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Concern over deteriorating D&O market

Fears over deteriorating conditions in the market for US Directors’ and Officers’ insurance (D&O) have been confirmed by actuarial consulting firm Tillinghast in its annual survey on the sector.

Based on data compiled from 2,409 US participants and 46 Canadian participants, the survey’s D&O Premium Index registered a 10 percent fall in coverage costs – the first premium decrease since 1999 – as the median premium index reached its lowest point since 2001.

A total of 53 percent of US respondents said that they had experienced an increase in premiums from the previous year, while 32 percent reported a fall in coverage costs.

According to the report, much of the softening has been caused by new capacity entering the market, rather than a reduction in claims activity, as capacity increased from $1.35bn to $1.5bn. Indeed, claims frequency increased 11 percent from 2003 to 2004, with claims susceptibility up 6 percent.

The biggest falls in rates are occurring in the market for excess layers of coverage for large public companies, with deteriorations of 10 to 15 percent.

But despite the general softening, the report identified pockets of hard market conditions, particularly in banking, health services, and real estate and construction.

Jim Swanke, who heads up the company’s Strategic Risk Financing Practice, commented: “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.

Carriers will likely need to begin increasing rates in the short to medium term in order to maintain their return on equity.

Terms and conditions also deteriorated compared to the previous year, with increases in limits reported by companies with less than $400mn in assets and those with greater than $2bn.

Twenty-eight percent of US participants reported increases in deductibles, down from 44 percent in last year’s survey, while 65 percent registered no change in deductibles – up from 44 percent last year. Increases in deductibles were concentrated in the companies with assets over $2bn.

Elissa Sirovatka, who led the survey, said: “What's disturbing is that this is occurring at the same time that frequency and settlement costs are still rising.

The continued increase in the average cost to settle D&O claims combined with the significant number of open megaclaims makes a tough case for a sustained soft market. The claim conditions we're seeing justify premium increases rather than decreases.

The increase in open claims along with the increasing settlement costs will make it difficult for insurers to get a handle on their reserves for D&O liabilities. Couple this with premature pricing declines and a softening market, and insurers could be heading toward a D&O reserve shortfall if we don't start to see more disciplined underwriting and adequate pricing,” she warned.

The company also warned of the implications for reinsurers of current conditions and the threat of the megaclaims. It said that reinsurers will become “more cautious” in their support of multiple carriers’ D&O programmes to limit losses from any single occurrence, such as the impact of an Enron-style scenario.

Analysts from Morgan Stanley summed up the implications of the report, raising concerns over some of the business written in the softening market.

Prices are declining for many accounts, terms and conditions are loosening at the margin, and the frequency and severity of claims does not seem to be improving. That could mean that the profitability of recently written D&O business might not be as robust as many insurers envisioned,” they warned.

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