D&O: Good for now, trouble on the horizon?

The D&O insurance market is improving for risk managers after a period of turmoil, with capacity expanding, competition in the market and rates softening. But more difficult times may be around the corner as the macroeconomic climate deteriorates. Tony Dowding reports.

The D&O market was in a poor state for risk managers a few years back, with claims increasing, rates rising sharply and tight restrictions on underwriting. And then capacity came back into the market in the form of new players, especially managing general agents (MGAs), as well as existing insurers taking advantage of the hard market conditions to write more selected business.

And as a result, the hard market has moderated to the point where in some cases, brokers are talking of flat renewals or even modest reductions in some regions. But with the macroeconomic outlook globally deteriorating, new legislation, and corporate and social responsibility increasingly coming to the fore, underwriters remain cautious and the outlook for D&O insurance is unclear.

Currently, the D&O market in Europe is in a better state than it has been for a while and there is now enough capacity to place most of WTW’s accounts, says Louise Dennerståhl, head of FINEX Europe, WTW, stressing that she is referring to continental Europe and not the London market. “Q3 2022 has continued the improving trends in the continental European D&O markets. In Q3 this year, 43% of our clients saw their primary layer renew flat or with a decrease on last year’s premium whilst 59% saw their excess layers renew flat or with a decrease,” she says.

Matt McKenna, VP of Scale Underwriting, a US MGA of underwriters at Lloyd’s, says the D&O market is rapidly changing but generally softening in most sectors. “The most recent trend we see in the private D&O space is increased capacity in the form of new players and more established players entering new markets, combined with the impact that economic uncertainty is having on the price sensitivity of insurance buyers. This drives rates down at a time when, if premiums were determined solely by the likelihood and potential severity of claims and not market forces, they would likely be going up.”

Stable market
The market has certainly stabilised, according to Pawel Paluch, global underwriting manager, management liability, Zurich Insurance Group. “The magnitude of rate increases has reduced in line with the increased capacity now available and we have seen some evidence of modest premium reductions for specific business segments and well-performing business. That said the market is somewhat split with the ‘fresh’ capacity focused more on excess business, and as such the level of capacity actively seeking to target primary business is more constrained,” he says.

And in the US, Kyle Jeziorski, executive VP, Founder Shield, a New York-based broker, notes that securities class action filings have been on a downtrend since their peak in 2017-2019. “Market pricing is now catching up to this trend,” he says. “Additionally, with the current economic state, few companies are going public via SPAC or the traditional IPO route. As a result, insurers are forced to be more competitive in their offering to write this new business. Lastly, renewal pricing for newly public companies is decreasing significantly from both a pricing and retention perspective.”

Losses
McKenna says global and domestic risks are on the horizon, both political and economic, and these can’t be discounted. “D&O underwriters are again in the uncomfortable position of balancing competing in a soft market with adhering to underwriting philosophies that are designed to protect carriers from book-wide losses; often, these are actually not mutually exclusive principles, but when they are, the wise underwriter lives to fight another day and declines/non-renews/offers uncompetitive terms, as appropriate.”

Indeed, as the economic situation changes and there is talk of recession, inflationary pressures and growing insolvencies, the softening or moderation may be impacted in the future. In its whitepaper, A Changing D&O Environment in EMEA: More Volatility Ahead?, AIG says that surging loss costs as D&O claims have increased both in frequency and severity, and the long-tail nature of D&O insurance in combination with growing claims inflation, have led to many D&O insurers posting losses in the past few years.

“There are no signs that loss costs will improve in the near to midterm. With traditional types of D&O claims likely to remain and the addition of macroeconomic uncertainty, enhanced regulatory activity, society’s heightened focus on corporate social responsibility, and the passing of new legislation to support consumers, exposures remain elevated for the foreseeable future,” says AIG.

There are also legislative changes in Europe that may affect the D&O market. WTW’s Louise Dennerståhl says an important regulatory change coming in Europe is focusing on ESG and sustainability. The Corporate Sustainability Reporting Directive is being finalised by the EU, which will extend the non-financial reporting obligations already imposed on large public interest companies to a wider group of companies.

She also notes that ESG-related topics are increasingly shaping D&O risks and losses going forward. “With growing regulation and more litigation in the ESG area, this is to be expected. Greenwashing is the one to watch as it can become a major exposure if companies do not follow national and global ESG regulations as can be seen in recent Dutch and German cases, as well as increasing regulatory actions in this area.”

Terms and conditions
As for terms and conditions, Dennerståhl says that more carriers are offering better terms. “It is worth pointing out that the conditions in Europe did not change dramatically during the hard market,” she says. “There were of course some restrictions but they are now easing up again. There is more softening of wordings in some areas with some insurers showing willingness to strengthen their position in the D&O market. On the retention side, higher retentions remain common for Side C. For Side B, there is more flexibility to negotiate retentions downwards, especially for non-US claims.”

In the US, McKenna says terms and conditions are easing for desirable insureds. “If several carriers are quoting a single risk who all want to win it, these carriers are finding they have to be more aggressive this year than they were last year. But not all submissions are created equal. FUD (fear, uncertainty, and doubt) drives underwriters the same way it drives investors, so distressed companies may find that if good funding is hard to come by, good D&O terms may be too,” he explains.

Jeziorski adds that he is seeing carriers be more flexible on terms and offering enhancements such as increased additional Side A limit on renewal offerings.

Zurich’s Paluch on the other hand says: “At this stage, we have not seen any evidence of easing of terms and conditions and do not expect to see this become a factor in the short term, given the somewhat bleak global macroeconomic outlook. As a result, the changes we have seen to date are focused on rate as opposed to coverage.”

Capacity growth
Capacity has undoubtedly grown and is no longer such an issue as it was a couple of years ago in the market. According to Dennerståhl, the entry of new insurers in the European D&O market combined with the increasing appetite from existing carriers has generated more competition and increased capacity, particularly for new business. “The capacity inflow is a mix of established carriers increasing their capacity and new carriers opening offices across mainland Europe. What is notable is that all D&O carriers are now talking about growth, which is a big shift in the market and overall the trends are improving,” she says.

Paluch agrees that it is a combination of new players in the market and existing players stepping up. “The hard market trading conditions have certainly attracted more capacity into the market. Some of this is coming from existing players who have been attracted back to the market despite having previously scaled right back with additional new capacity coming from startup ventures with private equity backing or indeed through MGAs.” And he stresses the value of continuity offered by established primary lead carriers that have traded throughout the recent turmoil.

In the US market, McKenna says: “We’re seeing increased capacity market-wide driven by the entrance of newer and older, more ‘traditional’ carriers competing with the new players for risks that were previously too small or too emerging for them to invest time and resources in. I suspect that what we’re seeing in the private D&O space is a lagging indicator of what’s happening in the public space. These carriers are looking elsewhere for returns after the IPO market dried up.”

He adds: “These dynamics mean that a single D&O submission for a private software company could see quotes from specialty carriers that have been writing this type of business for over a decade, new entrants that have been in the space for less than five years, and household-name carriers whose appetites have recently changed. This is a buyer’s market.”

Jeziorski points to new insurtech entrants to the D&O insurer market targeting private companies. “We have seen insurtechs enter the cyber insurance market over the past several years, such as Coalition and At-Bay. We are now seeing this trend continue in the management liability space.”

Economic difficulties
The biggest concern in the market is of course the current economic difficulties globally. As Paluch explains: “History will show that there is a strong correlation between the propensity for D&O claims and macroeconomic performance. Volatility in the financial markets, rising interest rates, high inflation, high energy costs and continued supply chain issues will put additional pressure on all areas of the economy. Whilst the D&O market has stabilised, it is also faced with a myriad of economic headwinds that reinforce the need for heightened caution and continued underwriting discipline.”

Dennerståhl says there is always a concern around D&O when there are economic difficulties, especially inflation and the signals of a serious recession. “Several insurers in continental European markets were already imposing insolvency-related exclusions or a change in risk provisions, and the concern is that a recession will start to test some of these clauses,” she says. “However, the rates were significantly increased during the hard market and while we see a change in the way carriers are now writing business, the capacity in the European markets is not inexperienced. Rather, we are seeing established carriers in other parts of the world branching out into Europe.”

Inflation
In its whitepaper, AIG notes that soaring inflation could put some companies into financial trouble, potentially leading to an increased rate of insolvencies. “Insolvencies are commonly known as one of the most frequent drivers of D&O claims… In addition to this potential increase in insolvency-related D&O claims, for D&O insurers, increasing inflation can have a sensitive effect on the claims cost over time due to a greater compounding effect, as a result of the long-tail nature of many claims,” says the insurer.

It adds: “The combination of economic and social inflation will likely lead to claims inflation. Since both economic and social inflation are increasing, we can expect that D&O insurers will feel a double effect on the claims cost. This may be mitigated by the fact that investment income could increase in lieu of higher interest rates, but it is unlikely to increase enough to offset any claims inflation.”

“Rising claims inflation will have a direct impact on the profitability of the D&O market, and therefore an open dialogue and common understanding between insurers, clients and brokers on this topic remains more critical than ever,” says Nepomuk Loesti, AIG, in the whitepaper. “Awareness and appreciation of the risk landscape by all market participants will be critical in avoiding extreme market reactions like we have seen during the past couple of renewals. A sustainable D&O market is in the best interest of all stakeholders, especially our clients.”

McKenna says 2008 provides a useful guide: “After the financial crisis peaked, we saw large claim payments, a rapid hardening of D&O pricing and terms, consolidation of capacity providers, and in some cases, rebranding of capacity providers. But more to the point, we saw dramatic changes in how D&O underwriters approach risk. Gone were the days of flat auto-renewals and two-year policy periods for community banks. Today, easy, flat renewals are becoming more common. Policy period extension requests are getting longer and longer. What short memories we have when growth is our primary goal. Inevitably, we’ll see another macro crisis that demands the insurance market makes adjustments to its participants, products and practices.”