CURRENT D&O MARKET CONDITIONS AND RENEWAL EXPECTATIONS FOR 2009 David Purdy

CURRENT D&O MARKET CONDITIONS AND RENEWAL EXPECTATIONS FOR 2009David Purdy

30th October 2008

Page 230th October 2008Willis Amsterdam Seminar

Topics to be discussed

D&O Insurance Market Conditions

US Claim Statistics

International Regulatory Cooperation

Emerging Trends

What to Expect at Renewal

Concluding Comments





Introduction

The fast pace of globalisation in the corporate world inevitably brings challenges and risks to the directors and officers of international companies

– Gerard has presented an Underwriter’s overview of where he believes the D&O

market is heading

– Michiel has told us about the Ahold experience and the issues that they faced when claiming under their D&O policy.

– Hans has shown the growing trends and developments of D&O exposures in Europe

Should directors & officers be worried?


Current Market Conditions

Distinguish between Financial Institution D&O purchasers and Commercial Company D&O purchasers

Is it a Buyer’s Market?

Rates are down – For the moment!

D&O wordings are as broad as they have ever been

Capacity is at an all time high but not at any price


The “Cyclical” Nature of the Directors & Officers Liability Market

Time

19961998

2001

2004 / 2005

Soft Market

• Cheap reinsurance• Increased capacity• Cheaper premiums

• Rates increase sharply• Reinsurance Capacity reduces• Coverage restricted

2003 / 2004 • Profits emerge• Reinsurance capacity returns• Rates begin to reduce

2002

2005 / 2006• Increased capacity• Increased competition

2006 / 2007• Fewer claims

2007 / 2008

• Continued competition

• higher claims frequency

2008/9

• Increased number of claims filed

• Premium increases for FI D&O renewals

• Commercial rates remain competitive



Commercial D&O rates are continuing to fall but for how much longer?

The number of US claims against directors in 2008 is on the increase

The need for D&O coverage continues to be of importance

Policy wordings now offer seriously enhanced coverage

Significant global insurance capacity available – USD 1.5bn?

Still dominated by three or four major insurers

Worldwide


D&O Insurance Market Conditions (cont)

Against this backdrop of good news for the directors of international companies, there lies most of the ingredients for the perfect D&O storm– Increased number of Securities Class Actions– Stock market volatility and economic uncertainty/

recession– Increased regulatory activity – Premiums falling and policy coverage broadening – Catastrophe Losses (the only thing missing at the

moment!)


US Claims Statistics

Federal Filings for 2007 increased by 58% over the

previous year and this trend has continued for

2008


US Claims Statistics (cont)

Source: Nera Economic Consulting, July 2008

234

1

201

2

315

241

2

47

211

1227

236

1212

185

9

3

107

624

147

5939

65

3

49

22

139

0

100

200

300

400

500

Nu

mb

er o

f F

eder

al F

ilin

gs

2000 2001 2002 2003 2004 2005 2006 2007 2008

Federal Filings 2000 to 3rd July 2008

Standard Filings SEC Cases Options Backdating Cases Other Cases Subprime Cases Auction Rate Securities Projected


US Claims Statistics (cont)

Increased cost of defending actions with average

settlement values continuing to rise


Average Settlement Value ($m) 1st January 1996 – July 2008


$9 $9$12 $12

$45

$17

$22$24

$21

$76

$82

$31

$32

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Average Settlement Value ($m) All Cases

Average $17.1

Average $45.4


International Regulatory Cooperation

Much tougher stance taken by the Regulators with increased cooperation

between them


International Regulatory Cooperation (cont)

Cooperation between US and Foreign securities regulators is now expected and even budgeted for

0

200

400

600

800

1000

1200

2002 2003 2004 2005 2006 2007 (Plan) 2007 (Actual)

Number of Requests to and by Foreign Regulators for Enforcement Assistance

Requests to Foreign Regulators Requests from Foreign Regulators

Source: SEC Performance and Accountability Report 2007


SEC Enforcement

SEC can compel testimony and documents on behalf of foreign securities enforcement authorities regardless whether the facts suggest a violation of US law

SEC may provide foreign securities regulators with access to its non-public investigative files

Bilateral MOU’s with more than 30 countries

SEC makes approximately 500 requests for foreign assistance each year and responds to as many from foreign regulators

SEC has recently stated global enforcement efforts will increase together with agreements to facilitate sharing of information between regulators across borders


Emerging D&O Issues

Subprime

Foreign Corrupt Practices Act

Litigation Funding

Environmental/ Climate Change

Enhanced protection for Directors & Officers– Credit wrap– A Side DIC cover


What to Expect at Renewal?

Selected rate reductions on specific accounts with preferred risk profile

Policy Wordings will continue to reflect the broad cover that is generally available

Insurers will request confirmation about exposure to Sub-prime and other related issues

Consider whether or not local policies are required and review what insurers are offering


Renewal Checklist

Start process early: work with broker to prepare optimal risk profile to present to markets

Check insurers on programme meet your security requirements

Investigate insurer downgrade options during the policy year

Meet insurers at least 2-3 months before renewal

Check cover applies to your needs (claims language, mid term reporting requirements, excess form language)

Review limit adequacy for your D&O’s and Balance Sheet


Concluding Comments

Directors of international companies are operating in an ever more regulated and potentially litigious environment

D&O policies of the future will need to respond to several different legal environments

Directors of companies will also need to consider the increasing international cooperation between regulators

Whilst there has been an increase in claims activity and stock exchange volatility, it is expected that the soft market will continue into 2009/ 2010


QUESTIONS?David Purdy

FINEX

Tel +44 (0)20 3124 6328

[email protected]

Willis Limited, The Willis Building

51 Lime Street, London EC3M 7DQ

www.willis.com


APPENDIX 1:Litigation Funding


Litigation Funding

Litigation Funding companies are commercial entities that contract with one or more potential litigants – The company pays the costs of the litigation and accepts the risk of paying the other party’s costs if the case fails. In return , if the case succeeds the company is paid a share of the proceeds anywhere from 25% - 50% ( according to IM Litigation Funding)

Whilst Litigation funding is not new, the involvement of hedge funds and professional litigation funders has raised concerns that this could fuel a boom in class actions.

Specialist firms acting as “brokers” are on the increase and seem to have no problem in sourcing the funds necessary to mount litigation

MKM Longboat, a hedge fund has diversified and created a pool to invest in litigation

In June 2007 there was a report by the Civil Justice Council welcoming the concept of funding so long as it is properly regulated . The key concerns being compulsory disclosure of funding details and lawyers independence from the funders – the debate on transparency and the need for controls continues


APPENDIX 2:Environmental/ Climate

Change


Environmental/ Climate Change:Potential D&O Exposures

Global warming is an increasingly important topic for public debate

Directors seem to have evaded being in the sights of plaintiff lawyers, regulators and environmental activists on global warming issues

Public companies should all be evaluating whether climate change is reasonably likely to have a material impact on future earnings

Whilst it is highly unlikely that third party claims, relating to climate change, against directors will succeed. There have however, been several significant third party claims against companies e.g. American Electric Power ( USD 4.6bn)

Shareholders of companies, who have suffered losses, are a more likely source of claims in the form of derivative claims against directors for breach of fiduciary duty to the company with respect to climate issues


Environmental / Climate Change:Potential D & O Exposures

Regulators could also be a source of potential claims against directors. In Sept 2007 a petition was filed with the SEC for “Interpretive Guidance on Climate Risk Disclosure”

In the same month the New York Attorney General sent subpoenas to five electricity utility companies stating they had not adequately disclosed to their shareholders the financial risks relating to their greenhouse emissions

Directors per se have not been targeted but the regulators have focused on a classic D&O exposure that of material information to investors

Current D&O polices are not likely to afford much comfort to D&O’s. The Pollution Exclusion would apply to any discharge or release of air emissions or contaminants. There are however, carve outs to the exclusion where directors may not be indemnified by the company. There are also carve outs for security claims

D&O policies also have Bodily/ Injury and Property Damage Exclusions. So other Climate change claims will have possible coverage issues – depending on the language of the exclusion there may however be protection for shareholder derivative actions or securities class actions

A way around the Pollution/ Bodily Injury exclusion is for directors to purchase a Side A DIC cover with no pollution exclusion and with the Bodily Injury exclusion not applying to a pollution claim .


APPENDIX 3:A selection of Cases


CASE STUDY 1:Advancement of Defence

Costs


Advancement of Defence Costs

D&O policies generally indemnify directors for their legal liability and defence costs

However, the fact that a policy will eventually pay defence costs is of little comfort to those directors who need the money up front

Most policies contain an advancement of costs clause. Policies also contain exclusions for fraud and dishonesty


Advancement of Defence Costs

Wilkie v Gordian Runoff, Australia The High Court held that the insurer should pay a director’s costs until such

time if at all that he is found guilty of the sort of fraudulent conduct that would disentitle him to the cover. In short, the insurer could not rely on the exclusion unless or until the accused admitted guilt or a court reached a guilty finding. Then the insurer could claw back the monies paid.

Rich v CGU Insurance Limited, Australia The majority of the High Court rescinded leave to reconsider the NSW Court

of Appeal finding that the D&O policy gave the insurer discretion not to indemnify an insured suspected of fraud or other inappropriate behaviour. In doing so the court basically left as valid a Court of Appeal decision that produced the opposite result of the High Court’s ruling in Wilkie. However, in Rich the policy provided that the advancement of defence costs was discretionary and therefore, because of the particular wording, an allegation of fraud was enough to allow the insurer to refuse to advance defence costs.


Advancement of Defence Costs (cont)

The key message from these two decisions is:

– If a policy provides that an insurer cannot rely on the fraud and dishonesty exclusion until there is an admission or finding of guilt AND the policy also provides that the defence costs must be advanced, insurers will almost certainly have no choice but to pay up-front.

– However, if the policy contains a discretion about whether or not to advance these costs, up-front payments may not be obligatory

(Thanks to Peter Mann Partner of Clayton Utz Sydney)



Refco case in Southern District New York An appeal hearing from a bankruptcy court ruling addressed the question

whether an Excess Insurer could withhold advancement of defence costs based on its determination that an exclusion in its policy precluded coverage

The primary wording upon which the excess carrier followed stated that “the Insurer will pay covered Defence Costs on an as-incurred basis. If it is finally determined that any Defence Costs paid by the Insurer are not covered by this Policy the Insured’s agree to repay such non covered Defence Costs to the Insurer”

The excess carrier contended it did not have to advance defence costs, relying upon the word “covered” in the advancement provision of the primary wording, thus qualifying the type of defence costs it would agree to pay on an incurred basis – the excess carrier’s contention was that its policy’s Conduct Exclusion unlike the primary wording, does not have an adjudication requirement



The insurer argued that because the conduct exclusions in its policy have no adjudication requirement, “prior to a court determination, the insurer, has the unilateral right to determine whether defence costs are covered” – insurer determined that the insured’s claims were precluded under its policy

The judge noted that the insurers position placed undue emphasis on the word “covered” and that the word’s inclusion in the advancement provisions can “hardly be said to make an unambiguous change in the provision’s literal meaning and seems, at best, an unusual way to effectuate a fundamental change in the parties’ expectations”

The court found the wording to be ambiguous and interpreted the provision in favour of the insureds



This case highlights the importance of including an adjudication provision in the conduct exclusion because in its absence the insurer might contend that it has the unilateral right to determine coverage and withhold policy benefits

(Extracts taken from the D&O Diary 16th July 2008 published by Kevin M. LaCroix)

The other key point is where excess insurers contain terms and conditions (especially exclusions) not contained in the underlying, this causes all sorts of problems.


CASE STUDY 2:Adequate Limits of

Indemnity


Average Settlement Value ($m) 1st January 1996 – July 2008


$9 $9$12 $12

$45

$17

$22$24

$21

$76

$82

$31

$32

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Average Settlement Value ($m) All Cases

Average $17.1

Average $45.4


Adequate Limits of Indemnity

Just For Feet case The Limit was exhausted by shareholder class action litigation – Court

filings show only USD 100,000 of insurance was left for the outside directors after the preceding shareholders’ securities actions settled for USD 24.5m

– What is also interesting is that the outside directors paid out of pocket payments totalling some USD 40m the settle the trustees case against them

US v Stockman 17 months after the indictment there is still no trial date – the D&O policy

has been exhausted – there were some 12.5 million documents and 30 lawyers reviewing them. Thus far they have only completed examining a third of the total


Adequate Limits of Indemnity (cont)

What is important about these cases?

Defence costs are expensive and it is not just in the USA. The more complex the case the more expensive it will be

The definition of Insured Person has broadened considerably, many more “insureds” now have access to the policy

The D&O market has gone through and continues to remain in one of the “softest” cycles ever. Broad cover and competitive premiums mean companies and their Boards have no excuse for not seriously thinking about purchasing additional coverage


Adequate Limits of Indemnity (cont)

Broader cover means there is also the potential for more claims (and more complex claims) which are likely to be covered than in the past. Hence the need for buyers of D&O cover to be thinking about purchasing higher. Stockman is an example of the complexities and problems that can arise

Has Excess Side A DIC coverage been contemplated and purchased? The Just For Feet case shows how much directors may have to pay out of their own pockets in order to settle


CASE STUDY 3:Policy Interpretation –

Conduct Exclusion


Policy Interpretation – Conduct Exclusion

AT & T v Clarendon America Ins. Co. Coverage dispute arose out of stockholder litigation brought against several

AT &T directors alleging false and misleading statements. The action settled during trial with AT & T agreeing to pay USD 100m to the plaintiffs. National Union AT & T’s excess carrier denied coverage

The issue before the Delaware Superior Court was whether National Union could deny coverage based on the policy’s fraud exclusion. AT & T argued that the fraud exclusion requires an adjudication and does not apply to settlements

National Union’s fraud exclusion stated they were not obligated to pay any claim “brought about or contributed to in fact by any deliberate dishonest, fraudulent or criminal act or omission or any personal profit or advantage gained by any of the directors and officers to which they were not legally entitled and providing any such finding is material to the cause of action so adjudicated”


Policy Interpretation - Conduct Exclusion (cont)

The Superior Court found:– New York law applied to the D&O policy and held that the fraud exclusion did not

bar coverage for dishonest, fraudulent or criminal acts or omissions unless there was a finding that such acts occurred and such finding was material to the cause of action being adjudicated

– Since the litigation settled there was no finding and a settlement is a settlement not an adjudication

– National Union could not rely on the exclusion

The importance of this case is that special attention needs to be paid to the language of the policy during negotiations

There seems to be a tendency in large claims, that insurers would prefer to seek the Court’s opinion in instances where there are potential coverage issues rather than find an early resolution


CASE STUDY 4:Policy Interpretation – Non-

Disclosure


Policy Interpretation - Non Disclosure

Known circumstance exclusions are typically found in professional indemnity and directors and officers insurance policies which are claims made policies

They exclude cover for claims where the insured knew of circumstances, before the inception of the policy, that either the insured knew or a reasonable person in the insured’s position should have known, had the potential to lead to a claim


Policy Interpretation - Non Disclosure (cont)

CGU Insurance Ltd v Porthouse, Australia Section 21 of the Insurance Contracts Act 1984 effectively provides that the insured

has a duty to disclose to the insurer, before entering into an insurance contract, every matter that the insured knows or a reasonable person in the circumstances of the insured could be expected to know , to be a matter relevant to the decision of the insurer as to whether to accept the risk and if so, on what terms

Exclusion 6.1 of the CGU policy effectively excluded cover for claims directly or indirectly based upon known claims and known circumstances

The High Court of Australia unanimously allowed CGU’s appeal and held they were entitled to rely upon Exclusion 6.1 to deny indemnity to Porthouse

The decision provides clarity on the interpretation of known circumstances exclusions for underwriters of P I and D&O policies in the Australian Market – whilst the wordings may differ they will be interpreted by reference to an objective standard and determined as a question of fact independently of an insured’s idiosyncrasies or state of mind. Further, the Court will apply where the hypothetical reasonable person with insured’s knowledge would conclude that an allegation or a claim was a real possibility



Martin John Green in his capacity as Liquidator of Arimco Mining Pty Ltd (in Liquidation) v CGU insurance Limited & Ors

Another non disclosure decision just after Porthouse decision demonstrates the need for companies to disclose matters relevant to the risk of insolvency

Court reduced CGU’s liability to nil as a result of Arimco’s non disclosure

The claim against the directors was resolved however, the liquidators pursued the claim against CGU in respect of debts totalling more than A$ 21m incurred between 1st February and 14th March 1999

In defence to the claim CGU asserted that the directors failed to disclose a range of matters regarding the financial position of Arimco

CGU called evidence that it would have included an Insolvency Exclusion if it had been fully appraised of the true financial position of the ARL Group



This case is useful because the judge, His Honour Justice Einstein referred to director’s obligations of disclosure under section 21 of the Insurance Contracts Act

– Did the Director know of the matter?

– If so, did the directors know that the issue was a matter relevant to the decision of the insurer whether to accept the risk and if so on what terms?

– If they did not, would a reasonable person in these circumstances be expected to know the issue was so relevant?

– Even if the matters ought to have been disclosed or there had been a misrepresentation, would the insurer have issued the policy in the way that it did in any event?



His Honour found that the Annual Report did not reflect the company’s position in December 1998, despite the insured’s representations to CGU to the contrary as there had been significant adverse changes to operations of the company

This case is important because:– It highlights the danger of not fully and truthfully disclosing information to insurers

– It highlights the need for the insured to notify the insurer of any material changes to its financial position up to the inception of the policy and not to simply rely upon Annual Reports

The case also involved extensive evidence from CGU as to what would have transpired had it been made aware of Arimco’s financial position and the need for insurers to be able support their assertions that they would have insisted upon an insolvency exclusion if full disclosure had been made


What does this selection of recent cases tell us?

Despite the new and significantly enhanced wordings many of the same issues keep re-appearing

Insureds and Insurers are far more ready to go to court to sort contentious issues out

The cost of going to court is seriously expensive

Still have situations where insureds have inadequate limits of indemnity

There is a need to check the policies during renewal negotiations

Documents

CURRENT D&O MARKET CONDITIONS AND RENEWAL EXPECTATIONS FOR 2009 David Purdy