The directors and officers' liability (D&O) product line could become unprofitable within the next few years--if it hasn't done so already, said an article published by Standard & Poor's Ratings Services, titled "The Heat Is On: D&O Insurers To Manage Volatile Market Risks."

D&O insurers have been extremely busy during the past decade. The dot-com bust, accounting fraud, options backdating scandals, the real estate market collapse, the credit crisis, and--of course--Bernard Madoff's Ponzi scandal have made the D&O business particularly volatile because of the waves of litigation that followed each of those storms.

The D&O industry's exposure to erratic financial markets have produced volatile results. Other factors contributing to the volatility include reserve uncertainty, ever-present tail risks (the often underestimated risk of large outlier results), increasing market capacity, and broadening coverage. D&O insurers' exposures to financial institutions, initial public offerings, life sciences, and China-domiciled companies with U.S. stock exchange listings are particularly risky.

D&O pricing has gone down almost consistently since the early 2000s. "Some of this may be warranted because premiums were previously inflated," said Standard & Poor's credit analyst Jason Porter. "But recent market activity suggests that it has more to do with undisciplined competition than a price correction."

In addition, several new players have aggressively entered the business, which has driven market pricing lower. "We expect prices to continue to fall," said Porter. "Also, because of uncertainty in long-tail D&O reserves, the D&O business' current and future profitability could be questioned."

Overall, D&O insurance is a volatile business that has been under heavy competition. Losses in the D&O industry are substantially tied to the financial markets, which are exposed to systemic risks and increasing regulation. As the financial markets and litigation practices continue to evolve quickly, D&O carriers and other market participants may not be able to anticipate emerging risks.

As a result, Standard & Poor's views the D&O product line with skepticism from a credit perspective. "However, we believe carriers can mitigate risks by exercising conservative underwriting practices, closely tracking emerging risks, and maintaining strong controls on underwriting authority," said Porter.