As has been well-documented (on this site and in various other sources), securities class action frequency has soared to historically high levels in recent years. Given this development, it might reasonably be assumed that D&O insurance pricing has increased to account for the increased litigation risk. However, for a number of reasons – including the continued abundance of insurance capacity – D&O insurance pricing overall has declined. For that reason, it “should come as no surprise” that Transatlantic Reinsurance’s October 2018 analysis of the U.S. public company D&O liability insurance marketplace reveals “price inadequacy” – that is, that the “level of compensation in the market is not commensurate with the risks being taken.” The TransRe report, while technical, illustrates the currently challenging circumstances facing the D&O insurance industry.

The Report’s Methodology

The report is based on the authors’ analysis of a proprietary database of almost 190,000 policies representing almost $1 trillion of aggregate policy limits, supplemented by several third-party sources. As part of their analysis, the authors segmented the companies in the database into three market capitalization categories: small cap (under $1 billion); mid cap (between $1 billion and $10 billion); and large cap (over $10 billion). The authors segmented the insurance policies in the database by attachment point: high, medium, and working layer. The division of the policies by attachment point varies according to the market capitalization of insured company (for example, a high attachment point for a large cap company is $100 million or over, while a high attachment point for a small cap company is $25 million or over).

Pricing Trends Analysis

The authors used these categorizations to analyze pricing trends for all public company D&O insurance policies placed during the period 2013 through 2018. The analysis shows that overall across all market capitalizations and across all attachment points, D&O pricing has declined 15% since 2013. The pricing declines were steepest for high attaching policies – the pricing for high attaching policies has declined 28% since 2013.

Interestingly, the authors’ analysis also shows that for all layers except the high attaching policies pricing appears to have flattened between 2017 and 2018; with respect to the working layers, pricing may even have edged up slightly between 2017 and 2018.

When viewed according to the market capitalization of the insured company, a slightly different pricing trend pictures emerges. Thus, for example, for small cap companies, pricing for the working layer and medium attachment points policies increased in 2018 compared to 2017 and is now slightly above 2013 levels. However, for small cap companies, pricing for the high attachment point excess policies remains down and is about 18% below 2013 levels.

For mid cap companies, pricing overall is about 17% below 2013 levels, with pricing for medium and high attachment point policies down over 20% compared to 2013 levels. However, pricing in the working layers for mid cap companies increased slightly between 2017 and 2018 and now is only about 3% below 2013 levels.

For large cap companies, pricing overall is down 18% below 2013 levels, with pricing for medium attachment point and high attachment point policies down over 20% (30% down for high attachment point policies). Pricing in the working layers flattened between 2017 and 2018, and is currently about 3% below 2013 levels.

The authors’ detailed pricing trend analysis does not differentiate between new and renewal business, but breaking the policies down between new and renewal shows that the “worst premium deterioration” is with respect to new business “as carriers ‘buy’ accounts from one another – a classic soft market ‘tell.’”

Loss Experience Analysis

Having reviewed the pricing trends, the authors then looked at the D&O insurance industry’s loss experience during the period 2008 to 2017. In assessing the industry’s loss experience, the authors assume an industry cost ratio of 27.5%, implying that in order to break even insurers would need to produce a loss ratio of 72.5% or better.

The authors first considered the collective loss experience for commercial public D&O and financial institution (FI) D&O/E&O. The collective loss experience for these two segments shows that the loss ratios deteriorated significantly during the period 2013 through 2017 and are now well above the 72.5% break-even level. The authors comment that due to the impact of loss trends (both increasing frequency and increasing severity) and softening prices the loss results have deteriorated 19 points in the past five years.

The loss experience of commercial public D&O viewed alone (that is, without the results of the FI accounts), while more volatile than the collective results described in the preceding paragraph,  also  shows deteriorating loss results since 2013. The authors comment that as result of loss trends and price softening, the loss experience has increased 20 points in the past five years and 30 points since 2010.

The authors’ technical analysis of the industry’s IBNR (incurred but not reported) figures and of the gap between industry’s booked vs. developed ultimate loss ratios suggest that the industry’s booked reserves are optimistic. In other words, as the prior underwriting years develop, the D&O insurers are likely to see further deterioration in their prior underwriting year results, putting significant pressure on their current calendar year results, particularly given current pricing trends.

The authors include in the text of their report as well as in an appendix to their report a claims frequency analysis showing that securities class action frequency is up across all business sectors and for all market capitalization (although the increase is more pronounced for large and mid cap companies than for small cap companies). In addition to rising securities class action frequency, public companies also continue to see emerging areas of claims exposure, including “cultural EPLI issues,” data breach related claims, and a “proliferation” of Section 11 claims.

The Authors’ Conclusions

In their concluding analysis, the authors suggest that current conditions are comparable to the soft market trough during the period 1997-2001, with some additional factors unique to the current period. The current market is characterized by widespread pricing pressure caused by abundant capacity, increasing claim frequency, increased severity of derivative actions, and claim cost inflation, while at the same time policies are being written on broader terms at lower prices.

The report’s bottom line is that “prices are not keeping pace with loss costs.” The authors are “encouraged” by the signs of pricing improvement in the most recent underwriting year, at least for some policies and for some insureds. However, the report concludes, “underwriters must be vigilant to improve the profitability of their book.”

Discussion

The TransRe report is highly technical and for that reason it is something of a challenging read. Most of the information in the report is presented in graphical form, which I have tried to describe textually here. Some readers will find it helpful to review the graphics presented in the report rather than depending on my descriptions alone.

What is clear is that as a result of price declines and loss trends, D&O insurers’ results are deteriorating and are generating underwriting losses. Signs suggest further deterioration ahead. In the current low interest rate environment, insurers likely will not be able to offset underwriting losses with investment income.

The report’s message is that the insurers are not being compensated adequately for the risks the insurers are undertaking. The report’s value is that it substantiates this message. However, this message is not news for most  insurers. Indeed, for many months, D&O insurance underwriters have been poor-mouthing their business, complaining about their deteriorating prior underwriting year results, and bemoaning price inadequacy.

As the reports analysis shows, there are signs of some slight price hardening in some market segments and for policies at some attachment points. However, the modest price increases in some pockets is not sufficient to offset years of price decreases, particularly in light of adverse frequency and severity trends.

The challenge for the D&O insurers is that insurance capacity remains abundant. Insurers attempting to push for rate increases are finding relatively little marketplace support; in many instances, their efforts to increase prices are undercut by competition. As a result, insurers pushing for rate face pressure to back off their higher quoted prices or lose the business altogether.

All of that said, the numbers paint a grim picture. I expect that as we wrap up 2018 and we head into 2019, we will be hearing a steady drumbeat of messages from public company D&O underwriters that they are going to be pushing for rate increases. Indeed, this message may well extend beyond public company D&O to private company D&O, EPL, and FI.

For that reason, those advising companies about their management liability insurance will want to be sure to forewarn their clients about changing marketplace conditions. At a minimum, insurance buyers can expect the pricing on their primary and lower level excess insurance to be flat or up slightly compared to the prior year. Pricing for high attachment excess insurance may flatten as well as excess insurers start hitting minimum premiums.

Whether or not D&O insurers deteriorating results will translate into comprehensive price increases remains to be seen. Given the continued abundance of insurance capacity, insurers pushing for rate increases will be facing some powerful headwinds.