Changing corporate governance practices and excess capital in the insurance market have made directors and officers (D&O) liability premiums drop in recent years, according to Advisen Ltd., a provider of analytics, benchmarking and market information to the global commercial insurance industry.
According to pricing data generated by Advisen’s ADVx index, since fourth quarter 2003, average D&O premiums have fallen nearly 30 percent. The D&O premium decreases have been far more significant than declines in the overall market, and seemed to be picking up steam in the fourth quarter of 2006, when premiums dropped 5.5 percent.
ADVx tracks changes in average premiums paid upon the renewal of commercial lines insurance policies on four lines of business – domestic property, general liability, workers compensation and D&O liability – with the composite index weighted by their relative premium volume as reported in Best’s Aggregates and Averages.
According to Advisen’s “The D&O Market in 2006” briefing, the falling rates are the result of increasing aggregate capacity and decreasing frequency and severity of losses. The average premium for D&O liability insurance more than doubled between the fourth quarter of 2000 and the fourth quarter of 2003. That is rate of increase much sharper than for the overall property and casualty insurance market, the company said. The figures reversed course in the first quarter of 2004 and has been falling steadily since. Capacity withdrawn from hurricane exposed business and redeployed to other lines and regions, plus new capacity generated by 2006 profits and more than $30 billion in new investments in the industry, increased downward pressure on rates in 2006 for business other than hurricane exposed property, including D&O, the company said.
“We are now three years into the softening D&O market and can clearly see the extenuating factors that are contributing to a perfect storm for pricing declines,” said David Bradford, editor-in-chief at Advisen. “Since the corporate governance debacles of the early 2000s, shareholder activism and government oversight have created much greater transparency into corporate management, and when you combine that with the current capital environment in the industry, you have pricing conditions that may threaten to free-fall.”
Securities class action suits remain the principal source of D&O losses to public companies. However, the number of suits filed in 2006 fell sharply. Changes in corporate governance practices and transparency to shareholders as a result of the Sarbanes-Oxley Act have likely contributed to the decline, according to the company. Some practitioners have pointed to an increase in state shareholder derivative actions as an area of concern for D&O underwriters, but Advisen’s research indicates that those have historically been far less severe than securities class action suits in their impact.
Based on Advisen’s data, rate level erosion in almost every line of business will cut into insurer profits in 2007, but as long as it is not an unusually severe year for natural catastrophes, aggregate policyholders’ surplus nonetheless should continue to accumulate. This will further increase downward pressure on pricing in most lines of business including D&O. In addition, the trend towards fewer securities class action suits should continue through 2007, which will increase pricing pressure.
“Barring any major disruptions in the market in 2007, premiums are likely to drop further and the bottom will likely be established by insurer Risk Adjusted Return on Capital models which place higher return requirements on volatile lines like D&O,” said Bradford. “This kind of visibility into fluid market conditions was unavailable to insurance professionals even just a few years ago. But now we can have greater insight into the past which allows us to better understand the future and be prepared for, rather then react to, those market dynamics.”
The D&O Market in 2006 is available to Advisen subscribers or prospects through their Advisen representative. Advisen is scheduled to discuss the results of its briefing this week at the Professional Liability Underwriting Society D&O Symposium in New York.
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