Evolving Market Puts Spotlight on D&O
Although around $15 billion in premiums is collected annually for D&O insurance, the profitability of the sector has been challenged in recent years.
Several factors, including increasing competition, growth in the number of lawsuits, and rising claims frequency and severity, are to blame.
The D&O insurance loss ratio has been estimated to be in excess of 100% in numerous markets, including the United Kingdom, the United States and Germany. Recent loss drivers include event-driven litigation, collective redress developments, regulatory investigations, pollution, higher defense costs, and a general cultural shift—even in civil-law countries—to bring more D&O claims against both individuals and the company in relation to securities. At Allianz Global Corporate & Specialty (AGCS), we have seen double-digit growth in the number of claims received over the past five years.
Insurers are facing more legal costs as increasing attorney activity from plaintiffs requires more claims handling and settlements. Beyond that, event-driven litigation has resulted in aggregation issues, where multiple policies are triggered by an event. For example, one event could trigger both D&O and aviation, environmental, construction, product recall or cyber claims.
Increased claims activity combined with years of new capital and soft D&O pricing has resulted in capacity reductions at individual carriers, while the increasing number, size and tail of claims mean smaller insurers aren’t able to compete. Additionally, older claims are developing much later than they traditionally have. For example, AGCS has seen many claims whose first notice of loss came between 2012 and 2015 but only in the last 12 months have gotten to a point where a realistic reserve assessment or a payment could be made. In some cases, those claims have entailed more severe payouts or reserves than anticipated. AGCS has also seen a much higher frequency of claims in the upper bands of severity.
Despite rising claim frequency and severity, the industry labored under a persistent and deepening soft market for well over a decade before seeing some recent hardening of rates.
Market reports estimate that the D&O insurance industry has under-reserved for losses by somewhere between $3 billion to $5 billion in recent years, and loss ratios are among the highest since the financial crisis. Publicly disclosed data suggest D&O pricing turned modestly positive in 2018 for the first time since 2003. Still, at the end of 2018, pricing was still 20% to 25% below 2010 levels and was a fraction of the level from the prior market peak in the early 2000s. Premiums rose more dramatically in 2019, with D&O rates per million dollars of limit up 17.1% in the second quarter of 2019 compared to the same period in 2018. The overall price for primary policies renewing with the same limit and deductible rose almost 7%, according to Aon’s “Quarterly D&O Pricing Index” for the second quarter of 2019.
With stricter underwriting, decreased capacity, and higher rates in both primary and excess, customers are seeking alternatives to the standard D&O liability placement. We have seen an increase in those wishing to bolster Side A-only limits and using captives or alternative risk transfer (ART) solutions for the entity portion (Side C) of their policies. The rise in retentions, co-insurance and captives indicates a clear trend of customers’ retaining more risk in the current market.
Some policyholders coordinate and tie in international insurance solution limits, if appropriate, or remove sublimited extensions that can be easily self-insured. In some cases, multiyear solutions can be structured to allow policyholders to retain more D&O exposure while effectively reducing the carrier’s earnings volatility.
As underwriters grapple with the push to hold directors and officers more responsible for corporate failures, they need clarity from brokers about clients’ cyber and privacy exposures, corporate governance setup, intangible asset protections, reputation and brand protections, and crisis management plans, as well as how risks are monitored and managed at the board level.
Fortunately for brokers, these corporate governance demands are coming from investors as well as insurers, so insurance customers may be better prepared than in the past to respond. The question is whether they are prepared for the increased financial exposures they will have to take on and if brokers can propose appropriate and adaptable alternative solutions for those who aren’t prepared.
Paul Schiavone is North American regional head of long-tail lines and ART at Allianz Global Corporate & Specialty.