A budding market

With legal and economic risks increasing for businesses in 2009, many are expected to look at their insurance programmes in more detail. Sam Barrett reports on the unprecedented potential of the directors' and officers' market in this climate

It's set to be a tough year for anyone running a business. As well as the difficulties created by the economic slowdown, the introduction of more legislation will heighten the risk of legal action and financial penalties.

For those involved in insuring those risks, 2009 will bring a mixture of challenges and opportunities.

Doug Robare, D&O manager for Zurich Insurance, says: "There's going to be increased demand for directors' and officers' cover this year as more people think about their responsibilities. Yet after seeing prices fall, often substantially, over the last three years, there will be pressure on price as claims start to come through."

Certainly, claims are on the up. At the end of 2008, insurance research firm Advisen revised its forecast for D&O losses, taking it up to $5.9bn (£4.3bn) from the $3.6bn it had forecast in February. Its revision resulted from "the mushrooming of the credit crisis into a global financial calamity". It also reflected an increase in securities class-action lawsuits, securities fraud lawsuits brought by regulators and law enforcement agencies, bankruptcies, and shareholder derivative lawsuits.

The number of securities lawsuit filings in the US has increased sharply in the last two years. There were 119 filings in 2006, 176 in 2007 and 210 in 2008.

"The statistical average is 200, so we have moved to a position where filings are above that," says Mr Robare. "Additionally, it takes three to five years for a lawsuit to reach the filing stage."

See you in court

From a corporate perspective, there is certainly greater risk of litigation now. "There's been an unprecedented level of litigation in the second half of 2008," says Emmanuelle Tardy, vice president for the financial and professional services team at Marsh. "It's affecting all sorts of organisations. For instance, of the 15 largest companies in the world, 12 of them have already been sued."

And with new legislation coming into force this year, directors have additional rules to observe. Most recently, the Health & Safety Offences Act came into force on 16 January and will increase the penalties for companies that break health and safety law.

It is not just domestic regulation that directors need to be mindful of, either. A company can also face legal action from the US, regardless of where it is domiciled. A prime example is the German engineering company Siemens, which paid $800m to the US Justice Department and stock market regulator the US Securities and Exchange Commission in December to settle corruption charges. This was on top of the EUR395m (£370m) it had already paid to German regulators.

Ms Tardy says the Siemens case is a noteworthy development for large European multinationals. "This might not trigger a D&O claim, as very few policies cover this area, but as it would often be followed by civil action, it has implications for D&O cover," she explains.

There has also been an increase in regulatory risk. The Financial Services Authority and the Serious Fraud Office have become more aggressive in their approach to fraud over the last 12 months. The FSA has beefed up its criminal prosecutor and enforcement teams and sent out a clear message about its intentions by carrying out a series of dawn raids to combat insider dealing.

Andre Basile, vice president of commercial D&O at AIG, points out that fraud becomes more common in difficult economic times. "The number of incidents of fraud increases in tough economic times either because more fraud occurs or because it's easier to uncover," he says. "When revenues are increasing it's easier to hide fraud, but this isn't the case at the moment."

As well as action from the regulatory bodies, Matthew Allen, a partner at law firm Eversheds, believes there will be more claims brought against former directors this year. "There's been a lot of change in the City's boardrooms and as the new directors settle into their roles, it's not inconceivable that there will be claims brought against former board members," he says.

And there has been a steep rise in the number of firms going into liquidation, which will also result in an increase in claims. Figures from the Insolvency Service show that 4001 companies went into liquidation in the third quarter of 2008, an increase of 10.5% on the previous quarter and a rise of 26.3% on the same quarter in 2007.

"You do see more claims being brought against directors in a recession," says Colin Peck, partner in the London market team at Weightmans. "If a company goes out of business, people, including the administrator, look to the directors for potential redress."

Market squeeze

These factors are starting to influence the market, with rates hardening and terms and conditions getting tougher on some cover.

"There is nervousness around, especially in the London markets," says Mark Shreeve, chief executive officer at Angel Underwriting. "No one knows what risks they've written and the claims they could face."

The market is also very divided, with financial institutions facing very different conditions to companies in the commercial market. John Taylor, European financial lines manager at CNA, explains: "Rates are hardening for financial institution business. You can't open a newspaper without seeing something about the problems in this sector, whether it's the credit crunch or the alleged Madoff fraud."

The extent to which premiums are rising does vary, with sectors like hedge funds and US banks hit hardest. But while recent press reports have put a figure as high as 50% on the increases, this level of premium hike is still unusual. "An increase of 50% could happen for a highly complex financial business but for most in this market a rise of between 5% and 25% would be more standard," says Kevin Cleary, UK development manager at Dual Corporate Risks.

But while the financial market may be having a tough time, it's pretty much business as usual for the commercial market, with the 1 January renewal date passing relatively smoothly.

"It's still a bloodbath in the commercial market," says Mr Cleary. "Insurers are fighting for market share and there's plenty of competition for this business. The loss ratios are low and profits are good. That market hasn't really been affected by what's happening in the financial market yet."

Some areas are particularly well cushioned too. For instance, Craig Watson, UK regional underwriter at Brit Insurance, says the SME market and private companies have been largely unaffected.

However, this is expected to change. As many insurers have exposure to both the financial and commercial markets, the problems facing financial customers are likely to have a knock-on effect for commercial customers. Already Mr Robare has noticed a subtle change across the commercial market. "Pricing has stabilised," he says. "Where we used to see prices falling, renewals were flat in January. Some are gradually moving up and we expect to see this accelerate."

T&C trade-off

Another factor that is coming into play is a tightening of terms and conditions. This will enable insurers to maintain pricing levels and retain business. Mr Watson believes this pricing strategy will become increasingly common. "Crazy quotations won't be an insurer coming in really low to win business, it'll be an insurer keeping the price down by adding in terms and conditions," he says.

But while insurers may be shifting slightly in anticipation of the commercial market hardening, any wholesale change is unlikely to happen in the near future. "We're expecting capacity and pricing to stay the same for the next six months and then to harden," says Keith Mather, vice president of commercial D&O at Liberty Mutual Insurance Europe. "Renewals were much more stable than predicted in January."

While premiums may be edging up already or at some point this year because of the increase in risk, many are seeing renewed interest in cover. Although D&O is commonplace among public limited and large privately owned companies, the SME market has not embraced the cover. Estimates suggest that as much as 80% of this market does not have cover. This is changing, though. "We're seeing a lot more submissions and broker enquiries," says Mr Taylor. "Penetration will increase significantly this year."

This increase will be driven by a number of factors. Mr Shreeve, who specialises in the UK and European SME market, says that he has seen a steady increase in awareness. "Businesses are aware of the increased legislation and when they discover that they can buy a product that will protect them, they do," he says.

In addition to this growing awareness of the products, and the risks involved, more brokers are expected to introduce D&O to their product range this year. "I've come across a lot of brokers who are looking to set up a facility to sell D&O to their client base," says Mr Watson. "Penetration is low in some areas of the market and with the risks so high-profile, it is a good time to promote cover."

He does, however, warn that it will not necessarily be an easy sale. "A director who understands the risks will continue to buy cover, but, with costs under scrutiny, not every client will be prepared to spend money on additional cover," he explains.

Boost for service and quality

Clients are paying more attention to the cover they purchase. "Rather than buying purely on price, directors are giving more thought to their purchase and analysing coverage as part of a broader risk management and corporate governance approach," says Mr Allen. "This is good news for those in the market who can distinguish themselves on service and quality of product."

With a higher level of claims anticipated, capacity could come under pressure this year. It is likely that, although there will still be plenty of cover to go round, it will not necessarily be as easy to obtain. This will require insurers to adjust their pricing strategies. "It's all about risk management," says Mr Peck. "Before an insurer provides cover they're going to need to know the client well so they can appreciate the risk and price accordingly."

Mr Basile agrees that risk management will become a more important consideration. "Risk isn't being evaluated properly but this will have to change as claims increase," he explains.

He adds that underwriters are still basing their pricing on financial stability and other financial factors, but that this does not give sufficient insight into the business. "Claims and bankruptcies can come from anywhere but it is more likely to be those companies that have poor controls in place as well as those with weak balance sheets," he adds.

In spite of the greater risks present in the market, new players may also be attracted to the market over the next 12 months.

Mr Peck explains: "Rates are hardening and there's demand for the product. An underwriter coming into the market now wouldn't have a history of claims and, with a good risk management strategy, could maintain a clean and profitable book of business. It could be a very good time to be writing D&O cover."

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