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Profitability in the U.S. directors and officers liability insurance market remains pressured amid unfavorable claims trends and a pricing environment that has not kept up with increasing risks, according to a new report from A.M. Best Co. Inc.
“Intense” competition from a number of new markets and emerging trends such as the #MeToo movement, cyber and technological developments could create complexity and systemic losses in the D&O market, according to the Best report released on Monday.
But insurers are continuing to invest capacity in the D&O market due to a softening catastrophe market and relatively robust balance sheets, according to the report.
“The relatively robust price increases in 2012-2014 (have) been replaced by flattening rates or minimal rate increases,” the report stated. “We expect losses in 2019 to continue their upward trend due to increasing litigation and while rates may increase, we believe capacity may constrain a large correction.”
Highly competitive market conditions for private and nonprofit D&O are also posing significant challenges, according to the report.
“Side A coverage, especially excess, continues to see rate erosion as insurers continue to perceive this as attractive,” the report stated. “Prudent D&O writers are seeking larger rate increases or striving to steer clear of some of the tougher Side B and Side C risk exposures that have led directly to the recent adverse loss trends.”
Side A covers directors, officers and employees for claims when indemnification by the corporation is not available; Side B provides indirect coverage for directors and officers for the benefit of the corporation by compensating the company or organization for claims paid on the board member's behalf; and Side C covers company's liabilities when it is sued along with its directors and officers in shareholder litigation.
Premiums have been unable to address all of the factors causing the deterioration in claims trend as direct premiums written have been flat for several years despite a rising calendar year loss ratio, according to the report.
“With the proliferation of legal actions against corporate officers resulting from class action suits, the rise in funds supporting shareholder activism, and the growth in overall loss costs, competitive pressure on rates won’t be sustainable for the health of the D&O industry,” the report stated. “The rate environment on excess layers continues to be soft while the primary layers may have more flexibility in rates as most carriers are risk averse when it comes to primary layer. Some insurers have already strategically shifted from quoting on primary coverage layers, in an effort to avoid areas that are more loss-prone.”
Certain segments such as public company D&O, private and not-for-profit companies and coverage for new initial public offering companies have seen reported rate increases between 5% and 10%, but overall D&O rates have been relatively flat since 2016, with the rates for private companies especially subject to downward pressure, according to the report.
Rates rose modestly in the first three quarters of 2018, by around 1% each quarter, “seemingly in acknowledgement of the need for more conservative pricing,” the report stated. “The recent rate firming is likely to continue over the near term, given that current loss frequency and severity trends are resulting in higher losses throughout the D&O market.”
The increase in federal securities class action litigation is a key driver for worsening claims frequency, according to the report. In 2017, the number of lawsuits grew 52% from the prior year, with the number of lawsuits seen on par through the third quarter of 2018.
“IPOs in particular have consistently been a target for class action suits and have thus been quite a challenge for D&O insurance providers,” the report said. “Coverage for new IPO companies has become harder to place following the Cyan Inc. v. Beaver County Employees Retirement Fund case, in which the Supreme Court decided that lawsuits brought under Section 11 of the Securities Act of 1933 can be filed in state court as opposed to limiting them to federal court.”
“The allegations of sexual misconduct involving men in powerful positions — prominent media figures, politicians, athletes, and corporate executives — have the potential for loss creep from employment practices liability to D&O as the board involvements and their roles and responsibilities get scrutinized,” the report continued.
The EU’s General Data Protection Regulation “places increased responsibility on corporations to protect the privacy of consumers and these monetary fines could be a significant impact to bottom lines,” the report stated, noting France’s $57 million fine against Google for violation of GDPR. “The GDPR and increased scrutiny of SEC and other regulators around the world can cause increased scrutiny of terms and conditions of D&O policies to identify explicit coverage and exclusion terms.”
The top 15 insurers maintained their market share, at just under 81%, while overall industry D&O premium rose 2.2%, reflecting rate increases in select lines and demand growth consistent with the overall economic growth, according to the report.
While employment practices liability insurance is the primary focus of claims in connection with the “#MeToo” movement against sexual harassment, directors and officers liability insurance is being affected as well.