Any General Counsel who has been through a renewal of the company Directors and Officers Liability Insurance policy in the past couple of years has experienced a highly distressed market, with dramatic increases in prices, and challenges with respect to availability in many cases. I sat down (virtually) with Michael Welling, a partner at Meridian Risk Management to discuss the state of the market and strategies going forward.
AJS: What are the factors that have led to the current difficult market?
MW: The current challenges we are experiencing in the D&O market actually pre-date the pandemic despite what many believe to the contrary. A critical development was the 2018 Supreme Court case, Cyan, Inc. v. Beaver County Employees Retirement Fund. The court unanimously held in the case that state courts retain concurrent jurisdiction over lawsuits asserting liability claims under the Securities Act of 1933, a development that has increased the number of state court securities class action lawsuits. This poses significant challenges to the D&O market, as state courts do not provide the same procedural protections as are available in federal court and without these procedural protections, “plaintiffs’ attorneys may file weak cases in state court in the hope of pressuring defendants to settle.” This translates into the new reality that there is nothing to stop plaintiffs’ lawyers from filing a duplicate lawsuit in state court even if there already is a Section 11 claim filed in federal court (and vice versa). D&O insurers now find themselves essentially facing double the exposure (and costs) that existed prior to Cyan. This caused a ripple effect throughout the industry that was compounded by catastrophic losses and financial instability, all of which landed us where we are today.
AJS: Practically speaking, what can General Counsels expect when renewing policies today in terms of premium, retention and terms as compared to a few years ago?
MW: The only universal truth is that we are facing an unforgiving market. Unlike in previous years, there are no “discounts” for being claim free; rather the best-case scenario is not incurring a “surcharge” for claims history or other unfavorable underwriter determinants. The best advice we provide our clients is that today, more than ever, insureds must approach their D&O insurance carrier relationship as a true partnership. This includes open dialogue throughout the policy term with regard to changes to operations and finances, so renewal time does not bring about any surprises to any party involved. From a practical standpoint, we are seeing increased premiums on primary layers (30% or more in many cases), excess layers not following traditional Increased Limit Factor calculations, increased retentions and reduced capacity (including carriers pulling out of excess layers). Although we have always preached “Excess Side A”, this has become a much more viable response for some insureds when ABC limits are in limited supply.
AJS: You mentioned before reduced availability. Are there insurers who have stopped writing D&O policies?
MW: What we are seeing is a much more limited appetite by all insurers. Whether due to industry, operations, market cap, revenue, claims or other factors – Carriers are looking to get off risks that do not fit exactly into their appetite. This is where relationships and history can be as valuable as any other factor.
AJS: What effect has the current COVID-19 pandemic had on D&O availability and pricing?
MW: As the impact of COVID-19 is still being determined, there are varying opinions as to “how” and “when”. At minimum, COVID-19 it is playing a direct role in delaying the markets ability to recover. Certainly the “uncertainty” surrounding the potential COVID related claims is also a concern and how insureds respond to COVID related underwriting questions at renewal could also have a financial impact.
AJS: Insurers have always considered the industry in which a company operates in offering and pricing policies. Are there particular industries that are considered of more concern in today’s environment?
MW: Keeping in mind that whether a company is Private v Public can exacerbate the industry related concerns, Healthcare/HealthTech, Financial Institutions/FinTech and anything related to digital currency are the most extreme industry challenges we see today.
AJS: Where are we in this cycle? Should we expect additional price increases and higher retentions going forward?
MW: That is a great question! As I mentioned before, the current state of the market is not the result of COVID-19. COVID-19 has just led to additional unknowns that are preventing the market to correct itself. With all of that said, and hoping we see a significant recovery from COVID on our business communities, I have been saying for some time that Q2 2022 is when I am hoping we start to see some meaningful relief. Anyone preparing for renewals in the next 3-6 months should prepare for the extremes.
AJS: For companies that are distressed or that are in distressed industries such that they are unable to get coverage in the commercial markets at a reasonable price, are there alternatives?
MW: There are markets that look to engage with distressed entities. They are specialized and require a detailed understanding of the marketplace. There are also offshore solutions that are becoming more in favor. But to your question, yes, we are seeing a huge uptick in interest in Captive Insurance Companies – both group and single and we have been working with the Alternative Risk Team from one of our strategic partners in trying to identify new solutions. Alternative Risk is fascinating, as it takes an insurance industry built on short term (12 month) loss-based opportunities and tries to identify long term, investment-based solutions. While not a fit for everyone, I think this will become much more mainstream in the near future.
AJS: There has been a significant increase in the use of SPACs as a vehicle for going public. During their short 12-18 month lives, the directors of SPACs need D&O coverage. I am sure you could write an entire article about insuring SPACs, but just briefly, what are some of the basics when dealing with SPACs?
MW: Yes, my new favorite “Four Letter Word”. The SPAC craze is a fascinating development. We are seeing sponsors from around the world looking to get involved and this is having a direct impact. The D&O market capacity was not designed to account for this significant increase in demand. One aspect of D&O that most insureds do not completely appreciate is the time, energy and costs it takes to underwrite and place a D&O policy. The D&O financial model was not designed for “18-month life spans” of policies. Typically an insurance company does not reach profitability on a D&O policy until that policy has been on the books for 3 years. So the SPAC model has thrown all of those variables out the window. Not to mention the fact that we do not have much precedent or even case law to fully understand all of the potential exposures. This has created a lot of volatility as we move through these iterations. Higher per $million of coverage rates at the lower end of the quotes has become the new norm, with the rate per $million being lowered at higher limits. Self Insured Retentions are very high and the availability of a pre-negotiated “extended reporting period” (a.k.a. “tail”) is critical. We believe the biggest risks to SPACs are going to come post de-SPACing.
AJS: Finally, what are some strategies that General Counsels facing a renewal or securing new coverage can employ to optimize their D&O coverage?
MW: There are two key “best practices” that we preach. The first is the “3 D’s”. Discuss. Document. Disclose. This relates to board room discussions, pre-IPO/SPAC strategy and matters of employment. My job is easier when I can present my clients as practicing transparency as a general rule and not just at renewal time. The second is what I call the “road less traveled”. There is far too much complacency in the insurance industry. You must hold your advisors and representatives accountable for doing their jobs. Their jobs entail having a clear understanding of your business and loss mitigation efforts; understanding the insurance marketplace and who might be the best insurance carrier partner for you; and making every phone call necessary to explore all potential options to ensure you have the most effective and efficient program. While these actions will not cut your insurance spend in half, it will ensure you are getting the absolutely best ROI for your premium dollar that you can bring to your board and/or shareholders. I preach “self-imposed accountability” to my team and welcome the opportunity to present and defend all solutions we provide to the board – and offer that to every one of our clients.