Should You Buy D&O ASAP?

Rates have dropped, but recent settlements may swing the pendulum in the other direction.

Just three years ago, directors’
and officers’ (D&O) insurance rates
were so high that Ron Foster, then
CFO for troubled fiber-optics giant JDS
Uniphase, threatened to set up a self-insured
facility with other companies rather
than pay the prices insurance companies
were demanding.

That approach would have tied up millions
of dollars in escrow and led to potential
legal complications, but Foster was willing to
risk those headaches because the rates for
D&O liability coverage “were verging on outrageous.”
Indeed, premiums rose an average
33 percent between 2002 and 2003 across all
industries. Foster ultimately got a more reasonable
bill from his insurers, but only after
tough negotiations.

These days the market looks completely
different. Foster, now CFO of semiconductor
test-equipment maker FormFactor, says rates were
down “substantially” when he renewed last May, and
he’s not alone. “It’s a very good market for buyers of
D&O insurance,” says Mike Rice, managing director
for Aon Financial Services. Rates have dropped about
46 percent from their 2003 high and are expected to
fall another 5 to 7 percent this year, according to Aon.
At the same time, many companies are finding it easier to get better terms, so much so that “you can
probably buy as broad a contract today as at any time
in the past 20 years,” says Rice.

But how long can these good times last? Prices
have fallen in large part because officers and directors
have faced less fire: the number of annual securities
class-action filings has decreased by more than 40
percent since early 2004. An absence of major scandals
has helped, and the fact that law firm Milberg
Weiss, renowned for its indefatigable efforts in securities
class-action litigation, has been hamstrung by
its own legal problems may not have hurt either. But
cases that have reached settlement have
become more expensive, up from an average
of $28 million in 2004 to $71 million
in 2005, according to PricewaterhouseCoopers’s
Securities Litigation study. Add to
that the growing prevalence of claims
related to the backdating of stock options,
and the next renewal season could spell
the end of the buyer’s market. As Rice
notes, “The combination of more-frequent
and more-costly suits is what typically
leads to problems,” and half that
equation already seems to be in evidence.

No company seems in imminent danger
of surpassing the Enron and WorldCom settlements ($7.2 billion and $6.2
billion, respectively), but plenty of companies
have been hit with outsized claims,
according to the Stanford Law School
Securities Class Action Clearinghouse.
Nortel and AOL Time Warner each faced
settlements totaling about $2.5 billion, for
example, while Royal Ahold was on the
hook for $1 billion. And those large
claims may set the stage for others
because, as Daren McNally, an attorney
with Connell Foley LLP who specializes
in insurance-coverage litigation, notes,
“highly publicized and extraordinarily
large cases threaten to redefine what’s
considered an appropriate settlement.”

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