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The Downturn and D&O

By Richard G. Clarke CPCU, CIC, senior vice president, J. Smith Lanier & Co Atlanta

Although any single issue would have had a huge impact on the D&O liability insurance market in years past, the culmination of many events occurring in the world in recent months will dramatically impact D&O underwriting for insurers in 2009, and likely for several years beyond.

Almost no entity is untouched: While the economic downturn for publicly traded entities can be gauged through stock prices, stock dividend reductions or even bankruptcy, the impact on private companies is measured in more subtle ways. Credit may be much more difficult to obtain; revenues may decrease to the point of furloughing or laying off workers; employee benefits may be reduced or even eliminated. Virtually no individuals or types of entities are untouched.

Events Associated with Economic Upheaval

Events are converging to affect the way businesses are operating in the economy, including;

  • Lending restrictions/credit issues. The lifeblood of any expanding economy is the businesses' abilities to obtain and use credit to manage acquisitions and even fund operations on a short-term basis, when needed. When banks aren't lending, or demanding unusually high interest rates, expansion doesn't occur and business becomes stagnant.
  • Consolidations and bankruptcies. When businesses cannot expand or have ongoing difficulty in funding operations, they must often offer themselves for sale to competitors. Fewer buyers means decreased revenue, or even the rise of monopolistic entities in certain business areas.
  • More regulatory oversight. The threat of increased regulatory oversight is already in evidence within the new federal administration-and who could argue, given recent developments and results. However, as we saw after the introduction of the Sarbanes Oxley Act in 2002, significant government regulation often means more management time spent on compliance, paperwork and attention to matters other than taking care of customers, which should always be at the top of management's priorities.
  • Other factors, such as increased legislation and morale issues.

The Impact on D&O Coverage

All of these types of events inevitably have an impact on D&O coverage availability and pricing. We already are seeing underwriters looking for price increases as we transition into a harder D&O marketplace, especially for certain types of businesses, such as financial institutions. Increasingly, premium decreases or "as is" renewals are becoming a thing of the past, or at least until the next movement of the traditional insurance cycle.

Another trend that's developing in this line of coverage is a decrease in limits capacity. In layered programs and/or situations where there are claims issues or there is deterioration of the firm's financial viability, underwriters will seek to reduce the limits of D&O insurance being provided, if not abandon the risk altogether. While there is still significant overall capacity to provide several hundreds of millions of dollars of D&O insurance on a given favorable risk, accessing this overall capacity can become more challenging for less-than- pristine risks.

Carriers also are considering the reduction or restriction of coverage terms. For example, in soft D&O marketing times, obtaining numerous extensions of coverage is the norm on many accounts-all the agent has to do is place the request. However, when the market turns less favorable, underwriters are more reluctant to provide these extensions, or may in fact start contracting or restricting coverage.

The sum and total of these issues makes the process of renewing existing D&O insurance or acquiring new or additional D&O insurance (for which there could be increased demand by perceptive potential buyers of the coverage) more time consuming, stressful and difficult for all parties to the transaction.

The Nuances of Language

D&O insurance is naturally complex, especially for publicly traded companies, with more nooks and crannies than an English muffin. Today's market difficulties and overall economic situation make the procurement or renewal process generally more frustrating and costly than in past years.

Part of the complexity of D&0 coverage involves policy language, which raises the question of what policyholders and agents can watch out for:

  • Avoid completing a new business application, except for the first time D&0 coverage is purchased by the insured organization. Most new business applications contain warranty-related questions, and the answers to these can jeopardize the insured organization by adv(lIlcing the initial warranty date (the date of the completion of the original D&0 application). Thus, completing renewal applications only can function to preserve the warranty which was initially placed into effect the first time D&0 coverage was purchased.
  • Understand the limitations of D&O policy severability provisions, and look for ways to provide D&0 coverage with enhanced severability language. The best way to do this is to propose Side A excess D&O coverage-protection for individuals in situations that are not indemnified by the entity in its corporate bylaws, and which potentially has full severability provisions, non-rescindable language, and even some forms of "dropdown" coverage to benefit the covered persons (the entity itself is not covered under Side A excess D&O coverage).
  • Always offer increased limits of coverage at each renewal date. Just because the incumbent insurer is not willing to increase its limits doesn't mean there aren't other insurers willing to provide excess limits. If the broker doesn't do this and there is a large claim, he or she could have a serious E&O exposure. The buyer always has the final say in how much D&O limits and what type of coverage to purchase. Money saving can be accomplished through the insured accepting increased per-claim retention amounts.
  • Review any proposed "bankruptcy" exclusions carefully. Underwriters might want to impose this language in renewal situations where financials are not particularly strong, but if it completely precludes coverage if the insured organization files for bankruptcy protection, it is unacceptable. There are versions available that only exclude coverage for certain types of claims.
  • Carefully review the financial situation through A. M. Best and other agency ratings of the insurer. Some insurers have made bad investment decisions, too, and if a carrier is significantly downgraded, this can present problems to insured organizations.
    In general, it is always important to understand the position of the insurer regarding renewal coverage well in advance of the renewal date. Even if the renewal application cannot be forwarded until close to the renewal date, the insurer should be able to provide a general idea of the renewal pricing indications, as well as details of potential coverage changes. If the broker is not properly prepared for a D&O renewal, he or she risks losing the account to a competitor at the next renewal date.

In fact, having a renewal timeline-- with entries for dates at which .the renewal application is mailed to the insured, date for receipt of the completed application, advance renewal indication from the underwriter, etc.works to the advantage of the conscientious agent' and prospective purchaser of D&O insurance. Although the primary function of a renewal timeline is to organize and formalize the renewal, renewal premium costs could be affected, too. If an underwriter believes there is a formal plan for renewal of a D&O risk, and that there could be alternatives to the proposed renewal, it certainly can affect. The subjective cost of the renewal D&O Insurance. Especially for private company D&O coverage, there are many underwriters and much competition for the best risks. A renewal timeline not only functions to allocate responsibility between the buyer, broker and underwriter, but also functions to control renewal pricing.

We're headed for some rough times for the foreseeable future. The D&O market likely will move to a position of renewal premium in increases being the rule rather than the .exception, even for successful entities. Forewarned is forearmed: Don't let the tough economic times sneak up on your D&O accounts.

Source: American Agent & Broker

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