The stock market recovery has brought mixed outcomes for D&O carriers. The recovery from the nadir of the financial crisis increases potential exposure, but low volatility mitigates this risk. This year, commercial rates fell 10 percent to 15 percent, largely because of a significant increase in capacity over the past three years and a relatively benign loss environment.
Financial institution rates, meanwhile, declined 5 percent to 10 percent, as the renewing risks are coming off of up to two years of substantial increases. In addition, many risks priced in 2008 or early 2009 based on a high probability of bankruptcy have been given significant rate relief in late 2009 and 2010. Further, several favorable court decisions on financial crisis lawsuits have left carriers less pessimistic about worst case scenarios. Nonetheless, carriers remain cautious in the community banking space, where there is a clear dichotomy between rates in relatively healthy areas (e.g., Northeast) versus other areas severely impacted by the real estate bubble (e.g., California, Georgia, Nevada and Florida).
Carriers continue to take down redundancies from the 2003 to 2006 accident years, but most of the profits from those years have been fully realized. Insurers have assumed incremental increases in loss ratios for 2011 based on continued rate softening.
Absent a new loss paradigm in the commercial sector, rates are expected to fall, although perhaps more modestly than in 2010. In the financial institutions segment, rate reductions may accelerate based on the view that carriers are further removed from the turmoil of 2007 to 2009.
In the commercial area, reinsurers are monitoring their exposure to the Deepwater Horizon event in the Gulf of Mexico, but so far it is not viewed as having a material impact to any carrier’s D&O portfolio. Reinsurers in the financial institution segment continue to be focused on the resolution of financial crisis claims from 2007 to 2009, but there have been no new significant claim issues to arise.
Reinsurers are examining the potential effects of the Dodd-Frank Wall Street Reform and Consumer Protection Act, but this is not affecting their appetite for the class of business. Reinsurers have also noted an uptick in regulatory actions such as (in)formal SEC investigations and increased Justice Department and SEC vigilance around the Foreign Corrupt Practices Act.
Reinsurers have not added capacity to these classes of business. There is arguably excess reinsurance capacity due to the fact that cedents have signed back placements, and a number of reinsurers in this somewhat long-tail class are not approved by all potential ceding companies. The only structural changes we noted at January 1 were increased co-participation and retentions.
In the proportional treaty space, cedents have retained a higher proportion of their business year over year to maintain profitability in the face of a decreasing revenue. As those top line pressures increase in 2011 and begin to significantly impact expense ratios, this trend may reverse if carriers are able to obtain or increase ceding commission overrides. Loss ratio caps or corridors were essentially flat in 2010 and the expectation is the same for 2011. We noticed a slight change in preference from some reinsurers quoting corridors instead of caps.