Client Advisory: Public Company D&O Insurance Market Update - August 2020
Hard market shows no signs of improving soon
There has been no shortage of recent public commentary on the very challenging market conditions for public company Directors and Officers (D&O) Liability Insurance. Fueled by several years of poor underwriting results created by inadequate rates, and a significant increase in the frequency and severity of claims, D&O insurers are aggressively seeking significant premium and retention increases. At the same time, we’ve seen a marked decline in underwriting competition as insurers take a conservative approach to managing their capacity and be much more selective and frankly somewhat opportunistic in considering new business opportunities. From a buyers’ perspective, this is the worst trading environment in well over 15 years, and, if anything, the pace of the market deterioration over the past 18 months only seems to be getting more pronounced. The economic and financial impact of COVID-19 on clients in many industry verticals has only exacerbated the turmoil in an already deeply troubled D&O market.
On the claims front, Securities Class Action (SCA) filings are at a record high, with almost 9% of all public companies being sued for securities fraud in 2019. The mid-year 2020 SCA statistics were a little more encouraging insofar as only 182 SCA lawsuits were filed in federal and state courts in the first half of this year versus 207 filings in the same period in 2019. Nonetheless, the number of 2020 filings still greatly exceeds historical norms. And the fact that there are fewer public companies now means the chances of a company being sued now are relatively higher.
Merger & Acquisition (M&A) litigation is still a key driver of SCA claims activity, but more recently we’ve seen a significant escalation in “Event Driven” litigation where directors and officers have been sued for their alleged mismanagement of underlying issues as wide ranging as cyber breaches, privacy, board diversity, the opioid crisis, wildfires, accidents, regulatory investigations and sexual harassment. COVID-19 has also already led to D&O litigation against more than a dozen companies for a variety of alleged underlying causes. Lastly, settlement values and legal defense costs continue to rise. It’s not unusual today to see partner rates at close to $2,000 per hour at leading defense firms.
From a pricing perspective, in our McGriff March 2020 Market Outlook we predicted that most companies would see total program renewal premium increases of 25% (with potentially much higher increases for risks perceived by underwriters to be more challenging). That guidance, in hindsight, largely proved to be overly optimistic. For most perceived high quality risks, 25% increases on primary layer placements are now fairly commonplace, but the cost of excess layer placements has surged based on underwriters’ insistence on higher increased limit factors (ILF), especially on lower ‘working layer’ attachments. Not so long ago, insurers regularly assessed excess layer premiums using ILFs of 50% to 60% in relation to the underlying layer premiums. In today’s market, however, ILFs for excess layers are more likely to be higher than 80%. Meaning clients who buy large layered program towers will see the cost of excess layers easily increase 75% to 100% of expiring premiums (and that assumes the primary layer premium "only" increased by 25%). Side A coverage layer pricing is still relatively reasonable versus the cost of traditional A/B/C excess layer pricing, but for companies that are viewed to have potential bankruptcy or financial insolvency risk, we have seen dramatic year-over-year premium increases on Side A towers. At best, we are seeing new floors being set on Side A towers in terms of underwriter requirements for minimum premiums.
The foregoing comments on market pricing relate to clients that are generally positively viewed by D&O insurers. For companies in certain industry sectors that have been most directly affected by COVID-19 (retail, hospitality, airlines, etc.), D&O program premiums can in some instances increase by multiples of the expiring premium basis.
Due to the historical frequency of SCA claims in their sector, Life Science and biotech clients can expect to continue to have a difficult time securing reasonably priced D&O coverage. And following the U.S. Supreme Court’s Cyan ruling (discussed at length in our March Outlook), companies undergoing Initial Public Offerings (IPO) or within a 3-year window of their IPO, will have a particularly difficult time with placements. Retentions are another area where clients are under pressure and now required to assume more risk for indemnifiable and Entity securities claims. It’s not uncommon for companies that had, for example, a $2.5 million retention for Securities Claims in the past to now have to accept renewal program options with a $5 million retention.
For the most part, we are pleased to report that coverage quality largely remains robust. We have not seen meaningful efforts from the market to materially alter or pull back coverage terms and conditions that we have carefully negotiated over the years. Some insurers however are looking to either reduce or eliminate sub-limited coverage for investigative costs associated with shareholder derivative demands and Books and Records coverage. We also note that many insurers are looking to amend Discovery or Extended Reporting Provisions to be unilateral and/or no longer subject to pre-determined pricing. On Side A towers, underwriters are seeking to remove limit reinstatement options that are a common feature of many client programs.
Like any other market, the changes we see today are simply a function of supply and demand. Global underwriting capacity supporting the U.S. public company D&O product line is clearly constrained and there have been very few, if any, meaningful new market entrants since Allianz and Berkshire Hathaway started writing D&O insurance more than five years ago. In that same period of time, in the P&C insurance industry, M&A activity has reduced the number of D&O insurer providers whereas other carriers have simply shuttered their underwriting operations due to profitability concerns.
Underwriting capacity for public company D&O insurance is still theoretically in excess of $1 billion, but in reality the practical underwriting capacity available to any one client is probably half that. As insurers continue to see significant increases on their renewal portfolio, they are often reluctant to take on new business opportunities unless the pricing and terms are strongly in their favor. It is hard for anyone to assume that the current hard market cycle will improve until we see new capital move into the D&O space. Based on the current pricing trends, we would be surprised not to see some form of capital influx in the coming months.
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