A very difficult D&O market after 2020 and COVID-19 brought financial stress and fueled the hard market flames already burning from a huge increase in Securities Class Actions (SCAs). To review, 2019 was a firming market with consistent price increases starting at a 3% average and finishing at 30%, followed by average D&O premium increases approaching 50% in 2020.
While 2021 is projected to be another year of increases, those increases are expected to be smaller. Before COVID-19 shut down the economy, the market was firm instead of hard, because capacity was still available for the most part, and terms and conditions were unchanged. However, the second quarter of 2020 easily earned the hard market designation, as every aspect of D&O placements was impacted, including premium, retention, capacity, excess attachment decisions and even terms and conditions.
Perhaps the most interesting aspect of the 2020 D&O hard market was the evolution of underwriting by class of business, referred to as the hard market expansion. Clearly, the difference between pricing for the lowest 20% (or most difficult accounts) and the highest 20% (or best accounts) has gone from being nearly imperceptible in 2018 (approximately plus or minus 5%) to being dramatically different by 100 plus percentage points in 2020.
At the end of the day, a company’s specific risk profile will remain the most important variable dictating renewal outcomes and risk management planning. Therefore, risk managers should expect loss experience, industry, location, financial health, communication style and other individual nuances to continue to have a significant impact.
There are at least four key D&O market disruptors. First is the lack of competition, especially at primary, as carriers universally agree on the need for more rate. Two more key factors are the increase in D&O claim frequency, as well as anticipated large carrier payments on open claims from the last five years. Finally, the fight for capacity remains real despite new market entrants as carriers cut limits on renewal programs yet deploy capacity for the many new IPOs coming on the market. Knowing how to navigate such market disruption can help create more confidence in your risk management program and strengthen renewal planning for 2021 and beyond.
D&O Pricing Creates the Most Boring Pie Chart
According to several leading D&O carriers, no public company D&O renewals went out the door in 2020 with a decrease; even flat renewals were nonexistent. This makes for a pretty boring pie chart. However, the private company D&O market fared much better, with small- and medium-sized private companies typically receiving small increases with an occasional nominal decreases or flat renewals. Notably, large private companies regularly faced huge percentage increases, often due to changes in minimum pricing parameters. Expect 2021 to be full of increases in premium as well—just not as much as 2020.
Federal SCA Frequency Doubling Historical Levels
D&O carriers generally point to adverse frequency trends like federal filings as the single most important driving force in carrier costs. The fear of increasing severity and a historically high backlog of large unresolved cases adds deep concern to a world averaging almost 400 SCAs (including 1933 Act state actions) per year. Although the COVID-19 pandemic has negatively impacted the overall insurance marketplace, it may also be responsible for slowing down the pace of D&O claims frequency in 2020, as federal SCA filings dropped by almost 20% from 402 to 322, according to Stanford SCA Filings. Frequency of securities claims will remain high, but COVID-19 may also continue to depress them somewhat. We may not reach 400 SCAs in 2021, but it will likely be close.
Spike in SPAC IPOs
Despite the challenges of the COVID-19 pandemic, 2020 was an excellent year for raising capital through stock offerings. However, the spike in special purpose acquisition companies (SPACs) IPOs drove a record-breaking year for total IPOs. Sometimes referred to as a reverse merger or blank-check strategy, SPACs are formed to raise money through an IPO, find a target company to purchase, make the acquisition and register the newly combined companies as a publicly traded corporation.
Since the target company has effectively gone from privately owned to publicly traded, this is also an alternative to the traditional IPO approach. In 2020, there were more SPAC IPOs than ever, and combining SPAC IPOs with traditional IPOs produces a total IPO count unsurpassed in recent years. If the IPO D&O insurance market is tough, then the D&O insurance market for SPAC IPOs has become equally problematic. SPAC D&O premiums have more than doubled recently, and retentions have increased even more dramatically. It is unclear whether the change in average financial condition of the SPAC targets will impact future success, but underwriters are cautious. Regardless, SPAC-related claims activity has risen along with their greater popularity. Some carriers are even predicting that there could be 1,000 newly formed public companies in 2021—all needing D&O insurance, and thus adding to the demand for D&O limits capacity. This is a subtle factor that could sustain this difficult D&O market.
Beating the Averages
The first piece of good news is that 2021 D&O premium increases are muted compared to 2020 and will hopefully stay subdued due to carrier loss ratio improvements driven by a dip in frequency, client win rates at record levels, and the huge premiums collected in 2020. But regardless of the increases, determined clients can renew below the averages if they start early and play smart. Quotes are being delayed due to massive marketing, so the early start must be combined with knowing the best markets for every sector and focusing on them. Rejuvenated carriers already on your program will fight new capacity for desirable excess layers. New market entrants have begun writing excess D&O at competitive rates. Communicate your process early and often to internal stakeholders and give time for strategic external relationships to play out favorably.
When it is time for the underwriting meeting, offer innovations to avoid carrier meeting fatigue and be sure to showcase positive risk factors while leveraging ancillary lines. And do not be afraid to consider restructuring with more Side-A, co-insurance or limited use of a captive.
Adding Risk Management
The past 18 months have shown that the risk manager role has expanded, become more sophisticated and more demanding. Increased scrutiny on corporate governance and event-based D&O claims both point to a broader need for insurance protection, but it equally suggests that companies must evolve and expand to create a culture of risk management across their enterprise. Internally, this means every employee should be more aware and able to adapt and take action. Externally, this means risk managers should bring outside brokers, carriers and legal teams in when analyzing risk and making decisions about their people and property and protecting their bottom line.