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D&O rates softening amid stable capacity

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Many risk managers are negotiating cheaper and broader directors and officers liability coverage, despite unfavorable severity results for underwriters, and the prospect of further market softening is strong, market experts say.

"I'd describe the market as single-digit soft," with rates for most buyers dropping 4% to 5% on average at renewal, said Tony Galban, a senior vp and the global D&O underwriting manager for Warren, N.J.-based Chubb Corp.

But the range of rate decreases can be as wide as 5% to 15%, with the biggest swings available in the excess market, said Lou Ann Layton, a managing director and the national D&O practice leader for Marsh Inc. of New York. Rates for excess coverage range from 75% to 80% of the underlying rate, but can be as low as 60%, Ms. Layton said.

In addition, buyers that had bad claims experience earlier in the decade "but now are back on their feet" can negotiate even greater rate reductions than most risks, said Greg Flood, an executive vp and the chief operating officer at National Union Fire Insurance Co. of Pittsburgh, Pa., a subsidiary of New York-based American International Group Inc. Mr. Flood explained that buyers with claim problems a few years can negotiate those sharper rate cuts because their expiring rates were so much higher than the average rate.

The most attractive, publicly owned risks for underwriters are small-market companies with capitalizations of less than $1 billion, followed by midmarket companies with less than $10 billion in capitalization, brokers and insurers report.

Because of their generally pristine experience, small-cap companies can command rate decreases of as much as 25%, while mid-cap companies can cut their rates up to 10%, said Carl Pursiano, a New York-based senior vp with Liberty International Underwriters, a unit of Liberty Mutual Group Inc.

"There are quite a few of those companies to choose from, so they're good business to pick up," Mr. Pursiano said.

Because they are the favorite targets of shareholder class action lawsuits, large-cap companies typically are renewing their coverage at expiring rates at best, Mr. Pursiano said.

Other large-cap companies with recent loss history problems or in industries that generate an inordinate number of shareholder claims—such as financial institutions and pharmaceuticals—should expect rate hikes of up to 10%, according to market experts.

And while companies involved in initial public offerings are not faring any worse at renewal, the loss experience of IPOs over the past 36 months suggests they should be paying higher rates, said National Union's Mr. Flood. That has not happened, but it may be in the offing, he said.

But even large companies or those in troubled industries can negotiate better renewal deals if they have a strong risk profile, Marsh's Ms. Layton said.

Coverage changes

While capacity remains stable— $1.2 billion, according to Marsh's estimate—buyers have been able to purchase additional D&O coverage because of insurers' willingness to utilize a greater portion of their capacity, market executives explained.

Market executives say buyers typically are using additional capacity to bolster Side A difference- in-conditions coverage. Those policies sit above traditional ABC policies to cover only directors and cannot be frozen as a corporate asset if an organization enters bankruptcy.

In addition, some organizations are buying $10 million to $15 million of additional Side A coverage or carving out a similar chunk of limits from their existing $50 million of Side A limits to cover only independent directors, Chubb's Mr. Galban noted.

He said he would not describe that purchase activity as "a wave" but said he expects to see more of it. Because independent directors typically are not held accountable for losses, dedicated Side A limits are sufficient to cover their defense costs, Mr. Galban said.

The softer D&O market means that terms and conditions are open to negotiation as well, according to market executives.

For example, Ms. Layton said that underwriters currently require "very few" buyers to accept coverage that provides only one set of limits in response to activity that generates both D&O and separate fiduciary liability claims.

Underwriters also are willing to provide employed-lawyers coverage in D&O policies to cover claims against the general counsel or legal departments that advised company boards on activities that later prompted shareholder claims, Ms. Layton said.

But "more and more buyers" also are paying closer attention to their policies' conduct exclusions and are not automatically seeking the most generous coverage terms, Mr. Galban said.

Some organizations have determined that arranging coverage that responds until shareholder fraud litigation has ended in a nonappealable adjudication "can be way past where a company feels an individual is guilty and should be out of coverage," he said.

But broker Steve Shappell said he sees buyers headed in the opposite direction with exclusions that bar coverage if shareholders successfully sue officials for personally profiting from their misdeeds. More buyers want that coverage to respond far longer into the litigation process, he said.

Conditions to remain

Market executives predict that current D&O market conditions will continue throughout 2007, even though claim severity has been dramatically rising.

But excluding a few outlier settlements, the median settlement value of shareholder claims dropped in 2006, said Mr. Shappell, a managing director in Denver in the legal and claim practice at Aon Corp.'s Financial Services Group. Combined with an increase in the number of lawsuits that are being dismissed, the more competitive D&O market "really doesn't surprise me that much."

Another important factor is that D&O underwriters have not faced any problems in arranging their reinsurance, "so there's no impetus" for the underwriters to halt rate cuts or hold firm on coverage terms, said Gary Dubois, a New York-based senior executive with Bermuda-based Ariel Reinsurance Co. Ltd.

"If anything, it could be a precursor of further softening in the market," said Mr. Dubois, who is working on setting up a U.S. operation for Ariel.

But Chubb's Mr. Galban asserted that D&O insurers are approaching "a fork in the road." He said underwriters soon would have to decide whether the decreasing number of shareholder class action claims will pull down loss severity as well or whether claim frequency—and, as a result, severity—is bound to spike again.

Regardless, said National Union's Mr. Flood, "the rate drops are not so significant as to eliminate our margins."