February 5th, 2009

Capacity Woes Pressure D&O

Posted at 1:00 AM ET

Christopher Ross, Senior Vice President
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The January 1, 2009 directors and officers (D&O) reinsurance renewal was challenging for cedents. The ongoing financial catastrophe complicated the effort, which was exacerbated by revelations of the alleged Madoff investments Ponzi scheme in mid-December - just as renewals were completing. Increased loss activity and a shortage of reinsurance capacity factored into the renewal, as well. Coupled with the depressed primary marketplace conditions over the past several years, reinsurers largely held terms at expiring levels.

While primary rates are flattening or moving upward by the month and positive judicial trends exist in securities class action, reinsurers are using larger margins as they price programs compared to last year. Reduced investment income potential and the extreme volatility of the stock market over the past two quarters are behind this trend. As a result, treaties for existing portfolios renewed approximately at expiring economic terms.

Capacity

Reinsurance capacity was the primary concern through the fourth quarter of 2008 and at the January 1, 2009 renewal. Several reinsurers all but exited the D&O market and capacity was implicitly reduced by cedents’ increasingly stringent market security standards. No new reinsurers have entered the D&O space. This lack of capacity was evident with start-up facilities in particular, as terms for support are tighter than those for existing carriers. That being said, terms are similar to those offered to the 2001 and 2002 class of D&O carriers, and these terms are expected to improve over time.

Despite the tightening of capacity, reinsurance coverage has not been restricted and is available for most classes of business from the current panel of reinsurers. The Financial Institutions (FI) and Fortune 1000 segments, of course, have had a number of high-profile claims, with activity expected to increase in a recessionary environment across all insureds. But, insurers were still able to secure reinsurance coverage, and ceding commissions largely stayed at expiring levels. This is because reinsurers have selected the cedents they want to support and will continue to ride the market cycle with them in anticipation of price increases in 2009. Excess of loss (XOL) treaty pricing is moving based on actual and potential loss history.

Pricing

The reinsurance market for both proportional and non-proportional coverage was fairly steady. All quota share program ceding commissions renewed as expiring. Private, Not for Profit, and International XOL programs that were flat-rated showed an average increase of 8.9 percent. Higher rate increases were purely loss-driven.

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While the reinsurance market had minimal increases and new capacity was difficult to find, the situation for primary insurers was much different with respect to capacity. The impairment of a major competitor in 2008 changed the market’s landscape dramatically. Firms in the D&O space pursued numerous opportunities to capitalize on this situation. As noted above, new facilities were started, and existing carriers sought to increase capacity or broaden their appetites.

Traditionally, an increase in capacity would mean a further softening of the marketplace, but this did not occur on a large-scale basis. Rates for the fourth quarter were flat to up slightly for commercial accounts. Accounts with FI exposure or with loss histories were charged significantly higher prices for their D&O programs. The discipline of the primary marketplace can be attributed to the greater use of analytical tools to monitor portfolio profitability, a heightened awareness of the riskiness of an insured, and insurance companies having their own constraints and cost of capital increases.

Outlook for 2009

Moving into 2009, we would expect the pressure on ceding commissions to continue through the first two quarters, possibly longer. The nature of those commission movements, however, will depend on how quickly primary market prices increase (if they do at all), the magnitude of market share shifts, and the ultimate depth of the current recession. The FI sector will continue to bear the brunt of primary price increases, particularly large banks, investment advisors and community banks. Finally, carriers writing D&O for non-profit organizations may experience a surge in claims in the near future as a result of the Madoff investment scandal.

Notably, treaty restrictions have eased over the course of the January 1, 2009 renewals but could become tougher. It will depend largely on loss history and the nature of the risks that a particular cedent is trying to transfer.

Despite the challenges that D&O carriers face in 2009, there are positive factors in this product line that suggest an optimistic outcome. As the economic environment continues to worsen, insurers will try to push through greater rate increases. Several recent judicial decisions have made it harder for plaintiffs to bring securities lawsuits, as pleading standards have increased. Additionally, the value of claims could decline, since the overall stock market capitalization has continued to decrease year over year. Finally, due to the demands of both reinsurance and insurance management, greater accountability exists as everyone seeks to manage their exposure in this environment.

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