Is The D&O Market Flattening Out at Last?

If I were writing this blog even a few weeks ago I would have been talking about the fact that there is no immediate end in sight for the hard market for D&O in London but that is no longer the case largely as a result of new capacity entering the market . (Interestingly there are still pockets of the international D&O market in parts of Europe and Asia Pacific that have never fully hardened and ones such as Australia which have experienced hard markets for a much longer time now.)

Beware More Restrictive Terms

To be clear when I talk about the hard market what I really have in mind is pricing and capacity. There is a third aspect of a hard market which relates to coverage i.e. more restrictive terms. It is often the lagging indicator of a hard market and I think that will remain an issue here in London and probably elsewhere for some time to come. One point which is worth emphasising here is that insurers never broadcast the fact that they are reducing the scope of cover . On the contrary , extensions to cover (counter-intuitively but not infrequently) result in additional restrictions on the basis that they are expressed to be subject to sub-limits and/or perhaps for other reasons related to the language used and the context of the wording.

The Effect and Consequences of the Hard Market

In 2020, the average cost increase for a D&O programme was around 130%. This came on top of prices already up by 50% on the previous year. Averages tend to disguise extremes and in some cases, rate rises exceeded 400% (and in one case a client came to us last year with a proposed rate rise of 4000% ). These increases were largely the result of the market trying to catch up in one giant leap for the fact that rates had been unrealistically soft for many years pre 2019. The industry seemed to have forgotten that D&O is long tail business. In other words the claims that are eventually made under these liability policies often relate back to wrongful acts which occurred many years before. A significant increase in the number of securities class actions, a more active plaintiff bar, the economic squeeze caused by the pandemic and indeed cases still coming through the pipeline from the 2008 financial crisis all led to this price and capacity crunch.

The main effect of this has without question been to drive the subject of D&O up boardroom agendas and force companies to ask themselves what they are really buying and whether it represents value for money. That’s no bad thing. I used to be a partner in a law firm and we used to take the purchase of professional indemnity insurance very seriously and depute a senior partner to be in charge of the process. With D&O insurance, by contrast, and especially for the larger companies (subject to a few exceptions where the relevant decisions are taken at company secretariat level) most D&O is procured by the risk management function which is often more focused on price and what they perceive to be “value for money.” The hard market has presented an opportunity for the board to focus often for the first time on this important class of insurance. 

Evidence of Flattening Out?

On one recent June 30th renewal for a high profile client we were able to secure a 30% plus reduction off what was admittedly a big number from the previous renewal running into several millions of pounds. The main reason for this was that we were able to introduce fresh competition because over the last few months there have been several new entrants to the market. These include Arcadian, ERS, Indigo, Mosaic, Scor Specialty, Convex, Rising Edge and Tegron Speciality. Many of these new entrants have employed senior and experienced underwriters and perhaps more significantly, do not have suffer from the drag of a long tail and are therefore able to be more competitive.

The effect of this can be seen not just in pricing but in capacity terms through the levelling off of ILF's. ILFs (or Increased Limit Factors) are a measure of pricing differential between lead and excess layers. If you think about a tower of insurance in which you start with a primary carrier covering say the first ￡5 or ￡10 million of the risk and then you add layers above that up to the desired aggregate maximum of say 100 million, ideally, the tower would be shaped in the form of a pyramid in terms of pricing but the hard market forced a change of shape so that it represented something more like a column. Now, slowly things are returning to normal. Whereas last year ILFs were consistently running at between 80 and 90%, now towers of insurance are seeing levels around 75% and the direction of travel is downwards.

An exception to this rule where the hard market persists is in the case of SPACs (publicly listed Special Purpose Acquisition Companies) and De-Spacs  (the process of merging a private operating company with a SPAC under which the shareholders of the private company receive shares in a SPAC and/or cash). IPOs are also still perceived by the market as significantly high risk . Whilst there is a general sense of optimism in the market about the profitability of business written in 2020, underwriters remain cautious about the fallout from COVID-19 and the easing of government support for businesses which may still lead to a wave of bankruptcies. So we are not likely to see a return to a soft market any time soon.

Lessons to be Learned

So what lessons are to be learned from this recent spike in rates? There is much to be said for a strategic approach to the purchase of D&O and that remains so even as the market flattens out . There are perhaps three key questions or areas in which advisers can assist boards. 

• How well does the board itself understand what the insurance protection actually provides, how it works, what it covers and importantly what it does not cover? We have just completed a survey of 200 directors with NedonBoard in which we asked ten simple multiple choice questions such as what happens to the D&O policy if the company becomes insolvent or what happens to the directors’ protection when they leave the company. Only around 1/4 could answer these questions accurately. There is much work still to be done in reconnecting this class of insurance with its end users. (I am doing a board workshop for a FTSE listed company next week and am expecting a range of interesting questions.)
• Does the company really understand the nature of the relationship between this class of insurance and other means of protecting its board from personal liability; the most important of these being company indemnification. (In some cases companies have changed their indemnification arrangements to provide additional comfort to the directors that, to the maximum extent permissible by law, the company will indemnify them. This has freed them up to restrict what they need from the market only only those forms of protection which they themselves cannot provide.)

There is a greater need to prepare and plan carefully for engaging with the insurance market. Our experience has been that provided companies have a credible story to tell both in terms of solvency and business strategy over the next 18 months and they know clearly what it is that they want and are prepared to invest the time and effort at a sufficiently senior level to engage with the market, acceptable terms can be found even for companies operating in so called distressed sectors . The key here is to allow enough preparation time and to be willing to explore all options including the use of captive insurance and other potential means of ring-fencing funds to protect directors from personal liability.

This article is intended to highlight general issues and benefits relating to its subject matter and does not take into account the individual circumstances or requirements of individual recipients. Specific advice about your particular circumstances should always be sought separately before taking any action based on this publication.