D&O insurers under pressure

The financial crisis is putting the directors’ and officers’ (D&O) insurance market under extreme pressure.

D&O claims are common when markets crash. Directors become the target of lawsuits as stocks and investments crumble and angry investors (and there are plenty of them) look for someone to blame.

As more companies collapse, regulators and shareholders are filing more claims of negligence or misrepresentation. Allegations of accounting fraud increase and liquidators may also sue former boards for mismanagement. Class actions are at an all-time high and these are no longer restricted to the USA. The Netherlands, Germany and the UK are building the legal mechanisms to encourage collective redress.

The economic slip comes at a bad time for the D&O insurance market. For the past five years capacity has been flooding in and insurers have been competing to offer the best cover at the lowest price – which makes life dangerous now the claims are coming in.

The soft market is particularly risky for new entrants that have yet to build up their reserves. Plus, several of the big D&O insurers – AIG, XL and Hartford – have been hit by their own financial problems.

This market pressure means serious readjustments are to be expected. But, so far, prices across most commercial D&O lines have remained stable. This is partly because of a glut of capacity and insurers attempting to win business from the troubled AIG.

The most dramatic changes are in D&O cover for the financial services industry. On some of the most distressed risks – such as banks with US exposure – premiums have increased by as much as 200%. Some insurers are stopping writing cover altogether while others see sky-high premiums on financial D&O as a bet worth taking. Overall D&O cover for financial institutions is being restricted.

At the same time, buyers are looking for more, not less cover. Directors themselves are jittery and some are demanding dedicated “A-side cover” to protect their personal assets in the event that the company chooses not to indemnify them if a claim is brought.

The changing risk appetite could affect other sectors. Insurers will do much more due diligence on the clients they take on with conservative insurers only wanting the best risks. Some are trying to claw back certain terms that in the past were standard fare, such as restricting the breath of cover relating to regulatory investigations. Those insurers would prefer to go back to the days of tightly worded policies with extensions sold as add-ons.

There are also questions over whether the insurance industry has properly risk managed D&O, which could have solvency implications for the sector. Insurers with a lot of exposure to the financial services sector could face significant losses on D&O business.

There is likely to be much more focus on capital management in the future with insurers spreading their exposure across a portfolio of risks. Reinsurers will pressure them to do this. This will mean writing a combination of low-risk, low-premium business as well as the high-risk, high-premium lines. Corporate buyers, concerned about the stability of their partners, will also want to spread their risk among carriers.