Is the D&O market finally moving in the right direction?

The directors and officers (D&O) market has endured a tough time recently. Despite rising regulatory requirements, increased enforcement and widespread claims inflation stemming from a series of adverse legal rulings in the US, the market has been unable to secure the rates needed as capacity has remained abundant.

But over the past year or so, there have been signs that the market is finally drawing a line under the downward pressure, and with new capacity coming in and demand spiking via various trends from the initial public offering (IPO) boom to increasing litigation, the D&O market is set for a comeback.

The question now is not whether prices will rise, but whether the upward trend will be sustainable.

Leading figures from the sector came to the Re/insurance Lounge, sister publication Intelligent Insurer’s online, on-demand platform for interviews with industry leaders, to discuss the market’s development and where it goes from here.

One aspect of the market prompts broad agreement: namely that there has been a dislocation of sorts in the D&O sector over the last few years. Low prices and a spate of high-value claims have prompted some carriers to pull back from the segment entirely, leaving gaps in supply just as demand for coverage have begun to surge.

That dynamic stemmed from chronically low rates, and Paul Shore, chief executive officer of D&O specialist underwriting agency Tegron, thought that allowed space for new players to enter the industry.

“The last few years have created quite a dislocation. It’s well known that there’s been a long cycle for D&O over the last seven years (probably from 2011 to 2018) when it was seriously underpriced—and that has caught some insurers out.

“Despite the attraction of new suppliers, demand stayed the same. The supply gaps just created an opportunity —a sharp increase in rates, a little tightening of terms, some correction on climate tensions and deductibles. But as the traditional market stepped back, it has created an opening for new insurers to come in and fill the void,” he said.

Litigation on the rise

Sridhar Manyem, director of industry research for AM Best, agreed with Shore’s assessment. He said that the market was undergoing a “correction” of sorts, given the increased litigation which companies have faced from both court rulings and a series of social movements ranging from the fight for diversity in boardrooms to environmental, social and corporate governance (ESG) concerns.

He highlighted macro-economic pressures such as low interest rates and the overall losses from the COVID-19 pandemic as other factors which had combined to push up pricing over the short term.

“A sense of the past has come to roost in terms of lawsuits—especially the key decision in March 2018, where the US Supreme Court ruled in Cyan v Beaver County Employees Retirement Fund. As a result, state courts were given the jurisdiction to hear lawsuits concurrently with federal cases.

“If you listen to any kind of commentary about casualty insurance, you’re going to hear about social inflation. Black Lives Matter and ESG movements have all caused an increasingly litigious environment, which has contributed to a hard market.

“COVID-19 actually created a lot of capital depletion, while lower interest rates, combined with the soft market as combined with these hard market conditions has caused a wave of new entrants into the market. A correction is happening right now,” Manyem added.

David Ritchie, managing director of management liability at Gallagher, noted that the phenomenon is purely down to supply and demand dynamics, with the surge in US IPOs creating increased need for coverage in the first half of the year.

However, he added, this had tapered off somewhat, and with higher-quality companies coming to market when they did, the level of demand has dropped in the second half of 2021.

“From my perspective, it’s purely a demand and supply issue. D&O went through the roof in the early part of this year, and we had a buoyant US stock market, with lots of IPOs needing insurance.

“That was at a time when the D&O market (particularly in London) was under considerable stress, and you had a huge dislocation between demand and supply that created acute pricing points. It had been going on for four years, but the last 12 months have been painful for the market,” Ritchie explained.

“Now the demand/supply balance has shifted in the client’s favour, with more supply brought in by good new entrants. Some froth is also being taken out of the IPO market. That means you’re getting better-quality companies coming to the US market, which has reduced demand.”

Long-term factors

Ritchie added that carriers shouldn’t point to increasing claims values and legal costs as the main drivers of higher pricing in the market, given the long-term horizons under which D&O coverage typically operates.

“On the point of social inflation, from the D&O perspective, it is very long-term, with a tail of seven years or more. Insurers shouldn’t hide behind that because it leads to rising market capitalisations, which create a severity issue in D&O.

“There is also real inflation in the US lawyers’ market—and lawyers do charge a lot of money for their services. To say that the insurers didn’t see that coming is a bit naïve,” he added.

Yoel Brightman, chief executive officer of D&O underwriting startup Rising Edge, said that while growth in premiums may remain broadly flat in the coming years, return on capital was likely to be more sustainable for carriers in the market.

“There’s likely to be a big growth in terms of return on capital, rather than growth relating to written premiums, and that’s probably sustainable—certainly for the next year or two, at least.

“That’s good to see, because for the last 10 years or so it has been suffering from a lack of returns.”

To view the full Re/insurance Lounge session click here