Towers Perrin D&O Report: Spike in Demand for Personal Cover, Higher Limits, Enhancements

May 3, 2007

Public and private companies — more than 66% of respondents — have received a record number of inquiries from potential board members who are concerned about their current directors and officers (D&O) liability insurance, an increase of 16% from 2005, according to the D&O Liability 2006 Survey on Insurance Purchasing and Claims Trends conducted by Towers Perrin.

Nonprofit respondents received similar D&O inquiries from approximately 32% of their boards, up slightly (3%) from 2005.

The report also outlines a continued general softening of prices in the D&O market, with some pockets of pricing increases, as well as trends in limits purchased and the claims susceptibility of different industries.

In response to the record D&O inquiries from board members, companies are responding by providing broader personal liability protection for directors and officers, the survey shows. In fact, 14% of those surveyed purchased Side A-only coverage in the past year. Side-A coverage provides D&O coverage for personal liability when they are not indemnified by the organization.

The Towers Perrin survey, which included 2,875 participants, is the 29th in a series of studies on D&O liability insurance purchasing and claims trends and the most in-depth study of its type.

“For the first time, a study is confirming a significant change in how companies are protecting directors and officers from personal liability,” said Michael Turk, Senior Consultant. “While Side A-only coverage has been growing in popularity over the last few years, we now have data to show just how prevalent the coverage has become.”

The popularity of Side A-only coverage reflects directors and officers desires for improved personal coverage. This is particularly true for public companies, where 38% reported purchasing a Side A-only D&O policy this past year. Notably, the majority of stock option backdating claims seen so far have resulted in shareholder derivative claims, a common source of Side A D&O claims.

Among repeat survey participants, there was a 53% increase in organizations that purchased a Side A-only D&O policy. Twelve percent of repeat participants purchased such a policy, up from 8% in 2005. Although public companies are the most likely to purchase a Side A-only policy, the largest percentage increases occurred with private and nonprofit organizations.

Looking ahead, Towers Perrin expects to see an ongoing demand for Side A-only coverage, but also anticipates even greater changes in the types of coverage required by independent board members, according toTurk.

“In the coming years, we expect that independent board members will demand specialized policies protecting only their interests. The limits of such a policy — usually called an independent director liability policy ¾ would not be available to officers or internal directors, who typically have a larger exposure to D&O claims,” Turk said. “The popularity of Side A-only policies reflects a movement in this direction.”

Softening of the D&O Market and Increasing Limits

Towers Perrin’s D&O liability insurance average premium index dropped 18% in 2006 after dropping 9% in 2005 and 10% in 2004. For repeat participants, the average premium reduction was 6.5%.

But while the downward change in premiums points toward a softening market, nearly the same percentage of companies experienced a premium increase (36%) as those that had a decrease (38%). Furthermore, changes in premiums varied substantially across organizations. Repeat public company participants with assets less than $6 million reported a 21% reduction, compared to a 4% reduction for public companies with assets greater than $10 billion. In contrast, repeat private organizations reported a 5% increase in premiums.

“Securities claim filings were down in 2006. Many reasons have been cited for this, such as improved corporate governance and reduced stock market volatility. We do not believe, however, that the current improved risk profile will support prolonged soft market premium decreases if underwriters want to write this line profitably,” noted Turk.

Consistent with the 2005 survey, 15% of participants reported increasing their D&O limit. The average limit purchased across all participants was $11.55 million, a reduction from 2005 that is based largely on increased participation by smaller organizations. If new participant data is excluded, repeat participants reported an 8% average increase in limits across all asset sizes, from $9.31 million to $10.23 million. The largest increases reported by repeat participants were for organizations with assets between $1 billion and $10 billion. The utilities and durable goods classes showed the highest average limits.

For 2006, claim susceptibility across all business classes decreased 2% from 2005, to 14%. Public companies showed significantly higher claim susceptibility (31%) than private companies (9%) and nonprofit organizations (4%). The claimant distribution continues to be heavily dependent on the ownership structure of survey participants. For example, 49% of the claims against public participants were brought by shareholders. In contrast, 92% of the claims brought against nonprofit participants were brought by employees. The health service and utilities industries are most susceptible to D&O claims, based on survey responses, with the health services industry experiencing the highest claim frequency.

Nearly half (46%) of claims against 2006 participants have been closed, which remains consistent with last year’s survey. The large majority of the closed claims were closed by settlement (61%), while the percentage of claims closed by litigation increased slightly from 10% in 2005 to 12% this year.

“While many companies focus on the possible negative impacts of D&O liability, managing D&O risks as part of a global enterprise risk management (ERM) program can deliver positive benefits for the enterprise,” said Prakash Shimpi, ERM practice leader. “Well-managed D&O liability risk can improve decision making through corporate governance and also contributes to the retention and attraction of strong directors and officers.”

Other highlights of the survey include:

Side A-Only Limits Represent Significant Portion of Total D&O Limits: The average Side A-only limit for those participants who also purchased a Side A, B and C policy was $15.0 million. This represented 31% of the organization’s total D&O limits purchased. Interestingly, this percentage was fairly consistent across all asset sizes.

Growing Coverage Enhancements: Thirty-one percent of participants reported an increase in coverage enhancements to their D&O policy, and 8% also reported a decrease in policy exclusions.

Average Retentions Down Slightly: Repeat participants reported an average 6% decline in their retentions (from $484,000 to $456,000). Among all survey respondents, only 20% with renewals since the second half of 2005 reported increases in their retentions, down from 29% in 2005. Overall, 70% of U.S. participants reported no change in their retentions, compared with 63% in 2005.

Participant Profile
The 2,875 U.S. companies surveyed include all major industry groups. The three largest participants by business class, representing over 60% of total participants, continue to be technology, governmental and other nonprofits, and biotechnology and pharmaceuticals. The number of participants increased 6.7% over 2005, with the growth primarily in the number of smaller organizations participating. Survey respondents with assets less than $6 million increased 68%, and 74% of the participants reported assets less than $50 million. In 2006, 25% of participants were publicly held organizations; 55% were privately held, and 20% were nonprofit, which is consistent with the 2005 survey.

For the first time Towers Perrin is offering the 2006 Directors and Officers Liability Survey free of charge to all interested parties.

Source: Towers Perrin
www.towersperrin.com

Topics Claims Directors Officers NonProfits

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