New D & O Trends Impact on the U.S. and Abroad

By Denise Johnson | June 17, 2014

Directors & officers claims are increasing here and in other parts of the globe, according to insurance industry experts. Claims centered on merger acquisition, health care service vendor operations and cyber breaches will be the new norm.

Eric Boyum, senior vice president and executive liability broker at Aon, said that while D & O activity in the last decade focused on securities class actions, the rate has been flat for the last decade or so.

“We’re usually coming in somewhere between maybe 110 and 125 claims a year. There was an exception, right after the economic bump we saw in ’07 ’08, and most of those claims came in by 2010, but since then we’ve really been bumping along at that consistent rate,” Boyum said.

Even though security class action claims have been fairly constant over the past decade, the number of public companies, at least until last year, decreased each year.

“While the number of securities class actions was remaining fairly constant, the number of public companies was actually decreasing,” Boyum said. “If we look at the number of securities claims per the amount of public companies, there’s actually a higher chance that any one particular company could get hit with a lawsuit because those numbers were holding up, even while the number of public companies was decreasing.”

The most significant trend from a D&O claim perspective is the increase in merger objection suits where a company wants to purchase a public company but at a price above the current price per share.

“We found that if you look at mergers or acquisitions with consideration of greater than $500 million or more say, the market cap of the target company is at least $500 million there’s about a 96 percent chance that they’re going to get that merger objection claim. The plaintiffs are going to allege, ‘Hey, you’re not paying enough for it. You didn’t go through the process right. The process benefits the insiders more than it benefits the shareholders,’” said Boyum.

He said the suits are frustrating because companies will pay to make the suit go away.

“In a vast majority of cases, greater than 85 percent, after those lawsuits are all settled and done, there was no additional consideration or additional money paid for that acquisition. You end up with, basically, a nuisance suit that costs you a couple million bucks to defend and pay the plaintiffs to go away,” the Aon executive said.

Though mergers and acquisitions generated the largest number of claims, they are not nearly as expensive as securities class actions, Boyum said.

“You look at a securities class action, and the median settlement of something like that is seven million or eight million bucks median, not average, the median. The median settlement amount, including defense costs, for these merger objection cases are typically between one and two million,” he said.

A D&O insurer that is the primary carrier will be more concerned about merger objection cases because if there is a million dollar retention, there’s a good chance the primary insurer will pay to make a case go away.

As a result, he said excess pricing continues to be competitive.

“The carrier on the bottom is saying, ‘There’s a much greater chance I’m going to see a claim and have to pay out than that guy above me, I’m going to push up my primary rates, but I don’t necessarily need to do that on my excess rates,’” said Boyum.

Some insurers have added retentions or deductibles specifically addressing merger objection suits.

“If there’s any claim that arises out of anything to do with a merger acquisition, it has a separate retention applicable to it, and typically, it’s high,” said Boyum.

Typically, the retention could be $1.5 million and $2 million.

Health care companies are a relatively new target for D & O claims, the senior vice president said.

“Some of that is being driven by the increased activity due to Obamacare,” said Boyum. “It’s not necessarily the hospitals or the insurers, but others that are involved in the process, either in provisioning the availability of services or actually being involved in the payment process for those services.”

Retail data breaches are sparking D & O claims too.

“Certainly, Target is the most public of those, but there are a couple of examples now where we’ve seen data breaches and cybersecurity issues move from being just the E&O for that company to being a D&O claim for the board,” Boyum said. “That is something we think will probably continue to grow.”

He noted that companies outline risk factors in their annual filings with the Security and Exchange Commission, known as 10 Ks.

He said his firm looked at the 10 Ks of 32 retail companies, big public companies, and how they addressed the issues of privacy information, cybersecurity and breaches. Of the 32, 29 had it listed as a top 20 risk factor.

“In fact, if we pick up just anybody who’s holding data, which is just about anybody these days, and that risk factor is not in their 10 K, we point that out to them,” he said. “We had a client that we pointed out to this year in the retail sector that it wasn’t there. Two months later it was there, so we think that’s a very significant area of exposure for boards.”

He said the claims will be dependent on the magnitude of the breach.

“That’s going to be what we call a ‘breach of fiduciary duty claim.’ There will probably be some disclosure or 10b 5 allegations, which are your classic securities class action things. The first D&O claims that came out were breach of fiduciary duty. You’ve breached your duty of care…to that company when you allowed all that information out. Now nobody else trusts you and you’ll never recover from that,” Boyum said.

He said there’s no way a D&O underwriter can possibly ask all the right questions, based on their area of expertise, to determine whether a company has exposure in this area.

D & O Claims Abroad

According to Boyum, the number of securities class actions in the U.S. is about 120. In the last 10 years, Canada hasn’t had that many.

“What really drives D&O insurers books is the U.S. based exposure. Sometimes, you see a company will be dually listed both in Toronto and the U.S. for example on the U.S. Stock Exchange, and you’ll see securities claims in both jurisdictions. For the most part, the U.S. is far and away the most litigious,” Boyum said.

He said the next closest countries are Australia and Canada. Germany is starting to see more D & O claims; likewise in countries with growing economies, like China and India.

Boyum said that D & O claims differ internationally, particularly in the less developed parts.

“The claims that you see from the D&O perspective, we always think about civil liability. They’re a lawsuit that’s intended to get money,” he said. “Most of the D&O cases on an international bases are criminal, meaning that they’re actually alleging that you didn’t just cause someone damage, but you’re actually committing a crime, and that tends to be more what those D&O claims are about.”

According to a white paper released by Advisen on the state of the European D&O market, concern over increased exposure has led companies to purchase higher limits or restructure current D&O insurance to provide broader coverage. Companies reported that “regulatory actions and employment-related suits are the most significant sources of increased D&O claims.” The report noted that bankruptcy is a major D&O exposure across Europe and that privacy and network security suits are a concern, as well.

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