In December, Cardinal Health Inc. got all its ducks lined up in a row before sitting down with the insurers of its directors and officers liability program. "We provide access to all publicly disclosed financial records, including our balance sheet and any litigation against us, to obtain the best pricing, terms and conditions," confides Linda Harty, executive vice president and treasurer of the $87 billion global manufacturer and distributor of medical supplies. "Not only did we get the same terms and conditions as the expiring D&O policy, we were able to renew the program at a lower price."
Dublin, Ohio-based Cardinal Health's experience shows what it takes for companies to achieve a good deal as current D&O policies expire. Rattled by a substantial hike in the number of securities class action lawsuits against corporate officers and directors, the D&O market is beginning to tighten. Financial services firms are in the worst position because most D&O litigation is aimed their way. There were 210 federal securities class actions filed in 2008, a 19% increase from 2007, and half of them--103 lawsuits--involved financial services companies, according to Stanford Law School and Cornerstone Research.
The potential cost of this litigation is staggering. Only three class actions against financial firms have been settled to date, but the largest settlement, involving Merrill Lynch, cost a reported $475 million. In response, D&O insurers are battening down the hatches and increasing prices by triple-digit percentages for financial firms deemed a risky bet. For all other industry sectors, pricing remains stable at present. Still, risk managers are waiting anxiously for the other shoe to drop.
"As more claims emerge, more settlements are reached, and more insured losses are tabulated, it will become much more difficult to purchase D&O insurance at current pricing, terms and conditions," says Janice Ochenkowski, director of risk management at Jones Lang LaSalle, a Chicago-based commercial real estate company.
Other risk managers say the writing is on the wall for bad times ahead. "It doesn't make any difference when the settlements are reached; the impact is already evident," says Wayne Salen, director of risk management at Labor Finders International Inc., a West Palm Beach, Fla.-based temporary staffing firm with $500,000 in annual revenue. "The number of cases filed is astounding and will only increase exponentially. The insurance capacity for D&O is already straining, with traditional D&O insurers like AIG and XL Insurance confronting ratings downgrades and solvency concerns. Any risk manager not thinking about a significant impact come [policy] renewal is in for a surprise."
In preparation, companies should follow Cardinal Health's lead and get those proverbial ducks lined up. As businesses renew policies, insurance brokers suggest creating a D&O checklist and advise companies not to wait until the last minute. "You want to start the policy renewal process early so you have plenty of time to fully evaluate and execute your renewal strategy," explains Lou Ann Layton, a managing director at New York-based broker Marsh.
Layton further counsels companies to understand how D&O underwriters will view their risk. "You want to be prepared to proactively address the underwriter's concerns in a meeting between the underwriter and someone from your senior management team," she says. All financial documents relating to the company's credit strength, debt obligations, liquidity and current litigation should be there at the ready for underwriters' perusal, she adds.
Salen strictly follows this advice in his meetings with insurers. "I've been a risk manager for 32 years, so I've been through a few insurance cycles," he says. "When the market begins to tighten, it's time to present your risk profile in the best light possible to underwriters and the insurers' credit team. You know your risks better than the carriers do."
Labor Finders' CEO is on tap to present the company's financial documents to D&O insurers, Salen says. "He's a CPA and is a great presenter from the standpoint of the strength of the balance sheet."
Other risk managers pursue similar paths. To prepare for Bank of New York Mellon's annual D&O policy renewal, Carmelo Casella, vice president of corporate insurance, arms himself with the financial institution's analyst presentation. "We call in the analysts once a year and do this huge 'dog and pony show,' where we go through all our financials," Casella explains. "It says more about who we are and our strategy and risks than I could ever provide myself."
"My philosophy is to give underwriters anything that has been publicly disclosed," he adds. The strategy has paid dividends. "Our renewal was pretty good," he says. "We got in flat."
There is more to D&O insurance than getting a good deal, however. Layton advises companies to review their limits of financial protection, "in light of current litigation and regulatory trends, macroeconomic conditions, and any specific exposures to your company and industry. Also evaluate the credit quality of your insurers and the diversification of counterparty credit risk in your program structure."
The latter is a reminder of the solvency concerns circling around insurers like AIG, whose hopes of selling some assets to repay the federal government's $170 billion loan evaporated in late February. The once grand insurer subsequently asked the government for even more money, a prospect that does not sit well with risk managers. "We're scrambling," says Salen. "I'm vetting the full marketplace so we can seriously look at replacing AIG in our D&O and other programs."
Other risk managers are juggling the financial limits provided by insurers in their D&O program and where insurers "play" in the program, from primary layers to more catastrophic loss layers. "By diversifying the number and range of insurers in the D&O policy, the risk of loss from a carrier's insolvency is spread more widely," Layton says.
If AIG or another D&O insurance provider does go under, diminishing the insurance capacity available to absorb D&O risks, Cardinal Health's Harty says it doesn't spell doom. "New entrants in the insurance market often emerge when a market suffers," she says. "It's an opportunistic time to offer better pricing, terms and conditions than the rest of the market. The challenge then become balancing the risk of an unknown entity against a tried and true insurer."
Check that one off the list.