For many years, U.S.-listed companies based outside the U.S. have enjoyed a relatively advantageous pricing environment for their D&O insurance. Because many D&O insurance underwriters based outside the U.S. used a different pricing model than their U.S. counterparts, pricing for these foreign filers was in many instances lower than the pricing available to equivalent U.S.-based companies. In recent months, however, as a result of surging claims frequency and loss costs, foreign filers’ D&O insurance costs have jumped significantly. These developments and the claims-related factors causing the changes are detailed in an interesting March 20, 2019 article by Jane Njavro of Woodruff Sawyer entitled “Why D&O Costs Are Soaring for Foreign Filers” (here). The article includes detailed statistical analysis of the relevant U.S. securities class action litigation trends.
Increased U.S. Securities Class Action Lawsuit Frequency
Njavro starts her analysis with a review of the U.S. securities class action frequency trends for the U.S.-listed companies based outside the U.S. She analyzed the number of suits filed against these companies in the ten-year period from 2009 to 2018, dividing the period into two five-year segments. During the first five year segment from 2009 to 2013, there were 143 securities suits filed against foreign filers. During the second segment from 2014 to 2018, there were 202 securities suits, representing a 41% increase in filings.
During the ten-year period from 2009 to 2018, nearly every global region experienced an increase in the number of claims. The largest number of the 345 U.S. securities lawsuits filed against non-U.S. companies during that period were filed against companies in the Asia-Pacific region (156 cases, representing 45.2% of the total, of which 140 involved cases against Chinese companies). There also were significant increases in the number of U.S. securities suits filed against European companies (90 cases, representing 26.1% of the total) and in Africa & Middle East (28 cases, representing 8.1% of the total, of which 25 were cases filed against Israeli companies).
Increased Aggregate Severity
Consistent with the increase in the numbers of lawsuits filed, the aggregate amounts paid out in U.S. securities lawsuit settlements also increased during the period 2009 to 2018. During the five year period 2009 to 2013, there was a total of $657 million paid out in securities suit settlements involving foreign filers, while during the period 2014 to 2018, there was a total of $1.2 billion paid out, representing an 83% increase compared to the prior period. (Please note that these figures exclude the $3 billion settlement in the Petrobras securities suit.)
The Asia-Pacific region had the highest number of settlements over the last ten years (83), but the European region, with fewer settlements (24), had the highest settlement payout total ($712.5 million for Europe vs. $562.9 million for Asia-Pacific). As a result, the average settlement payout in the European region ($29.7 million) was considerably higher than in the Asia-Pacific region ($6.8 million).
The Changing D&O Insurance Pricing Environment for Foreign Filers
The increases in both claims frequency and claims severity have, as Njavro puts it in her paper, “caused carriers to take stock of their books.” The market, she says, “has seen so many losses that the previous pricing was not sustainable.”
As a result, non-U.S. companies with listings on U.S. exchanges are now facing “unusually steep increases in D&O insurance premiums.” In many cases, foreign filers are “now facing premium rates that have reached parity with their U.S. peers, in some cases doubling or tripling the total spend from one year to the next.” In addition, insurers are increasing the policyholder’s self-insured retention, with retentions rising to as much as $5 million or even $10 million for larger or higher-risk companies. Many carriers are also reducing their limits exposed with some insurers “hesitating to provide $10 million in capacity.” Njavro also notes that in some cases, “the increases of the excess layers is more significant than that of the primary layer,” as excess carriers have reassessed which attachment points are in “burn layer.”
In her paper, Njavro also reports her findings from her survey of D&O insurance underwriters working on U.S.-listed foreign companies. She found that 100% of the underwriters surveyed thought that pricing was going up for U.S-listed companies. 95% of the respondents said they thought that at their next renewal these foreign filers would see total insurance cost increases of over 20%, with 67% of all respondents saying that these buyers could expect total insurance cost increases of over 30%
The difficulty of the current situation for these foreign filers was highlighted by one final observation of the D&O insurance underwriter survey; Njavro reported that 87% of the respondents thought that U.S.-listed foreign filers “are not aware as they should be about the risk and cost of U.S. D&O litigation.”
Over the last few years when I was confronted with the lower D&O insurance pricing available outside the U.S. to non-U.S. companies listed on the U.S. exchanges, I could only shake my head. Largely as result of intense competition for the business, these buyers were able to purchase D&O insurance at total costs that in many cases was substantially less than the amounts that their U.S.-based counterparts were paying, even though both the U.S. and the non-U.S. companies were equally exposed to the same significant U.S. class action securities litigation exposure.
This lower pricing was the result of a double delusion. In many instances, the non-U.S. D&O underwriters deluded themselves that they could get away with pricing the business lower, despite the equivalent risk exposure. (In some instances the underwriters’ belief that they could get away with this approach was based more on magical thinking rather than a detailed understanding of the U.S. litigation exposure.) Even though the insurance buyers enjoyed the benefit of the lower insurance costs, the buyers were also deluded because in many cases the insurance they were buying was not built to respond to the U.S. securities litigation exposure. In many cases, the insurance model outside the U.S. for non-U.S. companies listed on the U.S. exchanges was deeply flawed, even setting aside the recent adverse trends in claims frequency and severity.
While the changes in insurance pricing and in terms and conditions that Njavro describes in her paper are in part a reflection of past practices involving and changing claims conditions relating to foreign filers, the changes Njavro describes are similar to the changing marketplace that many U.S.-based publicly traded companies are also now experiencing.
That is, many U.S.-based public companies (particularly IPO companies, life sciences and high tech companies, companies with a poor claims history) are also seeing increases in pricing and changes to terms and conditions similar in many ways to the changes Njavro describes for foreign filers. The fact is that the adverse claims trends over the last ten years (particularly with respect to increased claim frequency) are not limited just to foreign filers; as a general matter, the adverse claims trends are affecting all U.S.-listed companies, and even the U.S.-based companies are facing the prospect of a significantly changed D&O insurance pricing environment.
Many industry observers have been aware of the claims trends for foreign filers for many years. I have observed many times on this site that in many annual periods the percentage of all U.S. securities suits filed against foreign filers was greater (in some years substantially greater) than the percentage of all U.S.-listed companies that the foreign filers represented. At the same time, I have also long thought that keep track of the foreign filers’ claims in this way could result in some “double counting” – that is, in many instances, the companies were not facing a heightened securities litigation risk because of where they were based, but rather because of what industry they are in.
For example, there have in recent years been significant numbers of securities suits filed against companies based in Ireland. However, these companies’ heightened securities exposure is not due to the fact that they are Ireland-based; the heightened exposure is largely due to the fact that most of these Irish companies are in the life sciences sector, which is an industry class facing heightened risk regardless of where the companies are based.
Similarly, the large numbers of lawsuits against Israeli companies is not necessarily due to the Israeli home base, but rather because most of the U.S.-listed Israeli companies are in the high tech sector. Similarly for Canadian and Australian companies; many of the U.S.-listed companies based in these companies are natural resources companies, an industry that has been particularly volatile over the last few years.
My concern is if this distinction is not kept in mind, some companies could be double-debited. For example, a pharmaceutical company based in Ireland should not be debited a second time just because it is based in Ireland, on top of being debited for being in a higher-risk industry.
At the same time, there are some companies that arguably should face a debit because they have a profile outside of the U.S. For example, U.S.-listed companies based in, say, Russia or Latin America have in recent years faced a rash of U.S. securities class action lawsuits following in the wake of bribery and anti-corruption enforcement actions. In some cases, these non-U.S. domiciled companies arguably should face higher premiums precisely because of their profile outside the U.S.
My point here if underwriters take a category-wide approach to all non-U.S. companies, they could sweep with too broad of a brush. A better approach would be more country and company specific, and take into account considerations such as industry and business footprint. Njavro’s article suggests that that underwriters’ current approach in some instances may reflect this kind of sensitivity; she comments that “companies with recent claims or in riskier industries such as technology and biotech are facing major premium adjustments.”
A Final Thought about Terms and Conditions
One can certainly hope that as foreign filers find themselves grappling with what may be unexpected price increases that these companies also take the opportunity to ensure that their insurance program is in fact purpose built in order to respond appropriately to U.S. litigation. Even without respect to the current pricing environment, these non-U.S. companies would be well-advised to have a detailed analysis of the terms and conditions available from insurance underwriters based outside the U.S. with the terms and conditions available from a U.S.-based or London-based insurer (assuming that from a regulatory standpoint, procuring insurance from a U.S. insurer is a realistic possibility).
These companies will find in many instances that the U.S.-based (and often a London-based) product is substantially better suited to addressing the companies’ U.S. litigation exposure than the product offered elsewhere. The fact that these companies are going to be paying a lot more for their insurance is all the more reason for these companies to make sure that they have an insurance policy that is actually built to address their litigation risk.
Some Final Thoughts about the Claims Statistics
I have a couple of final observations about the statistics in Njavro’s report. The first is that there is one way that the increase in the number of securities suits against foreign filers is particularly interesting, and that is that the number of suits against these companies has been increasing despite the impact of the U.S. Supreme Court’s 2010 decision in the Morrison case. At the time of the Morrison decision, it was generally thought that one impact of the Morrison would be that there would be fewer U.S. securities suits filed against non-U.S. companies. Instead, as Njavro’s analysis shows, the number of U.S. securities suits has increased in recent years, notwithstanding Morrison. To be sure, Njavro’s statistics relate to U.S.-listed companies, with respect to which Morrison’s holding is not a litigation-restricting factor.
One final thing I found interesting about Njavro’s analysis of the two five year segments during the last ten years was that there were fewer lawsuits against foreign filers in the first five year period (2008-2013), even though that period included 2011, the year in which there was an explosion of suits involving Chinese reverse-merger companies. There were 55 lawsuits filed against foreign filers that year, representing more than 35% of all securities suits that year, of which 39 were filed against China-based companies. The fact that the period 2014-2018 had more suits filed against foreign filers than in the prior five year period, notwithstanding the fact that the figures for the first five year period arguably were distorted upward by the one-year anomaly of the Chinese reverse merger filings in 2011, is interesting and underscores the significance of the increases in the number of lawsuits in the second five-year period.