Property/Casualty Market Report: Financial crisis pushes some D&O rates sharply higher; But many buyers outside of finance see prices fall further

Property/Casualty Market Report: Financial crisis pushes some D&O rates sharply higher; But many buyers outside of finance see prices fall further

January 19, 2009 – Business Insurance

The financial crisis has driven up the frequency and severity of securities fraud claims, but directors and officers liability insurers were taking a measured response at year-end renewals, market executives and risk managers said.

D&O insurance rates have ballooned as capacity has shriveled for financial institutions, the litigation targets that securities fraud plaintiffs have focused on so far, according to market experts. Companies with large market capitalizations also faced tightening market conditions.

But most other risks, including some traditionally tough-to-place buyers, were negotiating lower or flat rates and obtaining as much capacity as they wanted, experts said.

“There are two separate areas” of the D&O insurance market-“financial institutions and everyone else,” said Lou Ann Layton, a managing director with Marsh Inc. in New York.

“The market as a whole is still fairly soft,” said broker Karen Kutger, a Philadelphia-based vp for Professional Risk Solutions L.L.C.

“There are rate decreases, but this is a transition from a soft market environment to a hardening market environment,” said Nikolaj Beck, the Zurich, Switzerland-based head of Industrial Risk Insurer, a division of Swiss Reinsurance Co.

The overall market to date has not tightened even with securities fraud claims spiking since mid-2007.

Plaintiffs last year filed 210 securities class actions compared with 176 in 2007, according to the Stanford Law School Securities Class Action Clearinghouse in Palo Alto, Calif., in cooperation with Cornerstone Research of Boston.

The final 2008 tally is the biggest total since plaintiffs filed 215 securities class actions in 2004, according to the clearinghouse.

Subprime-related allegations are having an increasing impact on securities claims, the report says.

D&O underwriters understand that the financial institutions sector is driving up claims and have responded in a measured way so far, insurers and brokers say.

“The D&O underwriting community is very good at reacting to circumstances, but not anticipating circumstances,” said Carl Pursiano, a New York-based senior vp with Liberty International Underwriters, a unit of Liberty Mutual Group Inc.

That response amounts to boosting financial institutions’ D&O insurance rates 20% to 100% while halving their limits, according to market experts.

In addition, “anything related to leverage,” or debt-financed investments, has “become very difficult” to underwrite and, therefore, the coverage is increasingly expensive, said Greg Flood, the New York-based president of IronPro, a division of Bermuda-based Ironshore Insurance Ltd.

Those risks include real estate and asset management operations, Mr. Flood said.

Insurers also are reducing capacity offered to hedge funds and private equity firms, he said.

“The list keeps getting longer,” Mr. Flood added.

However, midsize financial institutions have faced smaller rate hikes and generally can obtain as much capacity as they need, Marsh’s Ms. Layton said.

“I think carriers are acting fairly regarding the financial institutions sector,” said Mike Rice, the Denver-based chief executive officer of Aon Financial Services Group, a unit of Aon Corp.

Despite the drastically tightening D&O market for financial institutions, their rates remain less than half of what they were at the end of 2003, Mr. Rice said.

Large market cap companies and smaller companies that have seen their market cap shrink also face rate hikes ranging from 5% to 20%, Mr. Pursiano said. Insurers are wary of those risks, too, because they traditionally are prime targets of securities fraud plaintiffs, he said.

Meanwhile, “it’s still competitive elsewhere” for most risks, according to Mr. Rice.

D&O buyers were able to negotiate rate cuts throughout the fourth quarter, though reductions were “narrowing a bit” from the 11.3% cuts on average that insurers offered during the third quarter, Mr. Rice said.

Mr. Pursiano estimated that underwriters were cutting rates 5% to 15% for attractive risks.

Privately held companies could more easily negotiate a 10% reduction, while publicly traded companies could expect 5% decreases, Professional Risk’s Ms. Kutger said.

Insurers are “trying to hold as much rate as they can, because of the financial institution claims that they know they’ll have to pay,” she said.

Ultimately, insurers have to engage in “cash-flow underwriting to get premium on the books to pay those claims,” Ms. Kutger said.

Meanwhile, “there’s every bit as much capacity as there was a year ago,” Mr. Rice said. “In fact, I might say you could get more” limits now than a year or so ago, he said.

Liberty International’s Mr. Pursiano agreed but also said he has seen some buyers who are troubled about how potential claims would be handled voluntarily limit their capacity options to steer clear of insurers if they or their parent companies are financially stressed.

Marsh’s Ms. Layton agreed. She also noted that those buyers pay more for their coverage.

For nonfinancial risks, insurers also are not pushing tougher terms and conditions, market experts said.

But some D&O buyers opted for larger deductibles in exchange for bigger rate cuts, Aon’s Mr. Rice said.

Even traditionally tough risks-including pharmaceutical, biotechnology, health care and telecommunications companies-negotiated rate cuts at year-end renewals, Aon’s Mr. Rice said. Their rates, however, still are higher than those for other nonfinancial sector risks, he noted.

Rates for energy and consumer staples companies, however, also were headed up, generally tracking their respective 10% and nearly 5% increases during the third quarter, Mr. Rice said.

While the D&O market is not as soft as it has been in recent years, some risk managers have higher priority concerns than their rates.

“I see people focusing on the global aspect of D&O,” said Leslie Lamb, manager-global risk management at Cisco Systems Inc. in San Jose, Calif.

D&O coverage for management in foreign countries “needs to become more efficient” in managing claims and issuing policies, Ms. Lamb said.

For the first half of 2009, several experts predicted continued stabilization of rates, but with some risks able to negotiate small decreases.

But Swiss Re’s Mr. Beck said he expects that most risks will face rate hikes during 2009 as insurers’ loss experience deteriorates.

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