Directors' and officers' liability is a complex market and not for the unwary. Rachel Gordon reports on the insurers who are diving in to murky waters and targeting small to medium-sized business
In the UK, claims against a directors' and officers' liability insurance policy happen infrequently but when they do, they hit hard. Providing D&O cover, for the FTSE 100 companies in particular, is not for the faint-hearted or run-of-the-mill insurer. This is a complex market, where wrangles over exclusions are common and lawyers slug it out - and all the while, costs mount up.
The case of Equitable Life demonstrates the size of sums that can potentially be involved. At the time of going to press, the messy business involving Equitable pursuing its 15 former directors is nearing some sort of conclusion.
It has dropped negligence claims against two of them - providing former sales and marketing director Shaun Kinnis and former non-executive director Peter Martin agree to end litigation proceedings and meet their own costs.
This follows on from a settlement a few weeks ago, when Equitable agreed to abandon its £700m claim against former auditors Ernst and Young. It is now understood that arrangements for the others to settle through paying their own costs are being put forward. Sources suggest that the majority of the directors' costs - estimated at being around £20m - will not be covered through D&O cover and will have to come from their own pockets.
In 2003, Royal and Sun Alliance, then Equitable's D&O insurer, was told it was required to pay some £5m towards defence costs - a sum it disputed but then was forced to pay at arbitration. RSA had argued that the claim against the directors alleged failure of judgement, which falls outside the terms of the policy.
Wrangles over D&O claims are nothing new - they are frequent in the US - and with costs increasing in the UK, insurers here are likely to follow suit. As Douglas Collins, a principal with actuary Tillinghast Towers Perrin, states: "The frequency of claims is increasing and it is not clear if rates are sufficient for this sector to remain profitable. There are always concerns over exclusions but at the same time if there is wrong-doing or fraud that would mean a get-out clause for the insurer. However, this can be exceptionally difficult to prove."
US giants AIG and Chubb may dominate the large corporate D&O sector but competition is sniffing at their heels. Within the past three years, new entrants have been tempted to enter the market by high premiums - which soared after 11 September 2001 - although the market has subsequently softened significantly.
The UK remains a far more favourable environment than the US, which has been battered by trillion-dollar lawsuits and resulted in providers such as Faraday pulling out of the market.
In recent years, the trend has been for D&O insurers to start targeting mid-range companies and increasingly the small to medium-sized enterprise sector. Zurich and RSA are among the providers looking to gain sizeable market share in this sector. They have, however, stayed notably clear of the FTSE 100 companies - perhaps in part because of the dominance of AIG and possibly through fear of potentially massive exposures. What is more, the large corporate sector is largely saturated.
James Weatherstone, vice president of one of the newcomers, Arch Insurance, says his company entered the market because it believed the UK had strong potential. "There is a high level of penetration within the FTSE 100 but we want to focus on the top 350 and beyond. There has not been a great deal of innovation in the market and we are in a strong position because we have no legacy," he explains. "It's a cliche but service does matter and brokers have complained that they don't want a London-based underwriter to refer a relatively straightforward risk to the US, which can happen. Feedback from brokers tells us that they can find a lack of consistency with the big players and this is beneficial for us."
However, Hartmut Mai, vice president with AIG, counters that his company offers unrivalled experience. "We write around 75% of companies in this sector although, of course, it makes sense to us to expand into the middle market and also worldwide. We're increasing our share in countries like China and Russia and in Eastern Europe."
In the UK, he says there is less loyalty than in the past and it would seem this is partly because of more competition, and also because brokers may now feel they need to move business more frequently to supposedly please the regulator.
When it comes to the buying behaviour of large corporates, Nigel Brand, D&O manager for Allianz Global Risks UK, comments that increased awareness - both from in-house risk managers and brokers - is encouraging movement: "Clients of all sizes are indeed beginning to flex their muscles and re-evaluate their insurance provisions across the board, not just within the D&O sector. Buyers have become much more knowledgeable in recent years and are naturally looking for the best value from their insurer."
However, he adds that within the FTSE 250 segment there is a reasonable amount of loyalty between insurers and customers, as clients tend to be less transactional in their dealings and look more towards establishing partnerships. "Where there is movement between insurance providers it will tend to be for a combination of reasons, not just price," he says.
"As security ratings of providers are pretty much on a par with one another, other factors - such as: the depth of the tripartite relationship between client, broker and insurer; the insurer's knowledge of the client and its industry; the levels of both dialogue and service that the customer receives; and the insurer's reputation - will all have a bearing on the decision."
Mr Mai points out that few FTSE 100 companies are likely to be solely UK-focused and that many will have overseas interests, including dual listings. "There can well be exposures in the US and huge potential claims. Brokers want to benefit from the experience of an insurer that knows what is going on in the rest of the world and has developed policies that reflect this."
He argues that brokers being told about the benefits of having 'no legacy' as an insurer should treat this with caution, commenting that claims have an average settlement time of three to five years. "Buyers need to know the insurer will still be around and equally that there is sufficient security." He comments that there are around 34 insurers providing cover in the D&O market and this has created a "fluctuating market".
Last month, AIG announced it was to relaunch its D&O products "in response to client demand" (PM, 29 September, p2) but it may also have been influenced to do so by increasing competition. The insurer revealed it would now provide non-rescindable polices for the non-US securities exposed policy, meaning that AIG cannot cancel cover if people have been misrepresented.
Policies now also include an additional £1m ring-fenced D&O limit for each non-executive director.
While competition has driven down rates, the continued soft market is causing concern. "The number of securities legal actions and settlements against UK companies has doubled in the past five years and correct pricing is essential," comments Mr Mai.
Rick Welsh, director with Lloyds's insurer SVB, adds: "The market is going to flatten out in the next few months and we will start to see some increases. Even in a good year, this is not a wildly profitable sector and, if there are losses, which are probable for some, then those companies will walk away."
According to responses to the Willis index for the third quarter of 2005 by D&O liability insurers from non-US companies, it was shown that all insurers surveyed said they had experienced a reduction in primary premium rates in the past three months, with 87% expecting rates to reduce in the forthcoming three months.
There is also no doubt that future exposures are increasing. According to Mr Mai, we can expect to see more claims related to the increasing regulatory environment, growing investor aggressiveness and the changes in accounting law adding to corporate pressures.
Mr Weatherstone emphasises that he sees non-executive directors as being in the firing line, a point that Mr Welsh agrees with, although he stresses: "In the UK, certainly compared to some European countries, there is a favourable corporate governance climate and this is why insurers have sought to do more D&O business here. If you compare some of the cases going on in Italy, the UK appears to be considerably better off."
He says that as far as non-executives are concerned, there is growing demand for advice and adds that SVB may consider designing products specifically for their exposures: "If they don't have protection, these people who tend to be successful and with considerable personal assets, will walk way from these roles."
There is no doubt that non-executive directors are in a complex position.
While they are required by law to be in place and their relative objectivity can be extremely useful, they are also held to account in much the same way as executive directors. There are also difficulties as their roles may not be defined clearly and, therefore, neither will the limits of their responsibility.
For companies themselves, there are also growing problems about the way they remunerate their non-executives. On one hand, there are increasing pressures to remunerate such people in line with their duties but many of these non-executives are resistant to receiving large sums of money as they feel this could increase their risk of being sued.
When dealing with potentially massive sums, claims are a sensitive area.
Mr Mai insists that his company has a first-rate reputation. "In D&O we have an in-house team that is market leading," he says. Meanwhile, Steve Blasina, senior vice president with Chubb comments: "I'm confident brokers see us as being better than others in claims handling, something that has been reported independently in surveys. It's important to do as we do and separate claims from underwriting. This means the underwriting profit and loss is kept separate and claims managers do not feel under pressure to reduce their costs."
Although the UK's top companies may have escaped lightly compared to their US counterparts, that is not to say they are immune from claims.
Mr Welsh adds: "There is no doubt that the risk of claims is increasing. Insolvency is a real trigger and many feel the likelihood of a recession increases risks."
Mr Brand says that increasing levels of regulation and legislation, as well as the number of joint ventures being conducted in recently opened up international markets, such as Russia and China, are giving rise to new D&O exposures. "The embedding of a new regulatory and reporting framework by the Financial Services Authority, coupled with the Sarbanes Oxley transparency procedures, all have the potential to increase a company's D&O exposure. Corporate manslaughter is another area where developments will need to be monitored carefully," he explains.
According to Mr Blasina: "Everybody is talking about some of the risks linked to the hedge fund industry, for example, and so there is a clear exposure. Consequently, we're doing a lot of work in developing cover for the fund management industry."
He adds that Europe, in general, has been quoted as a fertile breeding ground for claims in the Wall Street Journal, by US lawyers, and agrees that a recession will fuel this.
While there may be more claims in the pipeline, few D&O insurers are prepared to agree with the contention made by the Association of Insurance and Risk Managers: that providers have failed to take into account improved risk management standards; that pricing is often inaccurate; and that alternatives to traditional insurance are not being considered often enough.
"Risk managers will too often blame insurers but they can be wrong through recommending the cheapest insurer - this will never be a commodity product," says Mr Welsh.
Mr Brand adds that since 11 September 2001, rates have "become more stable, due to closer tripartite client/broker/insurer relationships and better reflect the track records, risk management and corporate governance adherence of buyers".
He concludes that while less costly purchase of Side A cover - that which cannot be indemnified by the company itself - has increased, this needs to be looked at in the context of the D&O market as a whole. "The trend is to purchase Side A cover in addition to the traditional D&O policy, rather than as a direct replacement for it."
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