Being informed and understanding the history of insurance coverages is critical to selling and writing them successfully say Nancy Hahn, principal and founder of EPIC and Sean Burke, director at Wholesale Trading Co-Operative Insurance Centers. Directors and officers coverage in particular, says Burke, is such a broad topic with a deep history and complexity that having a foundation of knowledge is essential for agents and brokers working in this segment.

Burke and Hahn spoke with MyNewMarkets.com Associate Editor Amy O’Connor about what historical events have helped shape the directors and officers market and how the coverage has evolved into what it is today, as well as what are some of the current challenges in this marketplace that could affect the coverage down the road. (Timeline of D&O Events).

Why do you think it’s so important to know about the history of the D&O market?

Burke: If you’re going to talk about insurance, to understand a little bit of what was behind the reason it came about is important. It’s pretty clear how insurance works when you have a building and it either burns down or there is a natural disaster, whether it be wind, flood, or fire, that affects a property. D&O can be a little more esoteric. You are insuring people, ultimately, and how does that insurance apply and why does it apply? In taking the approach of the history and evolution…really getting the foundation for why the coverage evolved to where it is today. It makes it easier to comprehend really the products you are selling your clients.

What events have shaped D&O policies and demand for the coverage through the years?

Burke: D&O, in many respects, and many of the major changes that happened to D&O throughout its evolution, were triggered either by a major financial event or a major regulatory event that really impacted not only the want for the insurance, the need for it, but how it is offered.

It originally jumped off as a byproduct of the securities reform that was done on the heels of the Great Depression in the 1930s. '33 and '34 Act were acts that were put in on the heels of the Great Depression that created protections for investors who were buying public securities who had been wiped out in the stock market in the late '20s… D&O was originally offered by London in response to the heightened exposure people running companies faced because of the new regulations… but there really wasn’t much litigation then so there wasn’t much of a market demand.

That really changed coming in the '50s and '60s, when there was more changes within state laws that allowed companies to indemnify people who ran them.

By the late '60s, early '70s, maybe 70 percent of public companies were buying the insurance. By the time you got into the mid '80s and '90s, especially after the stock market crashed in the late '80s, you saw the vast majority of public companies buying the insurance in the US domestically.

I would say today it's almost a compulsory buy for a US domestic company to have D&O insurance if they are a public company.

Now, there are different aspects to private companies. They really didn't get into buying the insurance or seeing those exposures develop until probably the late '80s, early '90s, where private‑company D&O started coming to the forefront of the marketplace.

What about nonprofits? When did they start buying the coverage?

Burke: The nonprofit, availability for the coverage has been really predominant, again, probably developing into the '90s over the last 20 years… There's been a significant amount of litigation in the past 10 or 15 years whereby nonprofits have been found not to be pursuing the goals that they have laid out and that the funds that have been afforded them, by grants or by private individuals, have not been utilized correctly.

Why has demand for the coverage increased so much from private companies and nonprofits in recent years?

Burke: We're in a very litigious society, and there's a lot more scrutiny that goes on how people operate firms. As information has become more readily available in a technology age, private companies and nonprofits have become far more susceptible to having that scrutiny as well and being subject to such litigation.

Who are some of the top D&O carriers now versus over the years?

Burke: Capacity and carriers have been an interesting evolution. People got into the D&O space ‑‑ London certainly founded the product and has been, in past and present, a mainstay within this product offering. When you got into the '70s and '80s, where people started offering the product for the first time, keep in mind it's a newer product, so it's not a tested product. What I mean by that is that there isn't a lot of actuarial information as to the profitability of it.

Through the crisis in '85 and '86, they found they didn't have much premium on the books but they had a lot of limits exposed, and when they started taking the hits, ultimately they pulled out of the marketplace.

By 1985‑86, you really only had three options in the marketplace that were viable ‑‑ Chubb, AIG, and London. As a result, it became a very, very hard market where terms were restricted and prices went up dramatically, because there was a dearth of capacity and a lot of need.

On the heels of the Private Securities Litigation Reform Act of '95 in 1995, there was a significant rush of capacity to the marketplace, because there was this belief that there was securities reform that was going to allow for a more stable litigation environment for D&O carriers.

Where we are today? Well over 50 to 60 carriers who are offering D&O, on either a public or a private or a nonprofit basis. There's a tremendous amount of capacity in the marketplace.

Do you think there is so much capacity now because carriers are better educated on how to manage the D&O losses? I would think 2007‑2008 probably showed some pretty significant D&O losses, considering a lot of those were financial companies.

Burke:  We're definitely, as an industry better equipped at managing losses, understanding the nuances of the coverage being offered and in what capacity, and being able to manage that on a portfolio basis much more effectively than they have been in the past… Many carriers are now limiting capacity to $5 million or $10 million in limits offered, as opposed to higher lines of $15, $20, or $25 million.

Hahn:   You're not seeing the reactivity of the markets either. There were years when the markets would react, especially in the technology sector, when there was a lot of litigation going on. Every time a company and a stock dropped, they would get sued. What would happen is your current incumbent carrier would double the premium, so you'd have a renewal and you'd have a client paying double what they paid the year before. They weren't able to budget for that. You don't see that same reactivity now in the marketplace, because there also is a lot more competition and there's a lot more carriers willing to play. It's a lot different than it was 15‑20 years ago. It's a lot more stable.

What about in terms of the carriers? Would you say London is probably the only market that's really been writing D&O the whole time?

Burke:   London, AIG, and Chubb are probably the longest‑tenured consistent players in the market. London started the product back in the '30s. AIG, Chubb, and London have been a mainstay of the market going back 30‑plus years now.

How do the D&O policies that are in the marketplace today differ from when the coverage started?

Burke:  The original policy was written to protect the individual board member for the liability they had serving the board and managing the company. As the regulations changed over the years that allowed companies to indemnify their board members to a higher level, that put the company's balance sheet at risk, too.

The policy really evolved from a cover wherein you had coverage for the individual board member and the corporation indemnifying the board member for their role on the board. Over the years, it has evolved further, with laws evolving that had seen the company also as a corporate person. Corporate personhood essentially says that a board member can be sued, a company can indemnify them, but the company can be sued as a natural person or as a person as well…

The policy has gotten considerably broader. Add‑ons throughout the years include how the policy responds in certain regulatory environments, with certain investigations. We've seen Sarbanes‑Oxley come in as a reform act in the early 2000s. We had Frank‑Dodd more recently. As these different regulations come into play, the policy needs to be updated constantly to respond to those newer needs as well…

The policy has gone from essentially a one‑insuring‑agreement policy to a three‑insuring‑agreement policy

Why did the side A, B, and C aspects of the coverage become necessary as well?           

Burke: What side A really is, is the original coverage. When you had coverage for the individual, side A is referring to an insuring agreement that's the original insuring agreement ‑‑ insuring agreement A, which gives coverage to an individual. Insuring agreement B is the company getting coverage for reimbursing that individual. The reason it was called side A and side B is, essentially, you used to have a two‑page policy. It's a very different contract today, but ultimately that's where the jargon comes from, Side A and Side B. Side C coverage is the Entity coverage that came into play in the mid '90's.

Side A coverage really is sleep insurance for the board member. That in addition to our underlying D&O policy, I know there's this dedicated limit that protects us in certain scenarios, whereby the underlying policy either doesn't have limit available anymore, because of a settlement. Or perhaps one of the underlying carriers is unable to pay for coverage, due to insolvency issues or due to a coverage dispute. It's really sleep insurance for the board member.

What are some of the challenges now in the current marketplace that are affecting this segment? How are these different than when you both, as long term underwriters started writing this coverage or started working in this segment?

Burke: Some of the challenges are the ever evolving regulations and the globalization of business. We work in an environment now where any individual company may very well be based in the US. They may manufacture their product in China. They may sell internationally throughout the world. As a result, there's a regulatory environment. There's counter‑party components to working in a global economy that just create myriad's of litigation scenarios that probably weren't even there 10 years ago. It's just the way people transact business now.

How policies respond to international regulators, or investigations coming from the international side, were something that didn't necessarily have to be contemplated 10 or so years ago. Those are ever evolving and changing.

That's what is both interesting and also challenging about this space. Is that you have to constantly be up to date on what the newer issues are that are evolving by way of litigation and regulation. Also, constantly be mindful of the contract you have, even 18 months later it may be a little bit outdated, because there's been so much change in such a short period of time.

Hahn:  The biggest challenge is educating clients. Because it is a very complicated coverage. You have to have a broker that knows what they're doing. You can't just go out and go to a couple markets, and pick a D&O policy and bind it. I see that happen often… It's challenging really to take the time to educate the client in all the nuances of the policy, and how important a lot of these endorsements and coverage features are.

How has the insurance marketplace adapted and responded to the needed changes, and how have insureds responded as well?

Burke: The market is very, very good right now at scalping out an issue, or taking a laser approach to an issue and addressing it to the best of their capabilities, than they have in the past. As we have these different changes and fast moving liability issues that arise. Frank‑Dodd gets passed on one day, and usually within months after insurance carriers are looking for an Informative way to tackle the issues that Frank‑Dodd poses… That discussion today is at an all-time high relative to 10‑15 years ago. The collaboration between attorneys, the buyer at the client level, and the underwriter, carrier, and brokerage, probably that collaboration is at an all-time high to try to find affirmative ways to tackle these issues.

With that in mind, how do you think this market will evolve over the next 5, 10, 20 years. Obviously, it's evolved a lot in the last 20. What do you think are some of the major events that have happened recently that could contribute to these changes?

Burke: We don't necessarily know what the new regulatory events going to be, or what the next major crisis will be that will impact the industry group.

What I can say about the industry group in the next 5, 10, 20 years, is that capacity is such, and the intellectual capital is such, and the commitment to the marketplace is such, that I don't think we'll ever see a scenario where we were in the late '80's, early '90's where there just wasn't capacity available.

Yes rates will go up where needed, and there will be form restrictions at times where needed, but people are committed to the marketplace. I don't think we're going to lack for capacity anytime in the future. It's just going to be smarter capacity. That's very different than 20‑30 years ago, when faced with some of the same issues that we're facing with now.

What are some of the current exposures right now in the D&O market that people need to be aware of that maybe are heightening the risk for directors and officers?

Burke: In the past 24‑36 months, a couple pieces of litigation that have been newer to the industry space that have been of interest and really driven the profitability of portfolios. One is foreign insureds. That is people who are US listed companies on the public exchange, but they operate in other countries. They're subject to a variety of different accounting standards that aren't necessarily as strict as the United States.

The other is something referred to as Merger Objection suits. That is, because we are coming out of an environment where valuations of companies drop so significantly with the stock market. There's a lot of M&A activity right now, because some companies are able to come in opportunistically and pick up some great organizations at a value price, because the valuations have diminished from where they used to be… Those Merger Objection suits are almost part and parcel of any M&A event right now. That, by far, has been the loss leader for insurance companies, I'd suggest, over the last 12 to 18 months. That's a new facet of litigation that's really risen up.

How important is this coverage to the insurance marketplace, and to the companies? Especially compared to other insurance coverages that are out there?

Burke: It's not a compulsory buy. From the standpoint of, you can't open doors if you don't have a GL policy in place or certain Property policy in place in many cases. But if you're a public company and you're operating in the US, if you want to have credible board members on your board, you are going to purchase the insurance, there's no doubt about that… For many reasons, it's a necessary buy for private companies but it's not at the top of the totem pole for everybody. So it isn't a compulsory buy by any stretch. The vast majority of private companies do buy the insurance and they see the value in it.

It is valuable insurance. It can save your company in the event you get sued. It protects the companies' balance sheet and it protects the people who run the company, their personal balance sheets. It's exceedingly important for people to give consideration to it.