Premiums for directors’ and officers’ (D&O) liability insurance fell 10 percent in 2004, the first decline since 1999, according to Tillinghast’s 2004 Directors and Officers Liability Survey.
At first glance, some observers may suggest that the declining premiums are a signal that insurers are more confident that Corporate America has cleaned up its act in the wake of Sarbanes-Oxley. But on closer inspection, the reason is much more mundane.
Indeed, much of the softening stems from the entrance of new capacity rather than a reduction in claims, Tillinghast found. Competition is especially intense in excess-insurance layers for large public companies, where rates are dropping 10 percent to 15 percent, the report noted.
Even so, the survey of 2,455 companies found that market conditions remain rigid in banking, health services, and real estate and construction.
More broadly, corporate buyers shouldn’t get too comfortable with the lower prices, because the drop could be short-lived. “This soft market for D&O insurance will be shorter and less pronounced due to lower investment returns than in the 1980s, when cash-flow underwriting was prevalent,” said Jim Swanke, managing principal for Tillinghast’s Strategic Risk Financing Practice. (“Cash-flow underwriting” refers to the insurer practice of taking on business that’s not necessarily profitable merely to have the cash to invest.)
“Carriers will likely need to begin increasing rates in the short to medium-term in order to maintain their return on equity,” Swanke said.
Tillinghast officials noted that capacity increased 11 percent to $1.5 billion in full limits from 2003. What’s more, 99 percent of U.S. respondents to the survey reported having D&O insurance.
The survey also pointed out that the top sources of allegations from shareholder and employee claimants were the same for 2003 and 2004. Shareholder complaints focused on general breach of fiduciary duty and inadequate or inaccurate disclosure (including financial reporting and disclosures involving stock or other public offerings). From employees, the most common charges were discrimination and wrongful employee dismissal or termination.
Allegations citing accounting fraud also remained the same, at just 2 percent, despite the increased awareness of the issue.
The research, however, noted a surge in open claims and an increase in settlement costs, which will make it tough for insurers to get a handle on their reserves for D&O liabilities. Throw in the price declines, and insurers could be heading toward a D&O reserve shortfall if discipline does not return to the underwriting cycle, Tillinghast warns.