Current Trends in D&O Insurance CAS Annual Meeting November 13, 2000 Bernard R. Horovitz, ACAS, MAAA Deteriorating D&O Profitability D&O (2000) D&O (1995) Higher Claim Frequency • Increasing securities lawsuits -- even in a bull market • Increasing regulatory scrutiny • Increasing cases alleging accounting fraud • Increasing financial restatement cases • Increasing M&A activity • Increasing securities lawsuits alleging insider trading -- +56% post-Reform Act Stronger Stock Market Should Result in Fewer Lawsuits... Average Number of Securities Lawsuits Filed per Month Historically, Number of Federal Securities Lawsuits Declines When Stock Market Performance Improves 20 19 18 16 16 15 14 12 10 Less than 0% Return 0% to 4% Return Over 4% Return 1991 through May 1999 Two Month Return on Wilshire 5000 Index Source: National Economic Research Associates, a Marsh & McLennan Company ...However, Lawsuits Are More Common Post-Reform Act Publicly traded companies: Federal securities lawsuits: 1995 11,688 194 1999 12,149 216 Change 3.9% 11.3% Increased likelihood of being sued: 7.1% The Wall Street Journal, 3/3/1997 Regulators Say Market’s Bullishness Has Led to Big Rise in Securities Fraud Despite the 1995 Reform Act, the strong economy, and the bull market, the likelihood of being sued has still increased 7.1% since 1995 Source: National Economic Research Associates, a Marsh & McLennan Company Increasing Regulatory Scrutiny Trends in Cases Alleging Accounting Fraud Accounting cases are increasing in frequency Accounting Cases Have Increased as a Percent of All Class Actions Number of Accounting Cases Exhibits an Upward Trend 100% Num ber of Accounting Cases 160 146 140 80% 120 100 91 77 80 60 65 68 40% 58 55 54% 60% 88 40 35% 39% 36% 40% 55% 55% 1998 1999 48% 36% 20% 20 0 0% 1991 1992 1993 1994 1995 Year of Filing 1996 1997 1998 1991 1992 1993 1994 1995 1996 Year of Filing Source: National Economic Research Associates, a Marsh & McLennan Company 1997 Financial Restatement Cases Show a High Rate of Growth Source: National Economic Research Associates, a Marsh & McLennan Company Increased M&A Activity... • $2.7 trillion of transaction value to date in 2000 Up 14.6% from the same period last year • $3.4 trillion in 1999 • $2.5 trillion in 1998 • Hostile takeover deals $487 billion of transaction value in 1999 $108 billion in 1998 Historical hostile deals success rate is 16% …Resulting in More Lawsuits... • M&A transactions have resulted in an increasing number of post-transaction (non-injunctive) securities lawsuits • Impacts both run-off policy and surviving company’s ongoing policy …Lawsuits Like These • • • • • • • Cendant (HFS acquisition of CUC) Mattel (acquisition of Learning Company) Tyco (acquisition of US Surgical, AMP, and others) McKesson/HBOC (acquisition of HBOC) Baker Hughes (acquisition of INTEQ) 3Com (acquisition of US Robotics) Adobe Systems (acquisition of Frame Technology) Claims Are More Severe • Exploding market capitalization leading to higher settlement dollars • Increasing settlements due to allegations of accounting fraud and inclusion of accounting firms as codefendants • Broader policy coverage including, but not limited to, entity coverage for securities claims Exploding market capitalization Higher $ drop in market cap Higher investor losses Higher settlement dollars Pricing vs. Exposure Average Market Cap Growth 600% NASDAQ 100: +1100% 400% DOW: +305% 200% RUSSELL 2000: +105% 0% 1995 1996 1997 1998 PRICING: DOWN 35% Source: Donaldson, Lufkin & Jenrette 1999 2000 Accounting Issues • Allegations of accounting fraud on the rise since the Reform Act • Inclusion of accounting firms as codefendants adds 80% to settlement value...However, accounting codefendants pay an average of only 32% of the settlement • Allegations of accounting fraud increases average settlement by 37% • Settlements are 106% higher when there is a finding of accounting irregularities Source: National Economic Research Associates, a Marsh & McLennan Company Settlement Size Increases with Presence of Auditor Codefendants Source: National Economic Research Associates, a Marsh & McLennan Company Increase in Allocation for Public D&O Securities Claims THEN (PRE-1995): NOW (SINCE 1995): 50-80% 100% (directors and officers primarily covered) (directors and officers and entity covered) = 25-100% increase in insured loss for securities claims* *Securities claims make up approximately 67% of all D&O loss dollars Case Resolution Slows Post-Reform Act Resolution of Securities Class Action Suits Total Dispositions 250 225 200 150 136 159 177 195 202 196 171 110 100 50 0 1991 1992 1993 1994 1995 1996 1997 Source: National Economic Research Associates, a Marsh & McLennan Company 1998 Jun-99 Examples of Settled Post-Reform Act Lawsuits... …With Plenty in the Pipeline …In the Pipeline... …and More Pouring In Other Sources • • • • • • • • AON 1999 Insurance Market Overview Bloomberg News Business Wire Jury Verdict Research PR Newswire Securities and Exchange Commission (SEC) Stanford Law School Tillinghast-Towers Perrin 1999 Directors & Officers Liability Survey