What AM Best Says
Competition, Emerging Trends Hit D&O Market
Best’s Market Segment Report (Excerpt): Emerging Risks and Greater Complexity Challenge D&O Insurers (Jan. 28, 2019)
- March 2019
AM Best expects that the profitability of directors and officers liability (D&O) insurance writers will remain pressured over the near term, owing to a number of challenges, including:
- A pricing environment in which rates are not keeping up with the increasing risks.
- Intense competition from a number of new markets.
- Emerging trends such as #MeToo, cyber, and technological developments that could create complexity and systemic losses.
Despite these challenges, supply has not been a constraint in the D&O segment—carriers are continuing to invest capacity in this segment due to a softening catastrophe market and relatively robust balance sheets. The relatively robust price increases in 2012-2014 has been replaced by flattening rates or minimal rate increases. We expect losses in 2019 to continue their upward trend due to increasing litigation and while rates may increase, we believe capacity may constrain a large correction.
Highly competitive market conditions for private and nonprofit D&O are also posing significant challenges. Side A coverage, especially excess continues to see rate erosion as insurers continue to perceive this as attractive. Prudent D&O writers are seeking larger rate increases or striving to steer clear of some of the tougher Side B and Side C risk exposures that have led directly to the recent adverse loss trends. Moreover, the sizable increase in federal securities class action lawsuits over the past few years has revealed a specific area requiring expert risk management from insurers of D&O coverage.
Divergence Between Premiums and Losses
Premiums have been unable to address all of the factors causing the deterioration in claims trends. Direct premiums written have been flat for several years despite a rising calendar year loss ratio. With the proliferation of legal actions against corporate officers resulting from class action suits, the rise in funds supporting shareholder activism, and the growth in overall loss costs, competitive pressure on rates won't be sustainable for the health of the D&O industry. The rate environment on excess layers continues to be soft while the primary layers may have more flexibility in rates as most carriers are risk averse when it comes to primary layer. Some insurers have already strategically shifted from quoting on primary coverage layers, in an effort to avoid areas that are more loss-prone.
Certain segments of the market, including public company D&O, private and not-for-profit companies (particularly those in emerging industries or financially distressed firms), and coverage for new initial public offering companies, have seen rate increases reportedly between 5% and 10%.
However, overall, D&O rates have been relatively flat since 2016, with the rates for private companies especially subject to downward pressure. These rate indications cover a broad spectrum of the D&O market and different risk classes such as life sciences, both public and private company D&O, and nonprofit entities, of varying sizes (small cap, mid cap, large cap). In 2016, efforts by more recent market entrants to build up their portfolios led to largely flat renewal pricing, following the modest average quarterly rate increases in 2014 and 2015—a trend that largely continued in 2017, as capacity remained abundant.
Rates rose in the first three quarters of 2018—albeit modestly, by around 1% each quarter—seemingly in acknowledgement of the need for more conservative pricing. Some insurers are re-assessing their strategies, given that the escalating cost of defending claims is putting insurers of lower excess public company D&O layers closer to a “burn layer”—raising the likelihood that an insured's self-insured coverage retention will be breached and trigger a policy response.
The recent rate firming is likely to continue over the near term, given that current loss frequency and severity trends are resulting in higher losses throughout the D&O market. Some carriers are being more circumspect in deploying their available capacity. Capacity for some of the more complex risks may be available if pricing is appropriate for the risk. However, the added complexity will cause underwriters to be conservative as it becomes difficult to assess these emerging losses.
Number of Securities Class Action Suits Remains Elevated
The worsening claims frequency is due to a number of factors, but the increase in Federal Securities Class Action (FSCA) litigation is a key driver. According to the Securities Class Action Clearinghouse, filings of federal securities class action lawsuits have risen dramatically in recent years. In 2017, the number of lawsuits grew 52% from the prior year, during which the initial calendar year direct loss ratios for D&O rose as well. Through the third quarter of 2018, the number of lawsuits for the year was set to remain on par with 2017, but the segment's direct loss ratio declined to 55.5 and was more in line with 2015 and 2016 performance. Nonetheless, according to many industry observers, securities-related claims, and their negative impact on D&O results across the industry, will continue to rise in 2019.
IPOs in particular have consistently been a target for class action suits and have thus been quite a challenge for D&O insurance providers. Coverage for new IPO companies has become harder to place following the Cyan Inc. v. Beaver County Employees Retirement Fund case, in which the Supreme Court decided that lawsuits brought under Section 11 of the Securities Act of 1933 can be filed in state court, as opposed to limiting them to federal court. The upshot for IPO companies and their insurers is that the Cyan decision allows plaintiffs filing class actions in securities cases to avoid federal court and instead file in state court, which is more favorable to plaintiffs asserting that they were misled by companies in which they invested. Class action lawsuits often arise when stock prices drop precipitously. The effect on DCC (defense and cost containment) expenses will be exacerbated, as insurers could be on the hook for more defense costs from law firms with expanding war chests. Considering the stock market's volatility in the latter half of 2018, when gains from earlier in the year were wiped out, we may see a further spike in lawsuits at the beginning of 2019.
The #MeToo Movement, Cyber, and Innovative Technology Pile on the Pains
The allegations of sexual misconduct involving men in powerful positions—prominent media figures, politicians, athletes and corporate executives—have the potential for loss creep from employment practices liability to D&O as the board involvements and their roles and responsibilities get scrutinized.
The newly implemented GDPR (General Data Protection Regulation) in the EU places increased responsibility on corporations to protect the privacy of consumers and these monetary fines could be a significant impact to bottom lines. France, for example, recently fined Google $57 million for violation of GDPR and reports indicate that the Federal Trade Commission (FTC) is weighing whether to fine Facebook for some of its past actions and privacy lapses. The GDPR and increased scrutiny of SEC and other regulators around the world can cause increased scrutiny of terms and conditions of D&O policies to identify explicit coverage and exclusion terms. Insurers are also examining the impact of companies adopting innovations such as blockchain, artificial intelligence technologies and the ramifications it may have on their coverage in general, and D&O in particular.
These claims have been tremendously impacted by social media's effect on the speed, strength and breadth of the movement. The result has been a growing number of lawsuits alleging corporate misconduct, leading to shareholder derivative actions. To combat the proliferation of these types of claims, corporations may choose to be proactive by providing necessary training, including scenario role play. From a risk management perspective, further educating employees about potential misconduct or harassment issues will also help get ahead of potential disputes. Helping policyholders/clients take steps to avoid sexual misconduct allegations, would exemplify prudent risk management for D&O insurers.
Leading Insurers Remain Steady While Facing Challenges
As the competitive market for D&O coverage shifts in response to loss frequency and severity developments, and new risks requiring revised strategies emerge, insurers—especially those with a sizable amount of market capacity—and appropriate risk management capabilities may look to re-orient coverage, pricing, reinsurance strategies and relationships to maintain their business profile without compromising on operating performance.
In many cases, market leaders are further leveraging their strengths to bolster relationships with brokers and clients. Based on financial statements filed through the first three quarters of 2018, seven of the top 15 D&O insurers reported yearly decreases in their direct D&O loss ratios, indicating an improvement in performance for the top writers as a whole, considering that 12 of the 15 reported increases for full-year 2017. Third quarter data, however, may not be a true indicator of annual results as insurers typically may do an annual reserve reviews, true up their adjustment expenses, and other costs in the fourth quarter.
The Best's Market Segment Report is available at http://www3.ambest.com/bestweek/bestweekreports.aspx?RT=sr.