In a recent guest post, industry veterans John McCarrick and Paul Schiavone outlined some policy terms and conditions they suggested D&O insurers may want to address as the insurers try to re-orient toward profitability. In the following guest post, Paul Ferrillo provides his response to John and Paul’s article. Paul is a shareholder in the Greenberg Traurig law firm’s Cybersecurity, Privacy, and Crisis Management Practice. I would like to thank Paul for allowing me to publish his guest post as an 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.
There was recently an article written by two old friends talking about a wish list to constrict existing coverage under directors and officers (“D&O”) policies on the grounds that, more generally, the carriers are suffering big losses.
Now to be honest about my intentions here, both Paul and John are really good friends (I have known Paul Schiavone forever since we both were at AIG in the late 1990’s) so I have no intention to impugn their integrity. I just think there is another side of the coin. Having been on the defense end of some really bad cases in my career (emphasis – “really bad” – like Worldcom), there is a reason coverage is broad — to protect the personal assets and professional lives of directors and officers caught in the cross-hairs of a fraud or situation they likely had no chance of catching or dealing with successfully. Cheaper coverage means narrower coverage. But narrower coverage is NOT what we need today for the reasons set forth below.
Cheaper is not better
Paul and John write: “And so brokers and risk managers have two choices: either accept steeply-increasing premiums for the foreseeable future and light a candle — praying for the end of the hard market, or conform the D&O policy to a narrower scope of necessary coverage in exchange for more moderate price increases.”
If I am a director and read this statement, I say, “nope on narrower coverage, not while I am on the board.” D&O risk is a function of corporate and enterprise risk. And enterprise risk has never been higher than it is today. According to NERA, securities class actions continue to be record highs. “Filings through Q3 2019 suggest that new securities class actions will peak at over 450 in 2019, making this year the highest level of filings since 2001. Through September, filings have continued to show a shift in the types of cases filed. Specifically, for 2019 Rule 10b-5, Section 11, and Section 12 cases represent a larger proportion of all filings than in prior years. On the other hand, the proportion of cases involving a merger objection has declined, a possible indication that these cases are returning to the pre-2017 levels.” See “Recent Trends in Securities Class Action Litigation: Q3 2019 Update,” available here. Cornerstone tells us SEC enforcement action levels remains at near record heights. See SEC Enforcement Activity: Public Companies and Subsidiaries, available here.
Let’s not forget that there is other risk for directors outside of securities law risk. Mergers are still happening (though M&A deal litigation is down). Cyber risk has never been higher. See “Data Breach-Related Securities Suit Filed Against Capital One,” available here. And some companies have even had to file for bankruptcy following a bad data breach. See “Guest Post: Buckle up Directors: Cybersecurity Risk and Bankruptcy Risk Are Not Mutually Exclusive,” available here.
So, reduce D&O coverage in today’s environment to get a “few dollars” back on premiums? “Not on my watch” so says the average, well-informed director.
The real problem is capacity and rate. Back when Paul S. and I were at AIG, you could count the number of “true,” long-term D&O carriers on your fingers and toes. And for a Fortune 100 company, the fingers on one hand. Today you would need a room full of fingers and toes in order to get to an accurate count. Especially when you include the Side A carriers. The increase in the number of markets came with an expected decrease in premium (meaning hey, “I am a new carrier, let me write a lot of cheap coverage to build my book”). And then the losses hit, as they always do. Including some really steep Side A derivative losses and some major cases settled for record numbers. In the face of several years of decreasing premiums, these more current losses have put pressure on a number of carriers. Though rates are up today at least 15% in some areas of the D&O market, several quarters of rate increases can’t overnight make up for years of premium decreases.
So its no wonder we are hearing “let’s narrow coverage for the directors.” But as we show above, that is not the issue. The real issue is over-capacity driving premium down, while the claim and risk side of the D&O market was steadily increasing since 2013-2014. While directors are faulted for many things in Corporate America, they cannot be faulted for the D&O carriers mis-pricing risk and retention for years, hoping the boogeyman would not strike hard. But as we know today, securities claims are at historically high levels, and the cyber and “me-too” event driven boogeyman have struck extremely hard. D&O risk has never been higher. On cyber, risk will grow even scarier as more and more regulators join in fining and sanctioning companies, creating more fodder for the plaintiffs’ bar. So “narrow coverage for the directors?” Nope, if I am a director I want more coverage, not less. I want to be protected, especially from the large spill-over of cyber risk into D&O and entity risk that we are seeing today post-British Airways and Marriott Hotels. Sitting on boards of directors was never “risk free.” Today, sitting on a board can be akin to the show, “Naked and Afraid,” on the episode where the lions where circling their camp every night looking for “snacks.”
Claims-Paying Differentiates the Markets – and Should Drive Premium Increases
So here is where I come out for most companies — here assuming they can fund whatever premium increases they need to in order to pass through the “hard market.”
Having spent years in the bankruptcy ecosystem seeing the pain and suffering of boards going through hard times, I can tell you its no fun. Especially when there are coverage issues, and especially when the D&O tower is the only thing that separates a director or officer from financial ruin. Skimping on coverage is never a good idea. For the same but a related reason, accepting narrower coverage can also be problematic. In a bankruptcy setting, “everything relates to everything.” Playing with narrower coverage, broader prior acts exclusions, different “related acts” wording? All bad ideas. All fertile grounds for coverage lawsuits. The worst thing you could wish for in bankruptcy.
If I am a director, I want broad coverage. By a primary carrier that is going to pay my claim without haggling me or my defense counsel to death over the price of paper clips and photo-copying. I want a primary carrier with plenty of claims experience, and with the “war-time” smarts to know when to show his cards and when to fold them too on the other hand. If the premium for that coverage is more than the “average” primary premium (by someone who is not going to pay claims) then that is the way it is. Let face it. Life is hard enough. A narrower scope of D&O coverage? I am sorry Paul and John. Not on my watch.