You know the one about the guy who went to a local diner and then complained, “The food was terrible, and there was so little of it”? The same could be said of directors’ and officers’ liability insurance.
“It’s a whole different animal right now,” says Wayne Salen, director of risk management for First Niagara Financial Group Inc., which just renewed its D&O policy in January. His insurer handed the company a 20 percent premium increase for the same coverage limits. And he’s grateful. In general, D&O premiums are running at least 30 to 50 percent higher this year than last. But it’s the insurer’s attitude that rankles, he says. “Everything was far more intensive, more time-consuming. They just wanted volumes of detail. It was unlike anything I’ve ever seen before, and I’ve been in risk management for 25 years,” says Salen, who is also a board member of the Risk and Insurance Management Society.
This time you can’t blame Enron–at least not entirely, although the losses the insurance industry expects to realize on Enron’s D&O claims are serving as a convenient excuse to raise rates. The industry points its finger at the jump in securities class-action suits in the past year as the main motive for the steep increases.
But this is a bit of a red herring, according to Jim Newman, executive director of Securities Class Action Services. Although the number of suits did jump dramatically, from 293 in 2000 to 511 in 2001, more than 300 of those suits were related to the fraudulent and allegedly widespread practice by underwriters of offering shares in initial public offerings in exchange for kickbacks and other side deals. Even including those anomalous cases, the number of suits per public company has been stable, says Newman.
The real driver of premiums is the recent trend toward astronomical securities class-action settlements, says Newman. The three largest D&O payouts in history were paid or proposed in the past two years: Cendant’s came in at $3.2 billion, Bank of America has proposed $490 million, and Waste Management has proposed $457 million. “In the past, a large claim was $100 million,” says Susanne Murray, senior vice president and D&O liability practice leader at Willis Group Holdings Ltd. “Suddenly, we hit the billion-dollar range.”
The Real Reason
Although insurers aren’t talking about it much, the other reason for D&O increases is that, until 24 months ago, those policies were dramatically underpriced. Many industry watchers say the current increases are simply a long-overdue correction.
Whatever the cause, a policy that formerly cost $400,000 for $25 million of coverage might now cost $1 million. It also may be harder for companies to get all the coverage they seek. Traditionally, D&O insurance policies were written by one primary insurer and a group of secondary insurers, each of which assumed a portion of the risk. Today, companies must line up more carriers to get the same coverage. “Insurers are unwilling to offer as much risk coverage on any one company as they did, mostly because the reinsurance market is less eager to buy it,” says Murray.