product that emerged this year was coverage against the threat of recision of D&O policies if companies fail to comply with recently introduced regulations for audit committees. The product was developed jointly by Marsh and Global Risk Specialists, a recently launched insurer.

When it was launched, other brokers and underwriters said that they saw little need for the policy and that the audit committee exposure should be covered by the traditional policy (BI, July 3).

Few policyholders have opted to buy audit committee coverage, said Mr. Anderson of Marsh.

"It takes a while to get things going. The same thing happened with employment practices liability coverage a few years ago. I'm not suggesting that we'll see the same demand as we saw for EPLI, but it took two years before that took off," he said.

The Hartford did not offer audit committee coverage as it determined that coverage was already available in the standard D&O policy, Mr. McElroy said.

Audit committees are covered under the standard D&O policy, said Mr. Stockton of Janson Green.

National Union also did not offer the coverage, said Mr. Schiavone.

"It's a nice idea, but I think most people realize that D&O policies just generally don't get rescinded," he said.

"But the audit committee issue is another example of increased exposures, because the committee will be looked at more closely," he said.

Another increased exposure is the implementation of SEC Regulation FD, which took effect in October, said Mr. Podolsky of Willis.

The regulation bars companies from selectively disclosing material information to stock analysts and institutional investors. Consequently, companies will be less able to manage their announcements by warning stock analysts about potential developments. Companies that do not conform to the regulation are subject to fines and penalties.

"There is a concern among policyholders that the D&O policy will not respond to the fines and penalties aspect of the law," Mr. Podolsky said.

The D&O policy does exclude fines and penalties, confirmed Mr. Schiavone of National Union. And there would be public policy issues to address if insurers did start offering coverage to alleviate the affect of a federally imposed fine or penalty, he added.

But the policy would cover defense costs for alleged Regulation FD violations, and in National Union's case, it would also cover costs associated with an investigation of the allegations, Mr. Schiavone said.

Regulation FD could increase D&O losses if companies react to it by restricting the amount of information they release to anybody, Mr. McElroy said. And whereas before, they might reduce the impact of poor results by warning analysts of them beforehand, now they may choose to stay silent. That, in turn, could lead to more market volatility as companies opt to withhold warnings of poor results, leading to dramatic changes in their stock price when the results ultimately are reported.