Costly Litigation Continues to Put Pressure on D&O Market

Historically, litigation involving directors & officers used to be somewhat contained within the primary $10 million of the public space.

But over the past several years, the legal and regulatory environment has shifted significantly, leaving directors & officers of all kinds of entities in all kinds of industries exposed to costly and potentially devastating lawsuits.

“Claims frequency is at historically high levels,” says Kevin LaCroix, Esq., attorney and executive vice president at RT ProExec, a division of R-T specialty, LLC, and author of the D&O Diary. “Just as a ratio of number of lawsuits to number of companies, the chance of a U.S.-listed company getting hit with a securities class-action lawsuit is higher than it’s ever been.”

Merger-related litigation is the primary culprit—LaCroix says that today, if a merger transaction is announced, the company in question is almost guaranteed to face a D&O lawsuit. “Those are typically not high-stakes litigation, but they are costly to defend,” he points out. “That means they add to loss experience for D&O insurers.”

A series of Delaware state court rulings in 2017, which were resistant to disclosure-only settlements, were expected to create an unfavorable climate for plaintiffs. But “rather than reducing the number of merger objection claims being submitted, these claims are now being filed in other venues—federal courts or other state courts,” explains Paul Larson, senior vice president of financial institutions and management liability, E&O and cyber, CNA Financial Corporation.

In particular, “we’ve recently seen these claims being pursued post-closing of the transaction, which results in increased defense costs and more uncertainty around the ultimate value of the exposure,” Larson notes.

And even aside from merger objection litigation, today’s “litigation rates are still very much higher than traditional levels,” says LaCroix, who cites a number of factors driving those conditions: changes in the plaintiffs’ bar, the rise of litigation financing and more.

Sean Jordan, senior research analyst, International Risk Management Institute, points out, for example, a recent Gibson Dunn report which found that shareholder activism campaigns related to board composition outnumbered those related to M&As 62-44 in 2018.

“Shareholders are filing lawsuits if they perceive there’s a problem that stems from a lack of diversity on the board,” Jordan explains. “That could mean a lack of diversity in terms of demographics, or it could mean lack of diversity in terms of experience. If you’ve got all people that are from one particular industry and there’s a massive stock drop, shareholders may argue that could have been better handled if they had different expertise on the board.”

Or consider that last spring, the U.S. Supreme Court ruled in Cyan, Inc. v. Beaver County that the Securities Litigation Uniform Standards Act of 1998 does not strip state courts of their concurrent jurisdiction over class actions asserting violations of the Securities Act of 1933—and does not empower defendants to remove such suits to federal court.

“This ruling effectively lowered the hurdle for bringing such a claim, while making the road to dismissal higher,” Larson explains. “It also permits plaintiffs to bring multiple state cases simultaneously without needing to consolidate a class.”

The decision directly affects the cost of defending claims, Larson says, and has serious ramifications for companies making initial public offerings. “As a result, fewer markets are interested in insuring IPOs,” he explains. “For those markets pursing such coverage, more stringent terms and conditions as well as much higher premiums are imposed.”

In the public company space in particular, all of the above is finally starting to have an impact on D&O insurance rates. “Essentially what’s going on is an accumulative effect of years of price decreases around the same time claims portfolios have been deteriorating,” LaCroix explains. “Several of the largest insurers in the space are cutting capacity, increasing retentions and seeking higher rates.”

While that’s particularly true for certain kinds of buyers—IPO companies and those in industries like biotechnology, life sciences or pharmaceuticals—don’t let your private or nonprofit D&O clients think they’re immune.

“It’s most prominent in the public space, but it is also true to a more limited extent in the private space, particularly for larger companies or companies with significant private equity or outside investor ownership structure,” LaCroix says. “What that means is the typical buyer in this cycle needs to be prepared for the possibility that their overall insurance pricing is going to go up.”

Thanks to the current legal environment, if that doesn’t happen this year, it will probably happen soon. “If you look at securities settlement statistics, not only are the averages going up, but also the median amounts,” Jordan says. “These are just becoming more and more costly. And at the same time, plaintiff’s firms are getting more creative. You’re seeing smaller firms targeting smaller companies and becoming more willing to take on some of these emerging strategies for litigation.”

Put simply, “from the perspective of the insured companies, the chances of having a D&O lawsuit is higher,” LaCroix says. “That means the importance of D&O insurance as part of their overall insurance program increases as well.”

Jacquelyn Connelly is IA senior editor.