David H. McElroy, senior vice president of Hartford Specialty
It should hardly come as any surprise that growing numbers of companies are becoming interested in writing D&O coverage. The current insured market, according to Business Insurance Research, LLC (BIR), of Fanwood, New Jersey, is just under $5 billion. However, BIR points out that, at manual, the market potential exceeds $80 billion--if all corporations bought coverage. When competition is considered, the market potential still exceeds $40 billion, a not incon-sequential amount. When you add in the employment practices market potential, estimated by BIR at between $15 billion and $20 billion, the amount is significant. Currently, insurers write some $2 billion in employment practices.
Of course, the loss potential is commensurate with the premium. Losses in the D&O market tend to be fairly infrequent, but close to catastrophic when they occur. As David McElroy, senior vice president of Hartford Specialty, points out: "$25 million excess of $25 million is now a working layer. We're seeing huge settlements in this arena that are pushing the limits."
As a result, there are basically two ways to handle the D&O market. You can roll the dice and pray a claim doesn't hit, or you can spread the risk sufficiently so the one or two huge losses won't jeopardize the whole shooting match. The Hartford chose the latter. Last September, the company purchased the Reliance book of professional liability coverages, including D&O, fiduciary liability, EPLI, large commercial crime and some E&O liability for lawyers and other professionals. It represented a $450 million book of business that had been built up over 13 years, with D&O being the largest line. The purchase made The Hartford the third largest writer of D&O.
McElroy, who came over from Reliance, points out: "This is a very tough business to start from scratch. You need critical mass. The availability of the Reliance book was fortuitous for The Hartford. This was one gap in the plethora of coverages being offered by The Hartford." He continues: "These products are predicated on the financial strength of the insurance company. The Hartford represents an extraordinary franchise, with an A+ rating from A.M. Best. Thanks to this financial strength and the company's strong reputation, we're seeing more and better opportunities. We've also kept about 98% of the business that came over from Reliance. It was as close to seamless as a deal of this size could be."
The product is being sold through independent agents, as well as specialists in the field. "Because The Hartford has such a strong franchise with agents, we're already being inundated in a positive way."
A changing marketplace
The D&O market is turning, according to McElroy. "Prices are rising anywhere from 5% to 30%. At the same time, we're looking at SIRs moving up. Clients have not had much skin in the game for the past few years, and that will be changing." In the employment practices arena, he adds, "Deductibles are going up and have to go up."
Commercial Insurance Research says the change follows a recent reversal after several years of profitability. Through the first half of the decade, CIR reports, the loss ratios for for-profit companies under D&O liability had improved from nearly 70% at the start of the decade to around 55% in 1995. However, that trend has reversed due to the inclusion of IPO coverage and EPLI, with CIR estimating that the loss ratio for for-profit companies in 1999 will be 75% on premiums of $4.08 billion. The loss ratios in the not-for-profit market have risen from 55% at the start of the decade to hit an estimated 81.5% in 1999 on premium of $830.7 million.
McElroy expands on that, noting that the industry responded to needs of its insureds by including full entity coverage to handle securities cases, but this also increased loss potential. "This has led to larger damage claims, but I don't anticipate any retraction of this coverage. Instead, this will add to the impetus for clients to participate in the risk through higher retentions."
He adds: "Reinsurance rates also are on their way up and this will have an impact on primary rates. Reinsurers will push hard on cessions and we anticipate that we'll be looking at more quota share arrangements as opposed to excess of loss."
Underwriting and risk management are key
The Hartford's book of D&O business includes companies of all sizes, including general partnerships and limited liability companies. The insurer also offers specialized D&O and E&O coverages for financial service companies. A final area of expertise is D&O coverage for emerging markets, principally life science and technology companies.
"The key to success in this field is risk selection and limit management," McElroy says. "We live in a time where litigation exists. Historically, management of privately held companies did not feel they needed this coverage. But over the past few years, they have started buying, largely due to coupling of employment practices with D&O. When or if these companies decide to go public, there is a whole new dynamic. Some of them are given ridiculously high values by the market when they make an IPO. Some are more rationally priced. We try to stay away from those IPOs that are overvalued, but there still are competitors who look at them as good writes. We look for companies that are able to have consistent earnings and, thus, are less subject to market upheavals."
On the risk management side, "A higher level of education is needed with these products," McElroy notes. "We usually work with corporate counsel and look at their rules on insider trading, disclosure of information and revenue recognition compliance."
"This is a product that demands a long-term commitment," McElroy concludes. "We're completely committed to writing and servicing this business for the long term and our agents and clients appear to have accepted that commitment. We look forward to a long and successful relationship with the people in this community." *