Your client’s directors and officers liability policy is coming up for renewal. What can you expect from the market? Like the Dickens classic, this is a tale of two markets.
The Best of Times
For companies with little or manageable debt, good cash flow and profits, and a decent claims history, the market has been good, with many clients seeing expansion of coverage and a decrease in pricing. During the past two years, three of the largest writers of executive liability coverage have experienced financial problems and ratings downgrades. The combination of these dominant wounded carriers fighting to retain business, coupled with new entrants into the executive liability market, has provided sufficient capacity to keep renewal terms favorable for this segment.
The Worst of Times
For companies in the financial sector, as well as those in industries that are reliant on the capital markets for funding (e.g. energy and biotech), the market has been far less kind. For companies struggling with claims issues, declining revenues, declining profits and sizeable debt loads, the market is downright ugly. Depending on the individual scenario, carriers have responded with reductions in limits, restrictions in coverage and increases in pricing and deductibles. In some cases, the pricing increases have exceeded 100 percent and in other cases, the carriers have refused to offer renewal terms.
Who Will Be Affected?
A common thread throughout the D&O and all executive liability coverage lines is the financial condition and performance of your client’s company. If you are experiencing operating losses, cash flow issues, have a sizeable debt load and/or significant debt due within the next 12-18 months, count on a tougher renewal.
Companies perceived to be at risk of bankruptcy in particular are viewed unfavorably by the underwriters due to the high likelihood of claims in a bankruptcy. This situation is exacerbated for privately held companies due to the relatively low premium levels allocated to the D&O coverage line. In short, even a doubling or tripling of premium may not adequately compensate a carrier for the increased risk of claims for a company heading toward bankruptcy. According to statistics from the Administrative Office of the U.S. Courts, for the 12-month period ending Sept. 30, 2009, business bankruptcy filings surged 52 percent from the prior year filing levels.
In addition to financial concerns, below are some other signs of potential trouble in your upcoming renewal:
- Presence in the financial, real estate, construction, or retail industry or any other industry adversely impacted by the downturn.
- Companies reliant upon the capital markets for funding.
- Significant layoffs.
- Increased claim activity in the past year, or one sizeable claim in excess of the retention.
- A significantly underfunded pension plan.
- Presence of employer stock in the retirement plan.
- Changes in senior management.
- Change in auditors.
- Sizeable impairment charge during the past year.
- Significant stock drop (public companies).
What Agents Can Do
In short, start early and be prepared. In this environment, information is king. Underwriters are asking far more questions, requiring more documentation, and requesting client meetings or conference calls. These additional steps take time, and you will be in for a rude awakening if you submit a financially distressed company a week before renewal.
The Debt Bomb
The amount of debt on your client’s balance sheet and its terms are a particular focus for underwriters. Banks are tightening loan standards and few clients are able to renegotiate their debt on their historically favorable terms.
Expect to answer these types of questions about your client’s debt:
- Are you in compliance with the covenants?
- Can you pay any debt due within the next 12-18 months?
- Do you anticipate a reduction in the borrowing base from a bank line re-determination?
- How is the relationship with the bank/creditor?
One discernible trend of the past year is that underwriters are no longer willing to accept the uncertainty that a company will be able to renew or extend their debt. They want proof. They also want to see contingency plans in the event the company cannot affirmatively answer the above questions.
Quality Financial Information
How many times have you asked for a financial statement, only to receive an interim ledger statement that is as incomprehensible as it is incomplete? In order to evaluate the financial condition of a company, underwriters want to see the most recent year-end CPA prepared financial statement, complete with notes. In addition, they want to see the most current year-to-date interim financial statements. The deterioration in revenue for some companies has been so rapid that the now one-year-old CPA audit bears little resemblance to the company of today.
One of the biggest questions you will need to answer is, “Will this company be in business by the end of the policy period?”
Underwriters are trying to peer into the future to envision what the company will look like at the end of their term. Many underwriters are looking for an 18-month window as they don’t want the company running out of gas at the end of their policy period. Prepare your clients to provide clear information about their business and an outline of projections for the upcoming year.
The ability to provide contingency plans for funding challenges is also helpful to assuage the underwriters’ concerns. Encourage your clients to select a company representative who can clearly articulate your plan to the carrier.
Address the Problems
If your client has some particular issue such as turnover in senior management, significant claims, layoffs or debt compliance, address these issues upfront with your client and present solutions as part of your submission to the carrier. If you wait for the underwriter to bring this up, they will have a pre-disposed negative outlook on your client and you will be fighting an uphill battle to renewal.
Dance With the One Who Brought You
Great relationships are born in tough times. The relationship with the incumbent carrier is paramount in working through a renewal with a financially distressed company. Now is not the time to be shopping the renewal unless you are faced with some particularly adverse renewal terms or a non-renewal notice. Many of the carriers I talk with are growing increasingly uncomfortable with the number of financially distressed companies on their books and are not looking to add another to their watch list.
There is no easy formula for handling a D&O renewal for a financially distressed company. By properly preparing your client, providing full submissions that address the problems in their business, providing sufficient lead time, and nurturing the relationship with the carrier, you can markedly improve your odds of a successful outcome.
Sandy is vice president, director of Financial Services for IMA Financial Group Inc.
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