D&O woes continue

D&O woes continue – Liability

Lori Widmer

Increased media attention to “accounting irregularities,” the uneasiness of the current stock market, escalating insurance prices and changing policy terms, as well as continued scrutiny by Congress make for an alarming situation in the D&O industry.

Early in the year, predictions for the directors’ and officers’ market indicated that 2002 would be a year of “considerable disarray.” Indeed, the proof came in mid-June when two reports– from Willis and Tillinghast-Towers Perrin–reported significant increases in the costs of litigation, as well as high-profile bankruptcies and questions about accounting practices that could be blamed for increases in premiums for D&O coverage.

And now a Republican push has begun for corporate accountability. President George Bush and Congress are addressing the issue of corporate responsibility, with the president even calling for criminal penalties, including jail time, for corporate heads who alter companies’ books. News of accounting discrepancies continues to hit the headlines, stirring more unrest in the D&O marketplace.

While the majority of the claims filed were charging discrimination in employment (46.1 percent of employee claims, according to Tillinghast-Towers Perrin), financial disclosure issues were on the minds of shareholders (38.8 percent of shareholder claims). With companies from WorldCom to Xerox experiencing the accounting distresses that Enron and Arthur Andersen felt, more litigation is to come.

Once again, insureds are facing hefty price increases for D&O coverage. “There’s no reason to think we’ve seen the last of the price increases,” says Mark Larsen, consultant and survey director for Tillinghast-Towers Perrin in Chicago. “I’m still looking for a price increase this year similar to the increase we had last year. It may not take the form of dollars paid to insurers. It may take the form of restructuring the policy.”

Restructured policies, he says, may be in order. “Last year, there were a lot of cases where buyers were presented with having the same policy with whopping increases in premiums, or that same policy with substantial coinsurance provisions and less of an increase in premiums. This year, having had that dollar pain last year, buyers presented with a very similar set of options may decide that they want to hold the line on additional dollars and opt for restructuring of the policy.”

In a recent market update, Willis reported that “prices continue to escalate sharply with no apparent signs of relief in the near–or for that matter distant–future.” The report blames high-profile cases and media attention for bringing the D&O liability issue onto the public’s radar screen.

Says Larsen: “High-profile financial disasters are catching the attention not only of the stockholders but also insurers. There should have been some way to detect this before it happened, to examine the financials, to ask the right questions of management. If a way can be found to enhance underwriting D&O insurance by looking again at these high-profile financial disasters and determining what it was that could have been discerned beforehand, that’s what’s going to happen. It’s an underwriting effect, not a pricing effect.”

The conditions of the market are not due to lack of capacity as in the hard market of the mid-eighties. The Willis market report suggests that there is ample capacity, but that the industry is afraid to use it. Insurers are justifiably skittish about offering higher limits.

The D&O carriers are exceptionally nervous about the recent demands from the SEC to have Fortune 1000 CEOs certify their financial statements, says Fred Podolsky, executive VP with global financial and executive risks practice, Willis, New York. “That clearly presents some challenges for the D&O marketplace to the extent that somebody now certifies results. Does that create additional liability for D&O underwriters? Right now, the underwriting community is really struggling and hasn’t come to a position of what that really means for them.”

What it means to their customers is higher premiums and more restrictions on policies. Renewals have been delayed beyond their renewal dates as insurers try to determine their own risks.

“If you could understand what was going on in the week leading up to July 1 renewals, the issues that have come out on various companies over the preceding weeks could not have come out at a worse time,” says Podolsky. “July 1 was a horrendous D&O renewal season for various reasons. For one, many carriers had not, as of July 1, completed their treaties, so they were not in a position to offer anything other than an extension of the existing program until such time that their treaties were completed. The psychology of the D&O underwriters, specifically those that are involved in large account underwriting, is that they don’t know what to rely on anymore. If average investors is bailing from stocks because they don’t know what financials to trust, the D&O underwriter is in the same situation.”

The problem, say the experts, is uncertainty about today’s economic climate. When uncertainty exists in the marketplace, the effects are felt throughout all industries. “In past hard markets, it was technology getting slammed,” says Podolsky. “The flavor of the day was biotechnology, for example. Now, the flavor of the day is everything, every Fortune 2000 company, every large, middle-market company, companies of all types, shapes, sizes, and industries are under the gun due to the continued economic pressures of the stock market.”

He continues: “Underwriters are being hit from all sides, from every industry, from every segment. Every segment is causing big losses on their books. When you combine that with incredible political pressure to root out so-called evildoers in the corporate world, a situation where you have everyone looking to the D&O carriers to fund those losses. What adds to this is the size of the market cap losses. The size of the meltdown automatically means that if just a fraction of those losses are covered, it’s going to completely erode the limits of the D&O policy.”

The D&O underwriters have begun to exclude financial restatements on renewal, especially if the company is under scrutiny. While the situation seems to be a crisis, Larsen says that a crisis is a long way off. A crisis situation, he says, would be when companies can’t buy D&O coverage for any price. That’s not likely to happen. “The number of healthy insurers writing D&O is much larger right now than in the mid-eighties, and the amount of reinsurance capital backing them up is much more substantial. I do not believe that the ability to purchase D&O insurance for the vast majority of potential insureds is going to go away.”

Lori Widmer can be reached at lwidmer@lrp.com.

COPYRIGHT 2002 Axon Group

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