Non-medical Professional Liability Directors & Officers Liability Insurance Jason Israel, ACAS, MAAA CAS Seminar on Ratemaking March 7-8, 2002

D & O Coverage Background Directors and Officers policies insure: directors and officersdirectors and officers –historically, only D’s & O’s, but broadened in soft market of 90’s to include entity for wrongful actsfor wrongful acts –which are defined as any act, error or omission in their capacity as D&O.

D & O Coverage Background Director’s & Officer’s provides Management Liability protection for claims coming from: StockholdersStockholders EmployeesEmployees Government and CompetitorsGovernment and Competitors Customers and ClientsCustomers and Clients

D & O Coverage Background D&O versus EPL A typical D&O policy will provide coverage for a Director or officer against claims such as discrimination and wrongful termination. So would an EPL policy. A typical D&O policy will provide coverage for a Director or officer against claims such as discrimination and wrongful termination. So would an EPL policy. So why do companies also buy an EPL policy? So why do companies also buy an EPL policy? A D&O policy generally: Has higher deductibles and/or coinsurance Has higher deductibles and/or coinsurance Provides narrower coverage, especially defense Provides narrower coverage, especially defense Covers only D&O not entities or other employees Covers only D&O not entities or other employees (although sometimes added by endorsement) (although sometimes added by endorsement)

D & O Coverage Background Where does the money go? For publicly traded firms, shareholder (securities) claims result in the majority of the lossesFor publicly traded firms, shareholder (securities) claims result in the majority of the losses For Private and not-for-profit firmsFor Private and not-for-profit firms –less or no exposure to shareholder claims –majority of claims are from employees

D & O Historical Perspective Mid 1990’s - D&O Pricing Erosion Reduction of Deductibles/RetentionsReduction of Deductibles/Retentions Introduction of Blended Program discounts (combining EPL, Fiduciary & E&O under single limit)Introduction of Blended Program discounts (combining EPL, Fiduciary & E&O under single limit) Multi-Year programs with significant discountsMulti-Year programs with significant discounts Pricing did not recognize expansions in coveragePricing did not recognize expansions in coverage

D & O Historical Perspective Mid 1990’s - Coverage Expansion Entity Coverage - eliminated allocation issues between D&O’s and uninsured corporation, but also lost “natural coinsurance”Entity Coverage - eliminated allocation issues between D&O’s and uninsured corporation, but also lost “natural coinsurance” Bilateral ERP’s (insured may elect, even if they choose to cancel or non-renew)Bilateral ERP’s (insured may elect, even if they choose to cancel or non-renew) Policies non-cancelable by insurersPolicies non-cancelable by insurers Broadened definition of claim to cover:Broadened definition of claim to cover: –formal investigations –non-monetary demands –criminal proceedings –formal administrative proceedings

D & O Historical Perspective Litigation Landscape: 1995 PSLRA (Reform Act)1995 PSLRA (Reform Act) –Higher Pleading Standard –Stay of Discovery Increased Market Capitalization and VolatilityIncreased Market Capitalization and Volatility Increased IPO/M&A ActivityIncreased IPO/M&A Activity Increased Claims for Insider-Trading/ Accounting Fraud/Revenue RecognitionIncreased Claims for Insider-Trading/ Accounting Fraud/Revenue Recognition Recession influencesRecession influences

D & O Historical Perspective Litigation Landscape Results:Results: –Jurisdiction has changed from CA to NY –Allegations have changed from promises about future performance, now protected by disclaimers, to accounting irregularities –Dismissals without leave to refile are down, as courts allow plaintiffs to ‘figure out’ the new Act and perfect filings –Settlements lag, since plaintiffs’ cases that survive motions to dismiss are stronger than before and hence demands are higher

D & O Historical Perspective Record number of large claims : –Cendant 3.5 b –Bank of America490 m –3Com Corp 259 m –Waste Mgmt I 220 m –Waster Mgmt II457 m –Ikon 111 m –Informix 142 m

D & O Historical Perspective Source: securities.stanford.edu - Increased frequency: Frequency back up to pre-Reform Act levels, with an increased number of securities filings: IPO/ Laddering cases

D & O Historical Perspective A different pattern emerging for large firms? Source: securities.stanford.edu 0% 1% 2% 3% 4% 5% 6% 7% All Public Companies Larger Firms 2002 (Annualized)

Key D&O Pricing Issues/Obstacles Low FrequencyLow Frequency High SeverityHigh Severity Bankruptcy/PersistencyBankruptcy/Persistency Complicated Program StructuresComplicated Program Structures Market-based PricingMarket-based Pricing Actuarial Considerations

Key D&O Pricing Considerations Ownership - Public vs. PrivateOwnership - Public vs. Private Size of FirmSize of Firm SectorSector Coverages/Terms/Limits providedCoverages/Terms/Limits provided Actuarial Considerations

Actuarial Modeling Modeling claim severity: Reasonable fits with Ln(Loss)=  * log(MCap) +  +  Reasonable fits with Ln(Loss)=  * log(MCap) +  + 

Model's Expected Severity ($M) Actual Settlements($M) Actuarial Modeling Modeling claim severity: Much Variability remains Median Loss