D&O Liability Premiums Jump 33 Percent; Tillinghast Study Reports Hard Market is Stabilizing Despite Record Premiums

Directors and officers (D&O) liability insurance premiums grew approximately 33 percent on average from 2002 to 2003, according to the Tillinghast business of Towers Perrin’s 2003 Directors & Officers Liability Survey.

While employee lawsuits were significant for all types of respondents, entities with more than 500 shareholders saw most of their claims come from shareholders. Despite record premium increases during the year, the 2003 D&O Premium Index indicates that the market started stabilizing toward the end of 2003 with premium increases beginning to level off. Tillinghast’s survey, which included 2,139 participants, is the 26th in a series of studies on D&O liability claims and insurance purchasing patterns and the only study of its type.

The 2003 D&O Premium Index median and average premiums were the highest ever reported by survey participants, with 70 percent of U.S. respondents reporting an increase in premiums from a prior policy and only 19 percent reporting a decrease. Signs of stabilization occurred toward the end of the year, with 62 percent of U.S. participants with renewals reporting a premium increase in the third quarter, compared with 76 percent in the third quarter of 2002.

“While many companies are still seeing increases in D&O premiums, the proportion of participants reporting increases declined in the last half of our survey period,” commented survey leader Elissa Sirovatka.

Other key findings from the survey include:

— Coverage available despite decreased capacity levels: According to information provided by D&O insurance carriers, $1.35 billion in full limits capacity was available during 2003, which is the lowest capacity level since 1997. Yet few survey participants cited availability problems — 2003 was the eleventh consecutive year that less than 5 percent of all U.S. participants not purchasing D&O coverage made their decision because coverage was completely unavailable to them. “Though 2003 capacity was low, we believe it has reached a bottom and will increase in 2004,” said Sirovatka.

— Employment practices liability (EPL) saw the most significant increase in incidence of D&O claims: “Employment-related claims have become a driving force behind D&O liability losses, increasing the perceived need for coverage among public and private companies alike,” said Sirovatka. During 2003, 91 percent of D&O claims against nonprofit organizations were brought by employees. At for-profit companies with fewer than 500 shareholders, 50 percent of D&O claims were brought by employees, compared with 24 percent at companies with more than 500 shareholders. Employment discrimination (40 percent) was the most frequently cited employment-related claim, followed by wrongful termination (24 percent).

— D&O claims decreased slightly: Though there was a dip in the frequency of D&O claims, severity — excluding shareholder claims — increased by 40 percent. The severity of shareholder claims averaged $14.2 million per claim award in 2003, down from $23.4 million in 2002. “We were surprised to find a drop in the average claim award; however, these claim trends are highly volatile and vary by category,” commented Sirovatka. “The drop in shareholder claims could be good news for the D&O insurance market.”

— M&A activity more than doubled odds of D&O claims: Twenty-seven percent of U.S. respondents were involved in a merger, acquisition or divestiture during 2003, and these companies were more than twice as likely to have at least one D&O claim. On average, they also had three times as many D&O claims as their counterparts that did not undergo such reorganization.

— Brokers/Carriers: In our survey, the leading U.S. D&O primary insurance brokers continue to be Woodruff-Sawyer & Company and Alburger Basso De Grosz, while Chubb and AIG continue to underwrite the largest share of U.S. D&O primary insurance.

Premium Index: Record High, but Hints of Market Stabilization

Since 1974, when Tillinghast developed a standardized premium index for D&O coverage, premium medians and averages have fluctuated with the highest values for both in the period 1994 to 1995. However, 2003 set a new record for both of these measures, with the median premium index for purchasers of D&O insurance up 13 percent from 2002 and the average up 33 percent. The spread between the average and median of premium has increased significantly since 1999. “This marked increase in the spread tells us there are still clusters of organizations encountering much higher premium increases than others,” said Jim Swanke, risk financing practice leader. “Regardless of premium changes, it is important for all purchasers of D&O insurance to examine the scope of coverage they are getting for their money. Given the critical nature of D&O insurance to an organization, it is also important for insureds to review the stability and service level of potential insurers.”

Predictions for 2004 D&O Market

Tillinghast predicts the D&O market will take the following shape in 2004:

— Capacity Will Increase: After bottoming in 2003, capacity should bounce back this year with new entrants coming into the market.

— Market Will Remain Hard: In spite of the increase in capacity, the market will not begin to soften. Though premium increases will stabilize overall, some industry sectors will still experience increases of 30% or more.

— Narrowing of Coverage: There will be some continued narrowing of coverage by virtue of more restrictive coverage forms and carriers imposing more exclusions. However, we anticipate most of this to occur in the first half of 2004 with coverage stabilization likely during the second half of the year.

— Sarbanes-Oxley Creates Interesting Dynamic: Regulation from Sarbanes-Oxley will likely make buyers more concerned about having enough coverage limits. However, insurers will be concerned about claim frequency increasing, and may become more selective in offering coverage limits.

Participant profile

The 2,139 companies surveyed comprised 2,068 from the U.S. and 71 in Canada, in 15 business classes across all major industry groups. In the U.S., the largest representation was from the technology and biotechnology & pharmaceuticals business classes. Companies with under $100 million in assets accounted for 69 percent of U.S. respondents, while 13.5 percent had assets greater than $1 billion. A wide variety of Canadian industrial groups were represented by the 71 Canadian participants, 31 percent of which have under $100 million in assets and 34 percent had more than $2 billion. Nonprofit (including governmental) organizations represented 11 percent of participants in both the U.S. and Canada.

Of the for-profit participants, 44 percent were publicly traded corporations. Within the past five years, 58 percent of the U.S. for-profit participants reported an after-tax loss in one or more years, 10 percent were involved in an initial public offering (IPO) and 27 percent experienced merger, acquisition or divestiture activity. Among Canadian for-profit participants, the corresponding figures were 41 percent, 7 percent, and 66 percent.