Directors & Officers liability insurance is a niche segment in the U.S. market that receives considerable attention relative to its overall size, largely due to outsized losses related to prominent corporate events or allegations, including bankruptcies, accounting irregularities or restatements, mergers & acquisitions or management malfeasance.
After several years of largely stagnant revenue volume, D&O premiums grew at an astonishing rate recently with sharp price increases in response to poor loss experience. Segment direct premiums reached a record $10.7 billion in 2020 with volume expanding by 67% in the last two years, according to industry statutory financial data.
However, pricing and underwriting actions have failed to generate a meaningful turnaround in D&O performance as claims severity and reserve adequacy issues fester. The segment reported a statutory underwriting loss for the last four consecutive years, with the direct loss ratio averaging 75% from 2017-20, with only modest improvement to 74% in 2020. This result compares to a 61% average loss ratio from 2011-16.
The market’s struggles are tied to an extended period of competitive underwriting conditions, under which pricing did not respond to continually rising loss severity from adverse litigation rulings and more frequent large verdicts, or social inflation. Underlying causes of social inflation are difficult to pinpoint, but include a higher propensity for filing suit, effects of legislative and regulatory changes, broader definition of liability, and changes in jury sentiment.
Pricing for D&O moved positively over the last three years, with a sharp acceleration in 2020, fueled in part by market capacity shifts and pandemic related uncertainty. Aon’s quarterly D&O Pricing Index reported a 9.6% average increase for all quarters in 2019 on renewal rates for policies with no change in limit and deductible. This average increased to 23.6% in 2020.
The effects of these pricing actions and more restrictive underwriting terms and condition will continue to flow through operating results, promoting improvement in segment underwriting results in 2021 and 2022.
Pause in class actions likely temporary
Securities class actions remain a key source of D&O losses and large claims instances.
Class action filings sharply escalated from 2017-19, with particular growth in merger objection claims that allege management acquisition actions did not meet shareholder interests. However, a pandemic-related slowdown in judicial activity and reductions in merger transactions led to a 22% reduction in class action filings in 2020, according to NERA Economic Consulting Inc.
Loss settlements rose higher for the year as ISS Securities Class Action Services reports that worldwide class action settlements tallied over $5.8 billion in 2020 compared with $3.6 billion a year earlier, with 95% of the total originating in the U.S.
Class action volume will likely revert to past norms as the economic recovery continues and a recent boost in merger transactions will promote opportunities for new litigation. The strength and durability of the economy, volume of bond defaults and business insolvencies, and equity market performance will greatly influence class action trends going forward. The recent spike in new public stock offerings, particularly from growth in popularity of special purpose acquisition companies (SPACs) will provide fertile territory for future class action filings in the event of a market correction.
Multitude of emerging risks
Responsibilities of organization leaders and source of D&O claims allegations continue to evolve with changes in economic conditions, the regulatory and legal environment, social norms and advances in technology.
D&O claims risks are more frequently emerging tied to events that traditionally triggered claims in other liability segments, including product liability or employment practices liability, where an adverse event is attributable to alleged negligence or poor governance practices. Cyber incidents are a newer growing source of D&O exposure, in which a data breach or ransomware attack leads to allegations of inadequate management oversight of information system security and lax risk management. Class action filings related to cryptocurrencies are also a recent phenomenon.
The recent D&O liability survey 2021 published by Willis Towers Watson and Clyde & Co. highlights market awareness of these emerging risks that are influencing demand for D&O coverage in the current market. For U.S. survey participants, events that were a more prominent current concern than shareholder actions or overall litigation risks include cyber, health safety and environmental prosecutions, regulatory risks and environmental claims exposures.
The coronavirus pandemic represents a new vein of insured losses in casualty segments, including D&O. Exposure can materialize from allegations that an organization failed to protect employees or customers from exposure to the virus or serious illness. Entities creating protective products or vaccines to prevent the virus or treatments for afflicted individuals that prove ineffective also may face unique new D&O exposures.
What lies ahead?
Pandemic-related D&O claims losses will likely take several years to fully measure and resolve, and will hinge on the extent that economic activity returns to prior norms, as well as the ongoing effectiveness of vaccination and treatments to combat the virus.
The recent substantive changes in the D&O market will improve near-term underwriting results for the segment, but a return to past levels of profit strength remains uncertain. The inherent uncertainty in projecting D&O loss severity may be exacerbated near term by an increase in general inflation levels, expansion of the litigation finance market that provides investment capital to plaintiffs, and limited potential for relief via class action or other tort reforms in the current political environment.
Pricing trends are anticipated to remain positive, but the pace of increase is likely to decelerate from recent extraordinary levels, partially influenced by underwriting capacity added from recently formed Bermuda entrants, among others. Competitive forces and pricing cyclicality will create challenges longer term for D&O pricing to keep pace with loss trends.
