Directors’ & Officers’ Liability

CAS Ratemaking Seminar – San Antonio, TX March 27-28, 2003CAS Ratemaking Seminar – San Antonio, TX March 27-28, 2003

Directors’ & Officers’ Liability

Richard J. Castillo, ACASSenior Vice PresidentZurich North America Specialties

Claude D. Yoder, FCASVice PresidentThe Hartford


Pure Premium

Pure Premium =

Claim Frequency * Claim Severity


AGENDA

•Frequency

•Severity

•Monitor Prices

•Rating Variables

•Questions


Historical Securities Fraud Class Actions

164202

163

231

188

108

173

238206 214

488

263

0

50

100

150

200

250

300

350

400

450

500

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Fed Securities ClassAction

Source: Stanford Law School Securities Class Action Clearinghouse


Claim Frequency

Assumed Securities Claims: 250 - 300

Approximately 10,000 - 11,000 Companies

Frequency of claims 2.5% - 3.0%


Claim Costs by Type

Claimant Class Median Average

Payments to Claimants:Employees/Unions/Physicians 40K 245KShareholder/Investors 4.9M 17.2M

Defense CostsEmployees/Unions/Physicians 30K 105KShareholder/Investors 450K 1.05M

Source: Tillinghast - Towers Perrin “2001 Directors and Officers Liability Survey”


Some Large Settlements

*Market Cap Drop in Cap #Settlement

Cendant 33.7B 11.8B 3.525B

Bank of America 95.4B 32.3B 490M

3Com Corporation 22.4B 13.5B 259M

*At Beginning of Class Period

# Source: Stanford Law School Securities Class Action Clearinghouse


Assumed Cost Per Mil

Frequency = 2.5% - 3.0%

Securities Class Action Severity - Assume Policy Limit

Assumed Cost Per Mil = 25K - 30K


Average Price Per Mil by IndustryMedian Total Average Est PricePremium Total Limits Per Mil

Biotech & Pharm 90,100 10.2 8,833Technology 80,000 13.76 5,814Personal & Business Services 90,500 16.94 5,342Merchandising 150,738 32.81 4,594Durable Goods Manufacturing 154,327 36.73 4,202Transportation & Communication 116,025 28.83 4,024Petroleum, Mining & Agric 153,000 40.26 3,800Non Durable Goods Manufacturing 139,500 37.29 3,741Banking 170,000 48.82 3,482Education 30,729 9.8 3,136Utilities 215,880 69.09 3,125Health Svcs 58,432 20.64 2,831Construction & Real Estate 19,398 9.26 2,095Non-Banking Financial Svcs 66,935 36.73 1,822Govt & Other Non Profit 3,450 3.6 958



MONITORING PRICES


Objective

Measure the premium adequacy of all new and renewal policies written in the current year against all new and renewal policies written in the prior year

New business can be monitoredNo “rate change”Rate adequacy

If exclude newUnderstate increases in hard marketsUnderstate decreases in soft marketsMiss multi-year renewals


Process

“Normalize” premiums to account for varying coverage parameters

Contrast w/Benchmarking and base rates

Reliance on judgment for class relativities,

other parameters


Process

XYZ Corp.

Expiring Renewal

Premium $100,000 $300,000

Limits $10 million $20 million

“ILF” 1.0 2.0

“Normalized Premium” $100,000 $150,000

Rate Change 50%


Rating Factors

ILF

Limit

Retention

Attachment Point

Part Of/Quota Share Arrangement

Exposure Base

Term

Industry Group

Public or Private

Prior Acts Exclusions

Side A only

Pre-set Allocation

Coinsurance


Rating Factors

Public vs. Private

Public company exposure is mostly class action suits

Private company exposure is mostly EPL

Term

Multi-years now annual

3 year terms had been commonplace 2 years ago

2.25 factors

Today – “unwinding” the discount


Rating Factors

Class of Business

Class relativities rely on judgment

Data available, but very limited (see class action suits)

Side A Only

Recent phenomenon

Reaction to “Enronitis”

Removes large portion of risk

D and O reimbursement only, no company reimbursement

Bankruptcy and derivative cases


D&O ExamplePRIOR YEAR

POLICY LIMIT SIR ATT PTASSET SIZE

(000s) TERM GWP ILFEXPOSURE

FACTORINDUSTRY

FACTORADJ

PREMIUM

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

1 15,000,000 25,000 15,000,000 160,000 1 45,000 2.02 4.67 1.00 4,7702 20,000,000 1,000,000 30,000,000 6,000,000 1 115,000 1.74 13.33 1.70 2,9173 10,000,000 100,000 0 350,000 1 101,000 4.17 5.33 1.50 3,0294 15,000,000 250,000 0 1,100,000 1 250,000 5.55 8.00 1.00 5,6315 10,000,000 350,000 25,000,000 1,200,000 1 45,000 1.50 8.00 1.60 2,344

PRIOR YEAR TOTAL 556,000 4,261

CURRENT YEAR

POLICY LIMIT SIR ATT PT

ASSET SIZE

(000s) TERM GWP ILFEXPOSURE

FACTORINDUSTRY

FACTORADJ

PREMIUMPRICE

CHANGE

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)

1-renewal 15,000,000 125,000 15,000,000 125,000 1 55,000 2.02 4.00 1.00 6,807 42.7%2-renewal 20,000,000 1,000,000 30,000,000 8,000,000 1 215,000 1.74 13.33 1.70 5,453 87.0%3-renewal 10,000,000 100,000 0 400,000 1 140,000 4.17 5.33 1.50 4,199 38.6%4-renewal 15,000,000 250,000 0 1,250,000 1 295,000 5.55 8.00 1.00 6,644 18.0%6-new 10,000,000 500,000 30,000,000 3,000,000 1 190,000 1.42 11.33 1.50 7,873

CURRENT YEAR TOTAL 895,000 6,246 46.6%

%6.461261,4

246,61

PREMIUM ADJ TOTAL YEAR PRIOR

PREMIUM ADJ TOTAL YEAR CURRENT CHANGE PRICE YEAR CURRENT

FACTOR INDUSTRYFACTOR EXPOSUREILFTERMGWP PREMIUM ADJUSTED


D&O Example

Price Change Effects

1. Renewal

2. Non-renewal

3. New


D&O Example

Renewal

Easiest to quantify

Non-renewal

Most subtle

Effect from prior policy “dropping off”

New

No actual price “change”

Presence of new policy does change rate level


Asset Size

PROS

Easy to Obtain/Verify

Correlates with Exposure to Loss

Accepted by Industry/Insured

CONS

Quality of Assets?

Correlates - NOT a Proxy

Asset Size - Not Market Cap


Average Limit Purchased

Average Limit Purchased

$0$20$40$60$80

$100$120$140$160

< 10

M

10M

- 50

M

50M

- 10

0M

100M

- 40

0M

400M

- 1B

1B -

2B

2B -

5B

5B -

10B

> 10

B

Size Of Firm

Avg

Po

licy

Lim

it (

Mil

lio

ns)

By Asset Size

By Mkt Cap



Public Vs. Private Loss Drivers

Public D&O

Severity - Securities Class Action Suits

Frequency - Employment Related (usually within SIR)

Private D&O

Severity - Private Placement Suits (Securities usually excluded)

Frequency - Employment Related (usually insured)


Common Claims by Claimant

ShareholderStock or Public Offering

Inadequate/Inaccurate Disclosure

Fraud (including Accounting)

Restatement of Earnings

EmployeeWrongful Termination

Discrimination

Harassment

Breach of Contract


How is D&O Loss Handled Under:

Deductible/Self Insured Retention

Coinsurance

Pre-Set Allocation

ASSUME: Loss = 25MSIR = 1MCoinsurance = 20%Pre-Set Allocation = 20%Policy Limit = 25M


Self Insured Retention

Covered Loss = 25M

Insured Pays 1M

Insurer Pays 24M


Coinsurance

Loss = 25M

Insured Pays 20% (5M)

Insurer Pays 20M


Pre-Set Allocation

Loss = 25M

Pre-Set Allocation = 20%

Loss Not Covered = 20% (5M)

Insurer Covers 20M

Similar results as Coinsurance except in the case of an Insured Bankruptcy.


Charge for Entity Coverage

Early 90s First Offered - Customary Charge = 10%

Late 90s - Thrown In

Today - Big Losses for Insurance Companies/Big Bucks forPlaintiff Bar Firms (Looking for Entity to Kick in BeyondInsurance Proceeds)

Average Allocation to Entity Used to Be 30%-35%


Other Rating ConsiderationsChange in Auditors

Severability

Insider Stock Sales

Leverage Ratio

Financial Condition

Quality of Balance Sheet

Sarbanes Oxley?


Sarbanes-Oxley Act

New certification requirementsCEO’s and CFO’s must sign

Reviewed financials and not misleading

False certifications mean fines up to $5 million and imprisonment up to 20 years

Audit servicesAccounting firms not to provide other services

E.g. consulting, legal, etc.

Audit CommitteesMust be independent

Cannot be employed by affiliated co. of issuer


Sarbanes-Oxley Act

Rotation of lead auditor

Statute of Limitations

Increased to 2 years/5 years from 1 year/3 years

Effect of lengthening class periods plaintiffs allege

Insider sale limitations

Prohibition of loans to D’s and O’s

Disgorgement of ill-gotten profits

Increased SEC budget


QUESTIONS?

Directors’ & Officers’ Liability

Documents

Transcript of Directors’ & Officers’ Liability