Directors & Officers Insurance Premiums Decline For First Time Since 1999, According To Tillinghast Survey

Tillinghast Predicts Soft Market Will Be Shorter and Less Pronounced Than Past Soft Markets

New York, NY, December 6, 2004 � Tillinghast’s Directors & Officers (D&O) liability insurance premium index dropped 10% from 2003 to 2004, the first decline since 1999, according to the 2004 Directors & Officers Liability Survey, done by the Tillinghast business of Towers Perrin. However, claim susceptibility, frequency and severity are still soaring. Tillinghast’s survey, which included 2,455 participants, is the 27th in a series of studies on D&O liability claims and insurance purchasing patterns and the most in-depth study of its type.

According to this year’s survey, much of the current softening in the D&O market is not due to a reduction in claim activity, but rather can be attributed to the entrance of new capacity. Competition is particularly fierce in excess layers for large public companies, where rates are dropping 10% to 15%. Despite the softening market, some pockets of hard market conditions remain, particularly in banking, health services, and real estate and construction. Looking at the historical data, it appears that 2003 was a turning point in the market; however, Tillinghast cautions not to expect the trend to continue.

“This soft market for D&O insurance will be shorter and less pronounced due to lower investment returns than in the 1980s when cash flow underwriting was prevalent,” said Jim Swanke, Managing Principal for the Strategic Risk Financing Practice. “Carriers will likely need to begin increasing rates in the short to medium term in order to maintain their return on equity.”

Capacity increased 11% to $1.5 billion in full limits from 2003, and a record number (99%) of U.S. participants reported having D&O insurance. Fewer respondents cited “cost” as the main reason for going without coverage (44% of participants in 2002 versus 26% in 2004). “The survey tells us that coverage is being offered broadly in the market, with decreased premiums, increased limits and enhancements, and fewer exclusions,” said consultant Elissa Sirovatka, who leads Tillinghast’s D&O Liability Survey program. “What’s disturbing is that this is occurring at the same time frequency and settlement costs are still rising.”

Among repeat participants*, claim frequency increased 11% from 2003 to 2004 and claim susceptibility increased 6%. Average severity for repeat participants increased in three out of five claim classes, including employees/unions/physicians, competitors/suppliers/contractors, and shareholders/investors.

“The continued increase in the average cost to settle D&O claims combined with the significant number of open megaclaims makes a tough case for a sustained soft market. The claim conditions we’re seeing justify premium increases rather than decreases,” said Sirovatka.

Top sources of allegations from shareholder claimants (general breach of fiduciary duty, inadequate/inaccurate disclosure, including financial reporting and stock or other public offering) and employee claimants (discrimination and wrongful employee dismissal or termination) were the same for 2003 and 2004. Surprisingly, though, allegations citing accounting fraud also remained the same at 2%.

More than half (56%) of claims against 2004 participants are still open, which is up from 37% in last year’s survey. “The increase in open claims along with the increasing settlement costs will make it difficult for insurers to get a handle on their reserves for D&O liabilities,” said Sirovatka. “Couple this with premature pricing declines and a softening market, and insurers could be heading toward a D&O reserve shortfall if we don’t start to see more disciplined underwriting and adequate pricing.”

Other highlights of the survey include:

  • Some Pockets Still Resist Softening � Premium increases were reported on average for business classes such as banking, durable goods, health services, and real estate and construction, as well as those in respondent size categories of $10 million to $50 million and $5 billion to $10 billion. Increases were far more common for Canadian participants, where 90% of respondents reported premium increases over the past five quarters.

  • Coverage Broadens For Most � The number of U.S. participants reporting increases in deductibles/retentions in this year’s survey (28%) is down drastically from last year (44%). Following this trend, 13% of participants reported increased coverage enhancements � the highest level since 2001 � and 10% reported a decrease in exclusions � the highest level since 1999. Average policy limits increased for most asset classes from 2003 to 2004, except for companies in asset classes $400 million to $1 billion and $1 billion to $2 billion, which saw 8% and 13% decreases, respectively.

Looking Ahead

Tillinghast doesn’t expect the current soft market for D&O liability insurance to last through 2005 and predicts a return to a hard D&O market by 2006. Tillinghast also anticipates continued upward pressure on frequency and severity of loss.

“The market peaked in 2003, and we feel that this decline in rates was far too premature in terms of premium adequacy,” said Sirovatka. “We expect to see a leveling of capacity moving forward, continued pockets of rate increases and a smaller magnitude of rate decreases as the market digests this ‘too much, too soon’ softening.”

Reinsurance Implications

Experts in the Reinsurance business of Towers Perrin say that reinsurers will be paying close attention to the D&O marketplace in 2005.

“We expect that in 2005, in an effort to limit their loss from any one occurrence, reinsurers will be more cautious in supporting multiple carriers’ D&O programs, which could aggregate loss to the reinsurers as a result of a single large loss scenario such as Enron,” said Michael Hollenbach, Professional Liability Practice Leader. “Furthermore, the effect of Sarbanes-Oxley is yet to be determined; we’re waiting to see whether the increased duties imposed on management will drive additional claims.”

Roland Stollsteimer, Senior Vice President, concurred that 2005 renewals will be a critical test for the D&O market; however, he is cautiously optimistic about some sectors of the business. “Competition and capacity among primary D&O insurers have aggressively gravitated toward the private company and nonprofit sectors.”

Participant Profile

The 2,455 companies surveyed included 2,409 from the U.S. and 46 from Canada, in 15 business classes across all major industry groups. In the U.S., participants in technology, biotechnology and pharmaceuticals, and governmental and other nonprofit classes represented 65% of respondents. The distribution of participants by assets and revenues has shifted to a greater percentage of small companies than in our 2003 survey. In particular, 52% of 2004 participants reported assets less than $10 million, compared to 35% of 2003 participants. Overall, 30% of the U.S. participants are publicly held organizations, 52% are privately held and 18% are nonprofit.

*Repeat Participants � This year, we introduced a new section to our survey. This section on repeat participants, of which there were 1,347, looks at the results of our survey for organizations that responded to both our 2003 and 2004 surveys. We added this section to look at trends in claims from 2003 to 2004 for a consistent group of participants.

The 2004 Directors & Officers Liability Survey is available on a prepaid basis for $700. Tillinghast also offers a companion report service, which enables risk managers and other D&O professionals to efficiently and cost-effectively compare an organization’s D&O program with information compiled from its peers with similar exposure characteristics. Both can be ordered by contacting Mary Maze at (312) 609-9347 or via e-mail at [email protected].

About Towers Perrin and Tillinghast

Towers Perrin is a global professional services firm that helps organizations around the world improve their performance through effective people, risk and financial management. Through its Tillinghast business, Towers Perrin provides global actuarial and management consulting to insurance and financial services companies and advises other organizations on risk financing and self-insurance. Areas of focus include mergers, acquisitions and restructuring, financial and regulatory reporting, risk, capital and value management, products, markets and distribution; and financial modeling software solutions. The firm’s other businesses are HR Services, which provides human resource consulting and administration services, and Reinsurance, which provides reinsurance intermediary services. Together, these businesses have over 8,000 employees and 78 offices in 76 cities in 24 countries. More information about Tillinghast is available at