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Current Trends in
Directors & Officers Liability
Current Trends in
Directors & Officers Liability
February 27, 2006February 27, 2006
AgendaAgenda
The D&O Market: Back to the Future
Claim Trends: The Best of Times, The Worst of Times
D&O Grows Up: The Day After Tomorrow
D&O Crisis Management Planning: Preparing for Barbarians at the Gate
The D&O Market: Back to the FutureThe D&O Market: Back to the Future
Determining market capacity: what’s available ($1.4 billion) versus what’s really available ($400 million to $800 million)
What factors are driving the pricing of capacity?
How is the reinsurance market affecting pricing, capacity and coverage?
What is the impact of reserve changes upon the D&O market?
Why have CLASH events taken on new meaning for D&O insurers?
How are D&O insurers evaluating their exposure to attachment point?
How does the structure (layered, quota share, size of blocks) impact pricing and claims handling?
The D&O Market: Back to the FutureThe D&O Market: Back to the Future
Key terms and conditions: severability; the dishonesty/fraud and other conduct exclusions; and rescission
The rapid growth of A-Side coverage in its various forms
If the underwriting of D&O coverage has not changed, then is the current market really less volatile than it was in 1986?
The D&O Market: Back to the FutureThe D&O Market: Back to the Future
Schedule P – “Other Liability” Claims MadeLeading D&O Liability Insurers Statutory Gross Accident Year Combined Ratio
(Assumes 23% Expense Ratio for All Companies) Source: A.M. Best, CFRA
Schedule P – “Other Liability” Claims MadeLeading D&O Liability Insurers Statutory Gross Accident Year Combined Ratio
(Assumes 23% Expense Ratio for All Companies) Source: A.M. Best, CFRA
91.687.2
117.2
142.1137.6
149.7
129.5
96.9
79.775.9
0
20
40
60
80
100
120
140
160
2004200320022001200019991998199719961995
Mature Immature
Claim Trends: The Best of TimesClaim Trends: The Best of Times
Number of Securities Lawsuits fell 17% in 2005 (from 213 in 2004 to 176 in 2005)
Market capitalization losses plummeted 33% (from $147 billion in 2004 to $99 billion in 2005)
The impact of Sarbanes-Oxley and lower stock market volatility are cited as explanatory factors for these results
The Dura Pharmaceuticals, Inc. v. Broudo decision: The U.S. Supreme Court weighs in on “loss causation” in securities claims
In re: Walt Disney Company Derivative Litigation: The Delaware Chancery Court reaffirms the Business Judgment rule
Claim Trends: The Best of TimesClaim Trends: The Best of Times
Big is big more often: the number of settlements over $100 million increased from 2.4% before Enron to 3.9% after Enron collapses
The average settlement increased from $26.4 million in 2004 to $28.5 million in 2005 (Cornerstone Research) – these figures exclude Enron and WorldCom settlements
Claim Trends: The Worst of TimesClaim Trends: The Worst of Times
The median settlement increased from $6.3 million in 2004 to $7.5 million in 2005 (Cornerstone Research)
Financial restatement cases nearly doubled to account for 40% of all cases in 2005
Institutional plaintiffs led 35% of all settlements in 2005 – this compares to only 20% in 2004
Claim Trends: The Worst of TimesClaim Trends: The Worst of Times
Companies paid more than $9.6 billion in settlements with shareholders in 2005
The rise of the individual, opt-out institutional shareholder makes a global settlement that much more difficult to accomplish
Claim Trends: The Worst of TimesClaim Trends: The Worst of Times
D&O Grows Up: The Day After TomorrowD&O Grows Up: The Day After Tomorrow
The insurance industry is entering a period of transformation
Volatility in the D&O market frustrates policyholders, underwriters, reinsurers and brokers
The lack of differentiation in the commercial market
frustrates many policyholders
Approximately 2% of publicly-traded companies are sued for securities-related claims in any given year
Why do so many companies have to pay for the sins of so few?
We know a lot about what causes D&O shareholder litigation
Risk modeling and predictive analytics require sufficient quantities of financial, governance and loss data
The data is available
The challenge is figuring out how to use the data to answer the right questions about D&O liability risk prevention, mitigation and transfer
D&O Grows Up: The Day After TomorrowD&O Grows Up: The Day After Tomorrow
Risk ModelingRisk Modeling
Business Effectiveness
Governance Practices
Accrual Practices
Firm Descriptors
Regulatory Forces (e.g., Sarbanes-Oxley)
Market Forces (e.g., premium levels)
Fir
m-C
ontr
olla
ble
Fac
tors
Risk ProfileClass Action
Litigation Likelihood
Expected Loss
Risk Quantification: Likelihood & SeverityRisk Quantification: Likelihood & Severity
Firm-specific class action likelihood will be quantified as a step toward risk assessment
Firm-specific probabilities will be computed relative to industry giving rise to likelihood level groupings defined vis-à-vis industry average
Not actual results--for illustrative purposes only
Likelihood Estimation
• 0% - 100%
• Size-adjusted for cross-company contrasts
• Standardized for longitudinal tracking
1 2 3 4 5 6 7 8 9 10
Above average probability Below average probability
Average Probability
1 2 3 4 5 6 7 8 9 10
Above average probability Below average probability
Average Probability
1 2 3 4 5 6 7 8 9 10
Above average probability Below average probability
Average Probability
1 2 3 4 5 6 7 8 9 10
Above average probability Below average probability
Average Probability
Next, the severity of loss will be estimated, also in a larger competitive context
The estimate will support firms’ classification in an appropriate damage level group, as illustrated below
Above average expected loss Below average expected loss
Average Loss Index
1 2 3 4 5 6 7 8 9 10
Above average expected loss Below average expected loss
Average Loss Index
Above average expected loss Below average expected loss
Average Loss Index
1 2 3 4 5 6 7 8 9 10
Above average expected loss Below average expected loss
Average Loss Index
Severity Estimation
• $0 - $upper limit
• Size-adjusted for cross-company contrasts
• Standardized for longitudinal tracking
Likelihood of Class Action Litigation Expected Severity of Loss
Risk Categorization: Likelihood x SeverityRisk Categorization: Likelihood x Severity
Risk = Class Action Likelihood + Estimated Severity of Loss
High
High
Low
Low
Hig
h
Hig
h
Lo
w
Lo
w
Overall largest likelihood &
severity
Overall smallest likelihood &
severity
MARA: Firm-Level Likelihood x Severity Tallying
Overall moderate likelihood &
severity
Overall moderate likelihood &
severity
LIKELIHOODS
EV
ER
ITY
RISK TAKERSNORMATIVES
NORMATIVESRISK AVOIDERS
Beecher Carlson’s Multivariate Algorithm for Risk Analysis—MARA—amalgamates the separately derived likelihood and severity profiles into a single risk categorization schema, as illustrated below:
User Benefits: Enterprise Risk ManagementUser Benefits: Enterprise Risk Management
Risk Characterization
Available DataMethodological Considerations
Risk Quantification
Risk Likelihood Estimation
Risk Severity Estimation
Risk Tallying & Categorization
On-Going Risk Management
Risk Transference
Drivers of Risk Delineation
What-If Decision Planning
Premium Differentiation
Terms Determination
On-Going Enterprise Risk ManagementOn-Going Enterprise Risk Management
Decision Scenario 1
What—if? Decision Scenario 2
Decision Scenario n
Sce
nario
-attrib
uta
ble im
pac
t in
cremen
tality q
uan
tificatio
n
Baselin
e
Scenario 1 Lift
Scenario 2 Lift
Scenario n Lift
The risk management advisory is supported by a quantitative scenario evaluation tool, the goal of which is to provide objective side-by-side comparisons of the expected risk impact of contemplated courses of action.
D&O Crisis Management Planning:D&O Crisis Management Planning:
Terrorist Attack
Business Interruption attributable to weather-related events
Disruption of IT and Communication systems by hackers or other causes
Avian flu
Major D&O claim emanating from securities-related issues
Preparing for Barbarians at the Gate
Which of these events is likely to be the most cataclysmic for your company?
How come very few companies have a crisis management plan for a D&O meltdown?
D&O Crisis Management Planning:D&O Crisis Management Planning:Preparing for Barbarians at the Gate
What are you looking to accomplish in structuring a D&O program?
How do you balance the interests of the individuals with those of the company?
How much coverage is enough? What does enough mean?
What is your crisis management plan in the event of a major D&O claim?
D&O Crisis Management Planning:D&O Crisis Management Planning:Preparing for Barbarians at the Gate
Developing a Crisis Management PlanDeveloping a Crisis Management Plan
D&O underwriters Shareholders Banks and other
Creditors Rating agencies Regulatory authorities Customers Suppliers Employees
The first 24 hours Financial issues Restructuring the
Board and replacing Executive Officers
Dislocation among employees
Brand restoration The damage created
by email Moving forward
Questions & AnswersQuestions & Answers