D&O and E&O - Is There Any Good News?
John Lewandowski, FCAS, MAAA
CNA Insurance Company
2004 Casualty Loss Reserve Seminar
Las Vegas - September 13, 2004
D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
D&O POLICY CHARACTERISTICS
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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
Coverage/Profile - What is D&O and E&O?
Directors & Officers Liability Policy – provides coverage for claims arising from the “wrongful acts” – i.e., any act, error or
omission -- of insured persons while serving in their capacity as directors or officers. Expanded to included Entity coverage
for “securities claims.” D&O coverage is simply a specialized type of Errors & Omissions coverage.
D&O’s have liability for misrepresentations and omissions
• in a public offering registration statement filed with the SEC
• in connection with any purchase or sale of securities
Errors & Omissions Professional Liability Policy – provides coverage for claims involving alleged “errors and omissions”
arising out of professional services rendered by the insured, e.g. banks, investment advisors, insurance companies, mutual
funds…
D&O coverage often includes Employment Practices Liability.
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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
Make-up of D&O Market
Distribution of Insureds by Segment
By Ownership Type
For Profit
Private
10%
For Profit by Account Size
Not for
Profit
10%
Very
Large
20%
For ProfitPublic
80%
Large
25%
Small
25%
MidMarket
30%
Small: Assets < $100M
Mid: $100M < Assets < $1B
Large: $1B < Assets < $10B
Very Large: Assets >10B
Public cos. represent the largest share of the market
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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
Typical (Large Public Co.) D&O Program Structure
Program size typically excess of $50 million, up to $200 million+
Limits offered range from $5 million to $25 million per carrier, many carriers on any one program
Retentions range from $100K and up!
Pricing varies widely from account to account, typically based upon :
• Sector/industry group
• Size –Market Capitalization, Assets
• Recent activities – IPO, M&A
• Financial Condition – consistent performance
• Financial Rating
• Corporate Governance – management quality, board independence
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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
Some Past Drivers of D&O results (1997-2002)
Increasing Coverage/Reducing Premium
Expanded capacity/larger limits offered
Expanded coverage, entity coverage eliminated pre-set allocation
Free/automatic Reinstatements
Multi-Year contracts, with significant discounts and no re-underwriting
Increasing Claim Costs – Frequency and Severity
2001 – IPO Allocation filings
2002 – Filings against Analyst and Investment Banks; Wave of Corporate Meltdowns Begins – Enron, MCI
Worldcom, Tyco, Global Crossing
2003 - Mutual Funds – Late Trading/Market timing
M&A Activity – Banking, Insurance
Deteriorating Investment Market
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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
Historical Avg. Policy Limits - Public Co. D&O
17,000
15,000
13,000
11,000
9,000
7,000
5,000
Policy Limit
1995
1996
1997
1998
1999
2000
2001
2002
2003
8,300
10,000
14,500
16,000
16,250
17,650
15,000
10,000
9,750
Policy Year
Limits in Thousands
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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
Current State of the D&O market
Through Year-End 2003
Market saw reduced capacity (limits), increased retentions
More players on each program, pricing less competitive
Large rate increases - more than 150% were common
Coverage restrictions – eliminate investment banking, entity coverage
Elimination of multi-year deals
2003/2002 Securities Class Action Lawsuits Decline by 22%
2003/2002 Market Capitalization Losses Decline by 72%
And Beyond…..
Once again, swift changes in the market in 2004……….
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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
D&O CLAIM CHARACTERISTICS
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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
Historical Legislation Impacting D&O Suits
1933/34 Securities Acts
D&O Liability for misrepresentations, omissions in public offerings, statements
1995 PSLRA
Intended to prevent abuses of securities class action lawsuits.
Heightened Pleading Standard
2002 Sarbanes-Oxley Act
Blackout trading barred
CEO and CFO certifications.
Faster insider trading disclosure
Increased Audit Committee duties.
Increased SEC review
More criminal penalties and fines
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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
D&O Securities Suits (Through August 2004)
Source : Stanford Research
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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
D&O Claims Characteristics
Some interesting Public Company D&O statistics*….
• Half of all suits against D&O’s are filed by Shareholders
• 24% of claims brought by employees
• 36% of all claims are class actions
• Low Frequency - average of 225 securities suits per year (excl IPO)
• High Severity – average settlement of $20 million
• Most active District Court is S.D. New York
• Most frequently sued Sector is Technology
• Most frequently sued Industry is Biotechnology & Drugs
• Most resolutions achieved through settlement, not judgment
*Source : Tillinghast D&O Report and Stanford Research
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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
Significant D&O Claims
Company
Settlement Amount
Cendant
$3,527.0 Million
Lucent
$563.0 Million
Bank of America
$490.0 Million
Waste Management II
$457.0 Million
Rite Aid
$319.5 Million
Oxford Health Plans, Inc.
$300.0 Million
3Com
$259.0 Million
Waste Management I
$220.0 Million
MicroStrategy
$192.5 Million
Dollar General Corp
$162.0 Million
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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
Major Factors For D&O Claims
1. Scope of Policy – is it a claim, a wrongful act?
2. Ground-up Nature of the Claim
3. Possible Defenses – exclusions, warrants, application.
4. Policy structure, coverage and wording
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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
Criteria Used to Establish D&O Claim Potential
•
•
•
•
•
•
•
•
•
•
•
Alleged Damages - “Plaintiff-style” damages
Length of Class Period – number of shareholders
Insider Holdings
Historical Stock Performance
Underlying carriers – who is lead on Claim?
Venue – circuit, pleading standards, judge
Attorney firms – both Plaintiff and Defendant
Industry – Telecomm., Pharm., Energy – any trends?
Procedural steps – Consolidated complaint, motion to dismiss
Lead Plaintiff - Institutional Investor
Insured’s stamina/motivation
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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
Key Takeaways
•Principal exposure is from Shareholders Class actions against Public Companies, Private Company
litigation less common.
•Pricing for D&O must recognize Size and Sectors as important factors, but not sole factors – all are
not equal.
•Last few years witnessed emergence of non-traditional claims (mega-torts) in addition to traditional
issuer fraud cases.
•Settlements are not keeping pace with filings, there is a large backlog of cases.
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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas
Is There Any Good News?
Lessons Learned from the past……..
•Keeping pace with the next possible mega-tort by identifying industries/markets in distress is critical.
•Reserving for D&O is multi-faceted and requires a continuous evaluation during the lifetime of the
claim.
•Strong working relationship between Claims, Underwriting and Actuarial is important since
traditional actuarial reserving methods do not work.
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