Roller Coaster Ride for D&O Rates May Persist
Over the past five years, the management liability market has been in a state of flux, with carriers trying to navigate social inflation alongside volatile economic conditions. This has led to swings in rates, market capacity, and underwriting demands. While there has been an increase in new players entering the market in 2021 and 2022 to take advantage of lower than expected losses, we expect rate, capacity, and underwriting to tighten in the coming year.
This report will provide perspective on the reasons behind these trends as well as a look over the horizon regarding some of the potential expected headwinds and the advisement businesses will need in place.
D&O RATE RECAP
The last 20 years can be characterized as a roller coaster of rates. When looking at management liability by quarter (Figure 1), you get a glimpse of the severity. While rates have stabilized somewhat, certainty is not the word of the day.
D&O shifted to a hard market in late 2018/early 2019 driven by a lack of overall profitability and, more recently, uncertainty around the pandemic. Profitability improved during this time as rates increased and the COVID-19 impact was less pronounced than anticipated.
Following the improved profitability, new capacity came online by way of current carriers offering higher limits, new market entrants, and additional excess capacity. More markets chasing fewer premium dollars following the crash in activity for initial public offerings (IPOs) and special purpose acquisition companies (SPACs) slowed the rate gains substantially on the back end of 2022. Rates have continued to soften in the first half of 2023, which is particularly noteworthy given the signs of deterioration beginning to show in the macroeconomic environment.
D&O TRENDS
While there is more capacity in the D&O market—due to a rise in carrier appetite and the rise of insurtechs in this space—improved pricing probably won’t have sticking power. There are numerous headwinds facing both insurers and company leaders that could make the relative calm of the D&O market short-lived.
Securities and Exchange Commission (SEC) rule proposals, Federal Reserve predictions of an upcoming recession, political instability in Europe, qualified-labor shortages, and unrelenting demands from stakeholders for both returns on investment and community benevolence broaden the chances for D&O missteps, liability claims, and capacity contraction. While many of the exposures are experienced in the publicly traded markets, we know that what happens there spreads into the private market over time.
Whereas claims against companies in the 20-teens focused heavily on securities class-action cases, federal securities class actions fell substantially in 2020—by 20% according to Bailey Cavalieri—and federal and state securities class actions were down by 36% in 2021, the law firm said in a November 2022 analysis. The report cited an 85% drop in M&A-related securities class actions as the primary cause of the decrease. It noted there has been a move away from class actions toward single-plaintiff cases, which allows for settlements out of court and makes tracking dollar losses and insurance payouts more difficult.
The use of SPACs seems to have run its brief course, and the spike in M&A activity we saw in 2021 and 2022 has already waned to below pre-pandemic levels (Figure 2). That said, director and officer exposure in the merger and acquisition realm is still very real, especially if deals fail, cost more than expected, or yield losses or little benefit to shareholders. There also are employment practices exposures over the handling and integration of companies and cultures, job consolidation, downsizing for efficiency, and changes in job accommodations. Across all mergers and acquisitions, it will be critical to assess D&O and employment practices liability as part of the due diligence process.
Derivative lawsuits—those brought by shareholders against directors and officers on behalf of the company—are becoming increasingly expensive, as plaintiff’s attorneys often will file lawsuits in courts across multiple states arguing essentially the same case against a single board or officer. It’s important for a broker placing D&O insurance to understand the bylaws of a company and determine if they contain a forum selection clause, which, where permissible by state law, stipulates the venue for the filing and adjudication of disputes over issues internal to the company.
Demands from underwriters also have increased, with requests for financial reports—even interim financials—occurring regularly. Favorable accounts, such as those with no claims and strong balance sheets, are seeing better rates and terms, as you would expect. Brokers need to make the case for clients with less than stellar track records, but capacity is usually available, albeit at higher rates.
D&O HEADWINDS AND HOT BUTTONS
Cyber
No discussion of D&O would be complete without addressing cyber. It would seem that, with the large losses and frequent attacks, cybersecurity failures would generate substantial D&O losses, but that hasn’t been the case, in part due to the exclusionary language included in many carrier policies. Brokers should work with clients to ensure cybersecurity protocols are in place—appropriate for the risk faced, aptly updated, and enforced. And where appropriate, they should look to place a separate cyber policy. When directors and officers can show that the company has a competent cybersecurity plan, followed it, responded to an attack quickly, and was transparent in the ramifications of an attack, financial liability may be mitigated or avoided.
ESG
ESG (environmental, social, and governance) has been a whipsaw over the past two years. The category is broad, comprising everything from net zero emission goals to increasing workplace diversity. While proactive measures are often integral in mitigating exposure, aspirational assertions by companies about their diversity, equity, inclusion, and environmental stewardship have generated complaints against directors and officers. However, 2022 court rulings in California rejected the validity of gender-based and other quotas and may provide some relief from D&O complaints. Moreover, shareholder lawsuits regarding diversity have largely been dismissed.
Greenwashing
Greenwashing—making false or misleading statements about a company’s or product’s environmental quality—and greenhushing, where companies conceal information on their risks to the environment, are rising D&O exposures. This may become more apparent if the SEC finalizes climate disclosure requirements. The proposed rules have generated much angst due to the difficulty of developing metrics that yield accurate information and a coherent story. The proposed rules include reporting about greenhouse gas emissions across a company’s value chain, meaning directors and officers would be tasked with validating the measurements and reporting of companies they are loosely connected with through sales or services.
The expansion of director and officer duties over the past five years and the SEC’s renewed focus on holding individuals accountable for corporate missteps following the 2015 Yates Memo may further complicate carriers’ approach to rates and underwriting.
With record-breaking inflation and increases in the cost of capital over the past couple years (Frigure 3), the effects can be felt far and wide. Each industry and specific business experiences a distinct impact. We can’t predict with certainty what lies ahead and instead recommend mitigating exposure by preparing for a range of scenarios. Appropriate action can include preparing contingency plans, building for long-term viability, strengthening capital position, and exploring hedging strategies.
A NOTE ON FIDUCIARY LIABILITY
Excessive-fee litigation hit a peak in 2020 and is still causing pain for employee retirement plans and plan fiduciaries. Costs of defense and early settlements to avoid protracted litigation are high. Last year’s filings were second in number only to 2020, with 80 some lawsuits brought against private, public, and nonprofit organizations. Settlements grew sixfold between 2016 and 2022, according to data published by Chubb.
Employer plans are increasingly a target of fiduciary litigation. One case garnering particular attention is Hughes v. Northwestern University, in which the U.S. Supreme Court remanded the case, which had been dismissed by the trial court (a decision upheld upon appeal), to the 7th Circuit Court of Appeals. The Supreme Court held that fiduciaries had a duty to remove imprudent investment options from the plan menu and could be held liable for losses incurred by participants who chose those imprudent options. In a March 2023 ruling, the 7th Circuit upheld plaintiffs’ excessive-fee claims and clarified pleading standards for Employee Retirement Income Security Act (ERISA) fiduciary breach claims, potentially opening the door to further litigation in this area.
ON THE HORIZON
Often the biggest concern of clients are insurance rates. As it stands, the most recent data indicates nominal rate increases for the majority of D&O risks. That said, the future is uncertain.
With qualified-labor shortages persisting and the Federal Reserve’s Federal Open Market Committee declaring in June it expects decelerating real GDP growth followed by a U.S. recession by the end of the year, companies may face substantial performance problems. Businesses can expect a credit squeeze, tougher standards to qualify for loans and letters of credit, and pressures on liquidity, all while workers demand higher pay to cope with ballooning interest rates and consumer prices.
Following the approval and adoption of cybersecurity disclosure rules, we will be watching to see if the SEC finalizes proposed rules on climate and greenhouse gas emissions reporting. These will open up new D&O exposures.
Court backlogs have kept long-tail claims in suspended animation since the pandemic, and the continuation and conclusion of those cases will be watched to see if they affect carrier losses and force upward adjustments to premium. It’s entirely possible D&O pricing will have to be corrected again for premiums that were too low to cover new exposures in addition to these legacy cases that are finally moving through the court system.
Michael McLaughlin, Management Liability Practice Leader
WHAT ARE CLIENTS TO DO?
IOA’s in-house management liability experts partner with our brokers to help clients navigate the turbulent waters of the D&O insurance marketplace. Our dedicated specialists keep abreast of regulatory and carrier changes and make sure clients have the help they need to find coverage options that fit their risk exposures and financial strategy. For more information or to begin a conversation on D&O, reach out to your IOA advisor.
To request the full report, email michael.mclaughlin@ioausa.com.
