Between a Rock and a Hard Market: Navigating the Turbulent D&O Insurance Waters in the Wake of September 11
 
May 9, 2002
 
Stephen J. Weiss- Washington

Months before last year's terrorist attacks, the market for directors' and officers' (D&O) liability insurance was changing from a buyer's to a seller's market. The attacks and the havoc they wreaked upon insurers fueled a further hardening of this market. But even in today's market, there are steps that potential policyholders can take to increase the odds of getting the D&O coverage wanted.

A tangible sign of a hard market is a letter from a D&O insurer to a policyholder a few months before the policy expires stating that it will not renew the policy. Another tangible sign is a letter from an insurance broker summarizing the results of his or her marketing efforts. A recent letter we saw said:

I approached 12 insurance carriers on behalf of the company. Some declined due to your industry classification and the economic impact of September11. Others will only entertain writing excess coverage. The incumbent insurer has conditioned its renewal on your acceptance of several new, restrictive terms.

What a Policyholder Can Do to Soften the Blow of a Hard Market

First, even if the policyholder gets letters like these, they shouldn't panic. A "nonrenewal" letter can be less ominous than its name suggests. In many instances, the insurer is not terminating its relationship with the company; it is simply giving the policyholder the advance notice legally required of an insurer that decides not to renew its policy or to materially restrict coverage on renewal. This letter protects the insurer's options. There's no question that the insured will face higher premiums, which is the bad news. But this is also good news in a way. Surging premium rates have attracted new capital to the insurance markets. This means insurers have underwriting capacity, and they need to put this capital to work.

Second, policyholders should explore new territory. For example, it might be a good move for a financially solid company to solicit quotes with ultrahigh retentions (deductibles) to reduce a sky-high premium quote. We are aware of one client that recently did exactly this: it purchased a $25-million primary policy with a $25million retention! This corporation will have to bear the first $25 million of covered losses before the insurer pays out dollar one. In essence, the insured corporation became the primary insurer and the nominal primary insurer became the de facto excess insurer. Because premiums for excess insurance are significantly lower than for primary insurance, the client's insurance tab was significantly reduced.

Third, policyholders should continue to negotiate policy terms. There is still give and take in the market. However, insureds should be sure to allow extra time for negotiations. This will allow enough time for the broker to find other insurers if negotiations with one insurer bog down.

Specific Negotiating Points

Some insurers are seeking to reintroduce co-insurance into their new policies, a provision they dropped during the soft markets of the late 1990s. What is co-insurance? It is a way for insurance companies to shift additional risk to policyholders and to get them invested in the effort to curb settlement and defense costs. In the event of a claim, a co-insurance provision obligates the insured to bear a portion of the loss, above and beyond your retention. For example, if the D&O policy provides for five percent co-insurance and there is a loss of $1million above the retention, the insured would pay $50,000 (in addition to the retention) and the insurer would pay $950,000. Without co-insurance, the insurer would pay the entire $1 million.

If an insured is offered a policy with co-insurance, it should not be accepted lying down. Most policies usually will not end up without this provision. Insurers usually will not say that co-insurance is the industry norm.

Another restriction some insurers are trying to reintroduce is the maintenance-of-insurance exclusion. A common version of this exclusion reads: "The insurer shall not be liable for payment for loss in connection with a claim based upon or arising out of the failure to effect and maintain insurance." What does this mean? It means that if the insured is sued by its shareholders for losses resulting from its negligence for failing to purchase a certain class of business insurance, the insurer can refuse to cover such losses in reliance on this exclusion.

To be sure, directors and officers can be held liable for losses resulting from their negligent failure to manage their companies. However, D&O insurance was created to insure such losses. Why exclude negligence related to the purchase of insurance but not negligence in the performance of other management duties? It makes no sense, and policyholders should say as much to any insurer seeking this exclusion.

The Tough Get Going

In our post-September11 world, the going is tough for buyers of D&O insurance - and it is likely to remain so into 2003. But while higher premiums are inevitable in this environment, overreaching exclusions and restrictions need not be. If policyholders give themselves time and are prepared to consider different policy structures, they will increase the odds of securing the coverage needed at a more affordable price.

For more information contact Stephen J. Weiss at 888-688-8500.

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The opinions expressed in this article are the author's alone, and do not necessarily represent the opinions of Holland & Knight LLP or its other attorneys. A similar version of this article was previously published in the Winter 2002 issue of Directors & Boards, http://www.directorsandboards.com/. It is republished here with permission.