D&O Insurance Pricing May Be Inadequate

After aggressive increases helped firms recover from a decade of woeful rates, premiums are declining. The shift may be too much too soon. 

Person Holding Pen Pointing at Graph

Current pricing trends in the directors’ and officers’ insurance market could yield premiums that prove inadequate to cover potential claims, owing to growing risks for which senior corporate directors and officers are held responsible.

After a decade of woefully inadequate rates in the U.S. D&O insurance segment that led to consistently unprofitable underwriting results, aggressive pricing increases in 2020 and 2021 finally made inroads for D&O insurers and led to much-needed market stabilization. These pricing increases also attracted capital to the market from strong underwriters with new, creative approaches to public D&O underwriting. 

However, beginning in the second quarter of 2022, D&O premiums began to decline materially in most sectors, as did retentions, resulting in much more favorable pricing for insureds. (Insured retentions tend to decline as markets grow softer, as clients can shop around for coverage.) Direct premiums written declined by nearly 10% in 2022, due largely to the economic environment that made M&A and IPOs less attractive. Less M&A and IPO activity diminishes demand for public D&O coverage.

D&O pricing in 2023 continued the momentum from the prior year, and renewal pricing was essentially flat, on average, by the end of the year. This has offered a reprieve for risk managers and brokers, but with pricing changes sinking below economic inflation, fear began to rise that the pendulum may be swinging back to rate inadequacy. 

See also: The 'B' Word: Bankruptcy and D&O

Third-quarter 2023 results show an uncertain picture for the D&O line going forward. Premiums declined for a sixth straight quarter on demand shifts and pricing changes; AM Best’s estimate for 2023 is $12 billion, which would constitute an 11% drop from the previous year. The number of IPOs declined again, to 72 in 2023, the lowest since 2009 during The Great Recession. With results leveling out and demand for transactional liability coverage declining, average pricing on D&O accounts has since fallen dramatically.

At the same time, the direct calendar year loss ratio for the line has also fallen, reflecting the realized benefit of the substantial up-pricing of renewals and new business from 2020 through early 2022. The direct loss ratio of 51.5 through third-quarter 2023 is on track to be the lowest in nine years, improving the industry’s underwriting performance. If results continue to be favorable and prior accident-year reserve development does not trend adversely, additional capacity may flow into the D&O market. That loss ratio does not factor in the potential impact that adverse loss reserve development could have on the net, bottom-line results for D&O insurers. With more lawsuits being settled or adjudicated as courts fully open following pandemic-driven closures and delays, the true profitability of policies underwritten is still maturing -- prior accident years 2017-2020 remain unknown.

AM Best is assigning a negative outlook to the D&O liability insurance market segment for 2024. Prior to this year, the D&O market outlook was captured under the professional liability catch-all, even as D&O represented the dominant line. That outlook was revised in 2020 to negative, so the new outlook on the D&O segment for 2024 is not a deviation from the previous few years.

An increase in players in the D&O market is a factor in the outlook, as the influx brings additional capacity and declined pricing amid growing exposures. Also included in the negative D&O outlook are expanded liability risks, as the business environment has become increasingly more complex and connected. Cyber and data breaches are becoming ever more pervasive in all different business sectors, particularly for businesses that rely on personal data. At the same time, new data protection laws and related disclosure requirements have added to the minefield senior executives must navigate to protect against potential litigation. The rise of generative artificial intelligence (AI) opens a whole new avenue for the plaintiffs’ bar, as well. Depending on how companies integrate AI into their decision-making process, corporate directors and officers could be accused of algorithmic biases in risk selection or underwriting decisions.

Inflation over the past 18 months, as well as interest rate increases to fight inflation and market volatility, have created negative pressure for stock prices and funding for privately held companies, which could result in shareholder and derivative actions. The bank failures of last year also have led to intense scrutiny of banks’ executive leadership and boards of directors. 

The rising cost of litigation owing to societal trends, such as broad interpretations of liability contracts, legal advertising and more plaintiff-friendly juries continues to drive increases in loss frequency and severity, and large, public-facing companies are particularly vulnerable. Litigation financing has been used for a range of lawsuits, including complex multidistrict and class-action litigation, in which D&O liability cases can specifically come into play. Third-party funders provide financial help in exchange for an interest in any recovery, and the financing can be offered to law firms that are unwilling or unable to fund a potentially protracted case or to help underfunded claimants directly. For D&O insurers, litigation funding pressures claims costs by driving up the magnitude of awards and settlements.

See also: Insuring Risks Amid AI's Constant Evolution

As the costs of litigation continue to rise, companies are becoming more likely to explore settlement opportunities even when the facts may be on their side. According to Woodruff Sawyer, settlement dollars during the first half of 2023 were up slightly more than 29% year over year, with settlements over $20 million up about 33% from the same period in 2022. These trends are apparent in underwriting results near year-end 2023.

If interest rates remain high and inflation persists, access to credit markets will become increasingly difficult, as companies struggle to balance the need for profits with prudent debt management. D&O insurers will need to better assess and adequately price for the ever-changing risk exposures while effectively focusing on evolving regulatory requirements.

David Blades

Profile picture for user DavidBlades

David Blades

David Blades is an associate director within the Credit Rating Criteria, Research & Analytics Department of AM Best, a global credit rating agency with a unique focus on the insurance industry.

Read More