In the following guest post, Paul Ferrillo takes a look at the current state of the D&O insurance market and provides his views on the importance of a healthy D&O market for corporate America. Paul is a shareholder in the Greenberg Traurig law firm’s Cybersecurity, Privacy, and Crisis Management Practice. I would like to thank Paul for his willingness to allow me to publish his article on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is Paul’s article.
It does not take a psychic to understand the title of this article. But maybe it takes one more phrase to make the title complete: “because of the increase in securities litigation, the increase in enforcement activity by the SEC, Cybersecurity issues (and their regulatory issues) and the general uncertainties of the political environment in the United States.”
What do all these things have in common? They can cause Claims. What do Claims cost? Money, and lots of it, to defend and settle them. And where does this money come from generally? The D&O carriers.
Not so complicated, right? Yet it is, as many of the above-mentioned elements can arguably double and triple the cost of Claims, meaning there is potentially a double and tripling of costs and expenses. But what you say? Aren’t the carriers making a fortune on premiums today because of these various factors? Well, maybe, maybe not. It depends upon who you ask and for what period you are asking about. The bottom line is that both corporations and D&O insurers need each other to remain healthy and strong. In uncertain economic times, corporations depend upon D&O carriers to be especially strong, since the corporations and directors may call upon the carriers to pay their claims. Market forces and heavy competition have not allowed this “balance” to happen for many years prior to the recent past. We explain why below, and why that fact is a potential problem.
Securities Litigation Claims are at record highs and have long tails
We won’t spend much time on this one. D&O claims have increased over the last few years. Securities litigation claims were at record highs in 2017 and 2018, with 403 new federal class actions being filed in 2018 (slightly down from 412 new cases in 2017). See “Securities Class Action Filings, 2018: a year in review,” available here. A continuing part of the increase in securities class action filings is the number of filings made after the announcement of a merger or acquisition – in 2018 there were 182 “deal” cases, the second largest number since 2009.
Though filings for 2019 are down slightly from record levels in 2017 and 2018, from a D&O insurance perspective the potential damage has already been done. Even assuming 45% of those cases filed in 2017 and 2018 get dismissed in one way or another (the average dismissal rate), it means that the 449 cases filed in these years in “inventory” will likely proceed, and cost money to litigate and ultimately settle. And factoring in an average settlement of $30 million dollars (excluding defense costs), see Recent Trends in Securities Class Action Litigation: 2018 Full-Year Review, available here, these cases could ultimately cost $13.5 billion dollars to settle. This estimated monetary number, amazing but true, would not include the recent trend of large shareholder derivative settlements that we have seen in the last two years. Since not all cases settle immediately, the number of cases in inventory is likely much higher than the 449 cases estimate we gave above. So $13.5 billion in potential settlement value is likely “low” as well at the end of the day.
Two more facts to entertain here regarding the impact of securities litigation claims on corporate America, and their D&O insurers:
1) SEC enforcement activity is on the rise. When the SEC chooses to investigate a company regarding an alleged securities fraud suit, there is no doubt that investigation costs both time, and money. Depending upon the nature and seriousness of the allegations being made (e.g. a “Worldcom” like case), the SEC investigation might ultimately cause the securities litigation suit to settle at a much higher number. There are plenty of examples for this proposition;
2) Cyber Risk can magnify, and in fact cause, securities litigation. We have seen this story play out before since 2013. Without identifying company names, cybersecurity breaches can cause loss of extreme amounts of data, a plethora of bad press, and generate privacy litigation and regulatory proceedings. And cybersecurity breaches can cause stock and market capitalization losses. Market capitalization losses generate securities class action lawsuits. Enough said.
Cyber Risk is increasing exponentially
We almost don’t need to reiterate this fact. It is evident every day of the week when the most recent hack or breach gets announced across the relevant high-activity blogs.
So, what is new about cyber risk? Two things that really matter to directors and officers:
1) Cybersecurity Litigation is now sticking: Though early cyber and privacy related litigation was flashy and new, it did not result in head-spinning monetary settlements. That is not true today and settlements since the Anthem Healthcare breach have been on the rise. Why is this important? Well merely that these settlements are evidencing to the plaintiff bar that cybersecurity breach litigation can be profitable, if not lucrative, for the right case. This will cause competition among the plaintiffs’ class action firms. And more litigation and more firms get in the game; and
2) Cyber regulators are more on the hunt than ever before. No doubt this was an expected occurrence in the cybersecurity ecosystem. It had to happen based upon the sheer volume of new laws and regulations that are being put on the books every month. We even expected the EU GDPR, which went into effect in May 2018, to be problematic based upon its sheer breath and the prior fines of US companies where privacy was at issue. But today, the world has changed again, with record fines being recently assessed against British Airways and Marriot in the amount of $230 million and $123 million, respectively. These are very large amounts, and potentially will be added into the mix of damages sought in against the companies and its board of directors.
D&O Premiums have increased, but only recently
So, we see some factors stacking up here that should have indicated steadily increasing premiums over the last few years to account for the breath of the new securities lawsuits (including the pre-existing glut of merger-related lawsuits and derivative actions) and expanded risk of the directors and officers to cybersecurity incidents and breaches.
But believe it or not, real increases of greater than 5 % have only occurred in the last four or five quarters. In the 4 years prior, not insubstantial rate decreases were the norm. Or increases were “close to zero” when it came to pricing coverage for excess D&O insurance layers.
Why we need a healthy D&O market for both coverage, and to pay claims
Stepping back, the natural reaction to these facts might be “too bad for the carriers.” But that really is not the whole story. There are good arguments for some insureds that rate increases should be supported. Why? D&O insurance serves an important purpose to both the healthiest of companies (to help them recruit directors), and to companies that are not so healthy since it serves to backstop claims for advancement and indemnification. This is especially true when insolvency or bankruptcy might be a real issue for a company. Getting the right primary D&O carrier who will pay your claim is critical. But getting the right level of excess D&O coverage is also critical for the larger company, and sometimes you can only build that tower with a “name-brand” carrier which might cost you a little more in premium. You tend to pay for what you get in D&O coverage, and paying a little bit more can help do the trick.
But rate increases also don’t mean a blank check should be given to your carrier either. In times like today, where rate increases are sought, it might be time to ask what your primary or excess carrier can do for you. Do you need a coverage enhancement? Do you need a $15 million primary policy instead of a $10 million primary? Do you need a $15 million layer at the top of your $100 million tower, but you can only get a $10 million layer? Maybe rate will help you accomplish your coverage goals.
Today’s D&O market is a fast and ever-changing one. So is the world for that matter, where political tensions seem to simmer constantly below the boiling point, both domestically and internationally. Ultimately, we are NOT saying to roll over and play dead when your carriers want a premium increase for all the reasons we mention above. But we are saying your response might rather be, “how can we both help each other in these challenging times.”