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Article | FINEX Observer

Excess D&O for public companies: No longer an afterthought

Financial, Executive and Professional Risks (FINEX)
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By Lisa Spiller | November 18, 2019

There has been much discussion of the firming of the public company directors and officers (D&O) liability insurance market. A recent twist is what is happening in the excess D&O market.

There has been much discussion and awareness of the firming of the public company directors and officers (D&O) liability insurance market. A relatively recent twist to this discussion is what is happening specifically in the excess D&O market. In Q2 of 2019, our proprietary rate trending analysis report depicted increases in the traditional excess D&O coverage outpacing primary rate increases. The trend widened in Q3. This is the first time in nearly 20 years we have seen this phenomenon occur.

Definitions

In discussing excess D&O insurance, some industry terminology is used and is important to understand. Rate per million (RPM) and rate-on-line (ROL) or increased limits factor (ILF) are key terms with corresponding acronyms frequently employed in reviewing programs.

Rate per million (RPM) = Premium for the layer (limit for the layer/$1,000,000).
Example: A $10,000,000 limit for $100,000 premium is $10,000 RPM.

Rate-on-line (ROL) = Percentage rate used to describe the RPM. In the above situation, the ROL is 10%.

Increased limit factor (ILF) = The RPM of the excess/RPM of the layer below.
Example: The primary premium for a $10,000,000 limit is $100,000, and the first excess $10,000,000 limit excess $10,000,000 limit is $50,000. The primary RPM is $10,000 and the first excess RPM is $5,000. The ILF is $5,000/$10,000 = .50 or 50%. A way of stating this is the first excess is receiving 50% of the premium the primary is receiving on a RPM basis. Note: Some industry professionals also refer to this as rate-on-line (ROL).

Attachment point = On a layered program, this is the combined value of the limit below where the respective insurance carrier begins its coverage. Keep in mind that retentions on the primary are generally not included in these calculations.
Example: The primary carrier has a $10M limit, the first excess a $10M limit, and the third excess a $10M limit. The attachment point for the first excess is $10M and the second excess is $20M.

Background

Over the past 10-12 years, excess rates were decreasing year over year. A decade ago, a 70% or higher ILF for the first excess was very common. Fast forward to 2018 and we saw many insureds' first excess ILFs between 50% – 60%, and on rare occasions, some even going lower than 50%! The ILFs for the second excess and above continued to decline over time as well.

Many carriers were amending their stated minimum premiums at each renewal cycle as well. In 2007, excess of $100M attachment point, any premium under a $10,000 RPM was a huge success! Fast forward to 2017, and many carriers were quoting an excess RPM at MUCH lower attachment points for $3,000 per million (or sometimes even less). Keep in mind, this was not just for Side A only coverage, but full, standard D&O coverage! Given the extreme and prolonged aggressiveness we experienced in the excess market, it was not uncommon for the end result of a D&O tower renewal to achieve a double-digit premium decrease after starting with a flat (no change) or even a small increase on the primary layer.

How was this achievable? Several factors came into play, but most notably was that supply outpaced demand and carriers were hungry to win business. There were many new entrants into the U.S. D&O market, some with recognized and respected names. Entering a D&O market as a new carrier, it is very challenging to be considered as a primary alternative. Newer entrants, therefore, often targeted excess capacity and were willing to quote well below expiring pricing. Incumbent and tenured carriers were fully aware of the market dynamic, most often did not want to lose the excess position on the tower, and were generally agreeable to lower pricing, sometimes quite dramatically in order to maintain their position on the account.

Today

What has changed in 2019 that excess D&O markets are now quoting rate increases in excess of primary increases? The insurance carriers' rationale:

  1. Rates on the excess went down dramatically over the past decade — at a much larger percentage than the primary.
  2. Loss ratios: Excess books (outside of Side A only) were performing worse from a loss ratio perspective than their primary books.
  3. Frequency and severity of securities class action (SCA) claims are up (see graphs below). It is more likely for a company to be sued than in prior years, and the median and average settlement values suggest lower layer excess carriers are contributing to more settlements. Additionally, defense expenses are not part of these settlement figures, and defense expenses, which are covered under D&O insurance policies, can be quite significant.
  4. The number of publicly traded companies is down significantly since 2000, so there are fewer comparable insureds paying D&O premium. There were 7,994 listed on U.S. exchanges in 2000 and 5,350 in 2018 (33% decrease).
  5. Mega settlements (over $100M) were up in 2018, and carriers believe there are more in the pipeline for 2019 and beyond. A $100M settlement could very likely involve 8 – 12 carriers, with many or all carriers contributing their full limits of liability. Point to consider: Using a $5,000 RPM, it takes 200 placements $10,000,000 in capacity to equal a full $10,000,000 loss.
Filings data based on The Stanford Law School/Cornerstone’s Securities Class Action Clearinghouse website and its Securities Class Action Filings: 2018 Year in Review.  The frequency and severity of securities class action (SCA) claims are up considerably over the last 10 years from 175 total filings in 2010 to 412 through Q3 2019. It is more likely for a company to be sued now than in prior years.
Filings

(as of October 1, 2019)

(Filings based on The Stanford Law School/Cornerstone's Securities Class Action Clearinghouse website and its Securities Class Action Filings: 2018 Year in Review.

Settlements data based on Nera’s Recent Trends in Securities Class Action Litigation: 2018 Full-Year Review.  The median and average settlement values suggest lower layer excess carriers are contributing to more settlements.  In 2018, the average annual settlement value is $69 and the median annual settlement value is $13.
Settlements

(as of January 2019, in million US$)

(Settlements based on Nera's Recent Trends in Securities Class Action Litigation: 2018 Full-Year Review.)

Example

Below is an example of the current market dynamic. For ease of calculations, all layers are $10M in capacity.

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If Expiring ROLs are followed
Limit (M's) Retention Attachment (M's) 2018 Premium RPM ROL / ILF 2019 Premium RPM ROL / ILF $ Change % Change
$10 $1M $200,000 $20,000 $230,000 $23,000 $30,000 15.00%
$10 xS $10 $100,000 $10,000 0.500 $115,000 $11,500 0.500 $15,000 15.00%
$10 xS $20 $55,000 $5,500 0.550 $63,200 $6,320 0.550 $8,200 12.50%
Total through $30M $355,000 $408,200 $53,200 12.50%


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Example of increasing ROLs up the tower
Limit (M's) Retention Attachment (M's) 2018 Premium RPM ROL / ILF 2019 Premium RPM ROL / ILF $ Change % Change
$10 $1M $200,000 $20,000 $230,000 $23,000 $30,000 15.00%
$10 xS $10 $100,000 $10,000 0.500 138,000 $13,800 0.600 $38,000 38.00%
$10 xS $20 $55,000 $5,500 0.550 $83,000 $8,300 0.601 $28,000 50.91%
Total through $30M $355,000 $451,000 $96,000 27.04%

The expiring premium on the primary was expiring $200,000, and the first excess was $100,000. This is a 50% ILF. At the renewal, the primary achieved a 15% premium increase — to $230,000. If the first excess followed the 15% increase, the renewal premium would be $115,000. In today's market, ILFs are also rising. At an ILF of 60%, the renewal premium of $138,000 is $23,000 more than if they just agreed to follow the 15% primary rate increase. Further, the second excess also quoted a 60% ILF. The compounding effect is a premium increase of 51% for the second excess. The end result: a 15% primary increase compounded to a 27% overall increase.

Expectations

It is not uncommon today to see excess carriers quoting ILFs anywhere from 65% – 100% (or more in extreme cases). We are also seeing carriers manage their capacity. It is not uncommon for a carrier who had $15M or more at expiring to want to reduce their capacity to $10M. Currently, there is not a problem replacing this capacity, but it will cost more than the expiring capacity.

Recommendations:

  • Make sure your broker understands this market dynamic, keeps you apprised and differentiates your risk profile in the marketplace. Start the renewal process early but anticipate that the market will continue to rapidly change and evolve.
  • Involve excess insurance carriers in underwriting meetings with senior executives. Consider allocating additional time with key excess players and not just the primary carrier.
  • Be open to potentially new program structures and insurance carriers.
  • Discuss with your broker the claim handling reputations of the current and proposed carriers. With the increased likelihood that excess carriers will be involved in the event of a loss, it is critical to have excess carriers who have experience in effectively handling complex claims.

Conclusion

The good news is that getting the desired excess capacity is not difficult for most companies (D&O limits for IPOs and companies with troubled risk profiles can be a challenge). Even buying higher limits is generally not a problem. The bad news is that it will likely cost considerably more premium for the same limits. Insurance carriers are no longer aggressively competing for excess layers, even when the incumbent is seeking a significant increase. So, while your primary D&O insurance relationship is extraordinarily important, it is only the first step in building your D&O program. The excess renewal negotiations may prove to be more challenging than your primary negotiations, and negotiating excess placements will also take longer than they have in the past. Making budget projections based on any guidance received from your primary carrier only without factoring in the compounding effect of the excess layers will likely be inaccurate. While there is still plenty of excess capacity in the market, carriers are displaying pricing discipline and it is simply costing more.

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FINEX D&O Observer Fall 2019 PDF 6.5 MB
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