D&O and E&O - Is There Any Good News?

John Lewandowski, FCAS, MAAA

CNA Insurance Company
2004 Casualty Loss Reserve Seminar
Las Vegas - September 13, 2004
D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

D&O POLICY CHARACTERISTICS

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 D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

Coverage/Profile - What is D&O and E&O?

Directors & Officers Liability Policy – provides coverage for claims arising from the
“wrongful acts” – i.e., any act, error or omission -- of insured persons while serving in their
capacity as directors or officers. Expanded to included Entity coverage for “securities
claims.” D&O coverage is simply a specialized type of Errors & Omissions coverage.

D&O’s have liability for misrepresentations and omissions

• in a public offering registration statement filed with the SEC
• in connection with any purchase or sale of securities

Errors & Omissions Professional Liability Policy – provides coverage for claims involving
alleged “errors and omissions” arising out of professional services rendered by the insured,
e.g. banks, investment advisors, insurance companies, mutual funds…

D&O coverage often includes Employment Practices Liability.

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 D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

Make-up of D&O Market

Distribution of Insureds by Segment
By Ownership Type For Profit by Account Size

Not for
Profit Very
10% Small
For Profit Large
Private 25%
20%
10%

Large
For Profit-
25% Mid-
Public
80% Market
30%

Small: Assets < $100M

Mid: $100M < Assets < $1B
Large: $1B < Assets < $10B
Very Large: Assets >10B

Public cos. represent the largest share of the market

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 D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

Typical (Large Public Co.) D&O Program Structure

Program size typically excess of $50 million, up to $200 million+

Limits offered range from $5 million to $25 million per carrier, many carriers on any
one program

Retentions range from $100K and up!

Pricing varies widely from account to account, typically based upon :

• Sector/industry group
• Size –Market Capitalization, Assets
• Recent activities – IPO, M&A
• Financial Condition – consistent performance
• Financial Rating
• Corporate Governance – management quality, board independence

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 D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

Some Past Drivers of D&O results (1997-2002)

Increasing Coverage/Reducing Premium

Expanded capacity/larger limits offered
Expanded coverage, entity coverage eliminated pre-set allocation
Free/automatic Reinstatements
Multi-Year contracts, with significant discounts and no re-underwriting

Increasing Claim Costs – Frequency and Severity

2001 – IPO Allocation filings
2002 – Filings against Analyst and Investment Banks; Wave of Corporate
Meltdowns Begins – Enron, MCI Worldcom, Tyco, Global Crossing
2003 - Mutual Funds – Late Trading/Market timing
M&A Activity – Banking, Insurance
Deteriorating Investment Market

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 D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

Historical Avg. Policy Limits - Public Co. D&O

17,000

15,000

13,000

11,000

9,000

7,000

5,000 1995 1996 1997 1998 1999 2000 2001 2002 2003
Policy Limit 8,300 10,000 14,500 16,000 16,250 17,650 15,000 10,000 9,750

Policy Year

Limits in Thousands 7
 D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

Current State of the D&O market

Through Year-End 2003

Market saw reduced capacity (limits), increased retentions
More players on each program, pricing less competitive
Large rate increases - more than 150% were common
Coverage restrictions – eliminate investment banking, entity coverage
Elimination of multi-year deals
2003/2002 Securities Class Action Lawsuits Decline by 22%
2003/2002 Market Capitalization Losses Decline by 72%

And Beyond…..

Once again, swift changes in the market in 2004……….

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D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

D&O CLAIM CHARACTERISTICS

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 D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

Historical Legislation Impacting D&O Suits

1933/34 Securities Acts
D&O Liability for misrepresentations, omissions in public offerings, statements

1995 PSLRA
Intended to prevent abuses of securities class action lawsuits.
Heightened Pleading Standard

2002 Sarbanes-Oxley Act

Blackout trading barred
CEO and CFO certifications.
Faster insider trading disclosure
Increased Audit Committee duties.
Increased SEC review
More criminal penalties and fines

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 D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

D&O Securities Suits (Through August 2004)

Source : Stanford Research

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 D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

D&O Claims Characteristics

Some interesting Public Company D&O statistics*….
• Half of all suits against D&O’s are filed by Shareholders
• 24% of claims brought by employees
• 36% of all claims are class actions
• Low Frequency - average of 225 securities suits per year (excl IPO)
• High Severity – average settlement of $20 million
• Most active District Court is S.D. New York
• Most frequently sued Sector is Technology
• Most frequently sued Industry is Biotechnology & Drugs
• Most resolutions achieved through settlement, not judgment

*Source : Tillinghast D&O Report and Stanford Research

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 D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

Significant D&O Claims

Company Settlement Amount

Cendant $3,527.0 Million
Lucent $563.0 Million
Bank of America $490.0 Million

Waste Management II $457.0 Million

Rite Aid $319.5 Million

Oxford Health Plans, Inc. $300.0 Million

3Com $259.0 Million

Waste Management I $220.0 Million

MicroStrategy $192.5 Million

Dollar General Corp $162.0 Million

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 D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

Major Factors For D&O Claims

1. Scope of Policy – is it a claim, a wrongful act?

2. Ground-up Nature of the Claim

3. Possible Defenses – exclusions, warrants, application.

4. Policy structure, coverage and wording

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 D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

Criteria Used to Establish D&O Claim Potential

• Alleged Damages - “Plaintiff-style” damages

• Length of Class Period – number of shareholders
• Insider Holdings
• Historical Stock Performance
• Underlying carriers – who is lead on Claim?
• Venue – circuit, pleading standards, judge
• Attorney firms – both Plaintiff and Defendant
• Industry – Telecomm., Pharm., Energy – any trends?
• Procedural steps – Consolidated complaint, motion to dismiss
• Lead Plaintiff - Institutional Investor
• Insured’s stamina/motivation

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 D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

Key Takeaways

•Principal exposure is from Shareholders Class actions against Public

Companies, Private Company litigation less common.
•Pricing for D&O must recognize Size and Sectors as important factors, but
not sole factors – all are not equal.
•Last few years witnessed emergence of non-traditional claims (mega-torts)
in addition to traditional issuer fraud cases.
•Settlements are not keeping pace with filings, there is a large backlog of
cases.

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 D&O and E&O – Is There Any Good News?
2004 CLRS – Las Vegas

Is There Any Good News?

Lessons Learned from the past……..

•Keeping pace with the next possible mega-tort by identifying

industries/markets in distress is critical.
•Reserving for D&O is multi-faceted and requires a continuous evaluation
during the lifetime of the claim.
•Strong working relationship between Claims, Underwriting and Actuarial is
important since traditional actuarial reserving methods do not work.

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