US and Canadian listed companies or companies having an IPO are more at risk of being hit with a securities lawsuit than at any time. Often a company defendant may have to fight a ‘multi-front war’, consisting of parallel state court and federal court lawsuits; with state court securities class action lawsuits being less likely than federal court lawsuits to be dismissed. 

Background and legal environment

According to latest report published by Cornerstone Research*, the number of federal court securities class action lawsuit filings remained ‘near record levels’ during 2018.

• 403 federal court securities class action lawsuit filings in 2018
• Many of these filings were driven by significant numbers of merger objection lawsuits
• 8.4% of the U.S. listed companies were hit with securities suits
• The median securities class action lawsuit settlement in 2018 was a “near-record” USD13m, more than double the USD6m median in 2017
• Aggregate market capitalisation loss of over USD1tn (well over the USD334bn in 2017 and much greater than the preceding five-year average of USD245bn)
• Industries: The 2018 filings were concentrated in the three historically dominant sectors in terms of losses; firms in the health care, technology, and financial services sectors
• Firms in the technology sector were particularly susceptible to allegations involving accounting issues, misleading earnings guidance, or firm performance issues.

What does this mean for the world of D&O insurance?

This changing legal environment coincides with a challenging insurance landscape, where insurer’s loss ratios are significantly higher than a decade ago. 2004 was the high tide mark of D&O pricing, where most D&O carriers sustained a loss ratio of around 35-45%. By 2016, with actuarial pricing models suggesting average rates are at 45-50%  from where they were in 2004, the markets base loss ratio, without factoring in any changes in the legal environment, will have risen to 75%-85% (hence a combined ratio of well over 100%). In Warren Buffet’s language, the ‘float’ is now costing serious money. 

These factors combine to create a perfect storm for D&O losses. Below we depict the market and focus in on premiums between 2002 to 2018.

Narrative: 

1. The potential client base has shrunk from 12,000 to 6000, due to companies being taken private (see orange line)
2. Premiums have been reducing as more underwriters pursue the relative attractiveness of D&O (purple line)
3. The number of class actions have been steadily increasing in both frequency and severity (green line).

Therefore there are some trends which can be identified in the marketplace that need to be navigated and managed:

• Pricing: Both Primary and Excess rates are increasing  even on clean accounts
• Capacity: Insurers are becoming much more cautious about managing their limit profiles and restraining the capacity they are prepared to deploy on each risk
• Increased limit factor: Excess layers are no longer strictly following a percentage cost of underlying layers (some pay the same or more than underlying)
• Ventilation layers are now being vacated creating gaps and collapsing towers. London participation is in increasing demand
• Private D&O: there are different loss factors beginning to manifest and this is partly because  D&O tends to be bundled with  other lines such as EPL, crime and fiduciary. The challenge is that the component parts have also been under-priced and attritional losses are percolating though. Consequently, some packages are being un-bundled and the private D&O is purchased standalone.

We are here to help you navigate this changing and challenging market. Please get in touch with Andy if you have any questions.

Sources:

https://www.dandodiary.com/2019/01/articles/securities-litigation/cornerstone-research-combined-federal-state-securities-suit-filings-highest-ever-levels-2018/

https://www.dandodiary.com/2019/01/articles/securities-litigation/nera-economic-consulting-securities-suit-filings-highest-level-years/

https://www.dandodiary.com/2019/01/articles/d-o-insurance/guest-post-year-review-2018-key-insurance-coverage-decisions/

http://securities.stanford.edu/