Not just because it was the day after Christmas does Duke Energy risk manager Jeffery Triplette recall December 26, 2002, as a particularly glowing time.
On that day, New York district court judge Jed Rakoff threw out 13 shareholder class-action suits alleging that the Fortune 500 utility was using “round trip” trades to overstate revenues. With that stroke of the pen, says Triplette, Rakoff made Duke’s negotiations with its directors’ and officers’ liability carriers a whole lot easier.
The suits, after all, had needed a great deal of explaining. Triplette was then bargaining with the company’s D&O underwriters for a decent renewal of Duke’s three-year policy, which was set to expire in June 2003. Once the lawsuits were dismissed, the company was able to hang on to its existing coverage for another year — but with an increase in the triple digits.
Considering Duke’s size, the fact that it was in the energy sector (think Enron), and the overall hardness of the D&O market, however, that premium hike of more than 100 percent didn’t look all that bad to the risk manager. Triplette feels that he was able to secure as good a deal as he did by talking to his underwriters often, even though the coverage had been locked in for three years. After litigation arose in mid-2002, he met frequently with the insurers, informing them of the claims and the company’s case against them. “We wanted to show the markets we were a good company,” says Triplette, “even though we had some D&O lawsuits to be litigated.”
The effort might pay dividends for Duke on its next policy renewal, slated for June 2004. Indeed, the prospects for D&O buyers in general seem to have brightened considerably in the third quarter of last year.
Both insurance brokers and underwriters say that price hikes for all but the largest and most difficult risks have typically moderated to the low double digits for coverage that’s the same or better. Indeed, some commercial insureds with lawsuit-free records and pristine corporate governance are reportedly enjoying price decreases. Citing Duke’s new CEO, Paul Anderson, as an indication that the company is “on the right track,” Triplette is looking for a D&O price cut in June.
To be sure, the current clearing of the D&O clouds came at the end of a particularly gloomy, scandal-plagued year. In 2003 the average D&O premium bump was 33 percent, according to just-released results of a Tillinghast-Towers Perrin survey of more than 2,000 companies.
Further, the maximum amounts of D&O coverage available to any one company shrank last year to $1.35 billion, according to the Tillinghast study. That was the lowest top level of coverage on the market since 1997.
In the latter part of 2003, however, such tight underwriting began enabling carriers to place bigger bets on the possibility that they wouldn’t have to shell out large sums for judgments against the boards and senior managements of their clients. As the economy improved, say managers who’ve been seeking coverage for their companies, insurers were able to keep prices stable to generate cash flow that funded investments in a rising equity market.
Now that whopping D&O claims payouts may follow in the wake of recent corporate scandals, however, no one can confidently predict a uniformly easy market for buying insurance. Greg Flood, the chief operating officer of National Union Fire Insurance Company, AIG’s D&O underwriting unit, cites Enron and WorldCom as particularly worrisome cases among many unresolved insurance issues. Says Flood, “It’s difficult for the insurance industry until those past expenses are resolved.”
Insurers — bearing in mind potentially large claims against the biggest public corporations and from companies in sectors like financial services and telecommunications — are asking potential insureds in those areas a lot of questions. Corporate buyers have found they need to make the strongest possible case that their directors and officers are less likely to be sued than those of similar-sized competitors.
Nonetheless, things do appear to be easing up compared with two years ago, when underwriters had grown extremely shy of D&O risks. Eager to preserve their profit margins because of the large losses that began to beset the line in 2002, they tended to “increase premiums across the board with little differentiation,” says Lou Ann Layton, national D&O practice leader for Marsh, the largest commercial insurance broker.
In contrast, insurers today are “underwriting to a little closer profitability,” adds Layton, noting that commercial insureds “that are a desirable risk will win in the marketplace.” The triple-digit increases suffered by Fortune 500 companies in 2002 and much of last year are only in the double digits this year, she says. And as for mid-caps, only a company that had undergone “a profile change to make them a worse risk” would see a premium increase of more than 10 percent.
Modern Insurance-Portfolio Theory
Unless convinced otherwise, however, carriers tend to charge the biggest public companies more for D&O insurance and to be more niggardly about coverage, say underwriters and brokers. One reason is that class-action shareholder lawsuits make the biggest news at the biggest companies, according to John Rafferty, a vice president in charge of D&O product management for Hartford Financial Products. And those big-time lawsuits often name board members and management as defendants.
Another reason is that the supply of reinsurance backing D&O policies on the largest corporations has been drying up. That’s because reinsurers, employing a broad, “index-fund-type approach,” observes Rafferty, previously stocked their risk portfolios with large-corporate D&O business from too many primary insurance carriers.
By backing a large number of insurers, he continues, an individual reinsurer also multiplied the chances that it would be exposed to one or more of the “massive settlements” that have been hitting large corporations with big policies in the last few years.
As a result of those bad bets, reinsurers have “gotten religion” about avoiding the risks of litigation, says Rafferty. Today reinsurers are more interested in backing insurers that cover companies with smaller market capitalizations — enabling the reinsurers to lessen their risk of overexposure to a scandal on any one insurance program.
Touchy about Tech
No industry reveals the current tenuousness of the D&O market better than technology. Tech companies have perennially raised red flags for underwriters, according to Flood. “The obsolescence factor is very quick, the expectation of investors is very high, and it’s an extremely volatile industry,” he adds.
From 1996 to 2002, companies in the technology sector settled 121 lawsuits alleging fraudulent increases in share price — more such settlements than for any other sector, according to a study by Cornerstone Research. In contrast, retail/wholesale companies reported 42 such settlements; telecoms, 36; financial companies, 32; and health-care organizations, 28.
The insurers of such companies, of course, aren’t pleased with having to pay for all that litigation. “You need liquidity to make those cases go away,” says Flood.
D&O carriers may be on the verge of losing their distaste for technology companies, however, says Steve Shappell, who heads the claims department at the Aon Financial Services Group. Shappell believes insurers will soon recognize that while securities lawsuits against tech companies may be more frequent, they tend to be less costly than lawsuits against other companies. In fact, during the years tracked by Cornerstone, the median settlement in stock-manipulation cases against technology companies was $5 million — lower than in any other industry.
At the other end of the spectrum, financial companies paid out a median of $9.8 million. Shappell suggests that D&O underwriters are growing increasingly wary of the financial-services sector in the wake of the mutual fund scandal and might look to take on more risk from technology companies.
The third degree that many companies must endure from underwriters can indeed be a pain. But it does have an upside for well-run corporate insureds, say experts: Underwriters are looking more closely at the risks of individual companies rather than making blanket pricing and coverage decisions.
That means that a company in a high-risk sector will be able to pay a decent price if it can show underwriters that it’s not one of the industry’s bad actors. “They’re not redlining anymore,” says Diane Askwyth, director of risk management at Avaya Inc., which secured a lower premium when it renewed its D&O coverage last autumn.
First, however, executives at the Basking Ridge, New Jersey-based seller of corporate telephone and voicemail systems had to exert a big push to distinguish the company in the eyes of its underwriters. “Otherwise, they tend to lump us in with the telecom carriers,” says Askwyth.
Often, the key for risk managers who must strut their companies’ stuff is to take along the CFO — and sometimes the CEO — to meetings with insurers. After all, D&O underwriters “are insuring the integrity of those people,” says Hartford Financial’s Rafferty. “It’s a powerful thing to sit down face to face.”
A big purpose of those meetings is to assure insurance carriers that a company embodies the spirit of good corporate governance and doesn’t simply go through the motions of compliance. In-person meetings also allow the CFO to interpret the company’s financial performance for D&O carriers.
Indeed, Askwyth credits her company’s decreased premium to the “good road shows” presented to insurers by finance chief Garry McGuire. Much of the presentation, according to the risk manager, was a positive description of how the company’s cost-cutting strategy pushed its share price from a little over a dollar at its 2002 nadir to recent readings of about $16. But McGuire also told underwriters about the company’s struggle to cut down its collection periods and its inventory.
Telling “the good, the bad, and the ugly” helped assure the underwriters that they were getting a credible picture of Avaya’s performance, concludes Askwyth. “They’re very worried about performance, because [severe changes in financial performance] lead to stockholder suits,” she says. “That’s the single biggest exposure to underwriters.”