STATE OF THE EUROPEAN D&O INSURANCE MARKET. Increasing Claims Do Not Dampen Insurers Enthusiasm. Spring Sponsored by:

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1 STATE OF THE EUROPEAN D&O INSURANCE MARKET Increasing Claims Do Not Dampen Insurers Enthusiasm Spring 2012 Sponsored by:

2 STATE OF THE EUROPEAN D&O INSURANCE MARKET Increasing Claims Do Not Dampen Insurers Enthusiasm Executive summary European directors and officers are increasingly exposed to investigations, regulatory enforcement actions and lawsuits, sparking demand for Directors and Officers Liability (D&O) Insurance. In an overall shrinking commercial insurance marketplace, D&O is one of the few lines of business to be growing a key reason more insurers are entering the D&O market. As a result, competition is pushing pricing down, even as claims increase. This scenario is setting the stage for a market correction, though most likely not in Once considered principally a concern of US senior executives, directors and officers of European organizations have found that they are now more exposed than ever to regulatory scrutiny and litigation. Introduction Once considered principally a concern of US senior executives, directors and officers of European organizations have found that they are now more exposed than ever to regulatory scrutiny and litigation. As a result Directors and Officers Liability Insurance (D&O) is increasingly viewed as essential insurance protection for public company decision makers, and it is rapidly gaining traction in the private sector. For many directors, adequate D&O protection is a prerequisite for serving on a board. A sea change in the exposures of directors and officers of European companies is largely attributable to far-reaching transformations in the legal and regulatory environments. A number of European countries have adopted forms of collective redress somewhat similar to the US class action system that have led to increased shareholder litigation against corporate executives and board members. At the same time, governments have responded to the corporate accounting fraud scandals of the first half of the 2000s and financial crisis and recession of the second half with heightened regulatory scrutiny and stronger enforcement initiatives. These, in addition to the higher number of business insolvencies as a result of the financial crisis, have transformed the D&O claims landscape and have sparked demand for insurance coverage. 2 Spring 2012 Advisen Ltd. Sponsored by:

3 Over the past decade, the number of corporate disasters as a result of perceived or actual negligence by corporate leadership rose dramatically. Claim frequency and severity have increased, but D&O rate levels have fallen. In a market where many lines of insurance have seen a decline in written premium due to falling rates and fewer exposure units an outcome of the recession, during which many businesses scaled back or closed their doors altogether the take-up rate on D&O continues to increase, making the line attractive to growth-oriented insurers. And though losses are growing, many segments of the D&O market are perceived as profitable. As a result, new players are staking a claim in the market and existing players are seeking to grow market share. The situation is not sustainable, however the combination of falling premiums and escalating claims make it inevitable that a market correction is on the horizon. Drivers of D&O Growth The growth of D&O insurance in the European market is directly correlated with the perception that the individuals making corporate decisions are under increased scrutiny by regulators, shareholders and other stakeholders; that European culture is growing more litigious; and that the economic environment makes it yet more likely that directors and officers will be targeted in investigations and lawsuits. Within the SME sector, concern about employmentrelated legal actions also is prompting companies to purchase insurance protection. Increased transparency and accountability Over the past decade, the number of corporate disasters as a result of perceived or actual negligence by corporate leadership rose dramatically. These disasters led the EU and its member states to pass corporate governance reforms which have resulted in greater transparency and in some cases heightened accountability for directors and officers. This in turn has led to increased interest in D&O protection. For example, since the implementation of the Companies Act 2006, which codified directors common law duties, there has been a significant increase in take up of D&O insurance in the UK. 1 More recently changes to the Commercial Code in Turkey, an EU candidate, further clarified the potential liabilities of directors and officers, leading to an increase in demand for insurance protection. 2 Shareholder suits Simultaneous with the passage of corporate governance legislation in a number of countries, the forums for legal battles in several European nations became more plaintiff-friendly. While none of the European legal systems are as favorable to plaintiffs as the US system, a 3 Spring 2012 Advisen Ltd. Sponsored by:

4 number of countries now provide mechanisms through which disgruntled shareholders can collectively bring suits against companies and their directors and officers. Additionally, litigation funding schemes in a number of jurisdictions help to overcome a serious obstacle to shareholders bringing suit the cost of complex and protracted litigation. The US traditionally was perceived as the capitol of class action litigation by overseas plaintiffs attempting to sue the leadership of publicly traded companies. In the past, US Federal courts had few issues with applying US securities fraud laws to claims coming from outside the United States, and overseas plaintiffs were keen to take advantage of the efficiency and The Converium Case Common shares of Converium Holding AG, a Swiss reinsurer, were listed on the SWX Swiss Exchange. Converium s American Depository Shares were listed on the New York Stock Exchange. After Converium announced an increase in reserves, the market price of Converium s shares declined. Investors brought a class action alleging Converium and its officers and directors had earlier misrepresented the sufficiency of the company s loss reserves and therefore gave the false impression that the company was in a better financial situation that it really was. Preceding the Supreme Court s decision in Morrison, the district court excluded the claims of most foreign investors because the alleged fraud was masterminded and implemented in Switzerland, not the US. What remained of the US securities class action was then settled. The non-us purchasers represented by Dutch representatives entered into a settlement agreement with Converium. Citing the Dutch Act, the non-us purchasers filed a petition with the Amsterdam Court of Appeal requesting that the settlement agreements be declared binding on non-us purchasers. Because a small percentage of claimants resided in the Netherlands, the Amsterdam Court of Appeal ruled in January of this year, that the Dutch Act was an appropriate mechanism for settling the claims and issued a ruling that the settlement is binding. This decision illustrates that the Dutch Act provides a viable class action settlement mechanism for complex multi-jurisdictional securities class actions and now, at least in principle, all EU member states will have to recognize the Amsterdam court s ruling as binding. 24 sophistication of the US legal system. This changed dramatically in 2010 due to the US Supreme Court decision in Morrison et al v National Australia Bank Ltd et al. In this case the court held that US law against securities fraud does not apply to investment deals that occur outside the country, even if they have domestic impact. Consequently, plaintiffs now are more likely to file lawsuits in their local jurisdictions as opposed to bringing the cases to the US court system as they did in the past. 3 The Morrison decision has not yet resulted in an avalanche of suits being filed in European courts. Despite more liberal legal systems, many European countries still make it comparatively difficult and expensive to pursue shareholder litigation. One country, however, is emerging as a likely alternative venue to the US for shareholder litigation, as was highlighted by a recent settlement of a suit involving shares in Zurich Financial Services subsidiary Converium Holding. In this case the Amsterdam Court of Appeal held for the first time that a collective securities settlement is legally binding. This settlement is now paving the way for the Netherlands to become an alternative venue for aggrieved shareholders to obtain compensation for shares bought outside of the US. It also provides a practical way for structuring global securities class action suits through the use of the Dutch statute in combination with US proceedings, especially in cases that involve significant European investors. 4 4 Spring 2012 Advisen Ltd. Sponsored by:

5 Companies across Europe are under greater regulatory scrutiny, and more likely to be subject to enforcement actions, than in any time in recent history. Suits against directors by their own companies In some European countries with Germany being the most notable example suits against directors by their own companies are more common than suits brought by shareholders. Speaking at a D&O conference in Düsseldorf, Oliver Sieg, from the law office Noerr LLP, observed that There is no country in Europe where companies battle so often and for such high sums with their managers than Germany. 5 These cases often are a product of Germany s two-tier board system a Management Board, which is responsible for managing the company, and a Supervisory Board that oversees and appoints the members of the Management Board. When Managing Directors breach their duty, resulting in a financial loss to the company, the Supervisory Directors are obligated to sue the managing directors responsible for incurring such loss. 6 Elsewhere in Europe, derivative actions where shareholders sue directors or officers on behalf of the company are common, and in some jurisdictions they are the only form of redress permitted to shareholders. The UK Companies Act 2006 broadened the circumstances in which derivative actions can be brought in that country. Regulatory enforcement Companies across Europe are under greater regulatory scrutiny, and more likely to be subject to enforcement actions, than in any time in recent history. Regulatory oversight and enforcement actions increased in the wake of major accounting scandals such as Enron in the U.S. and Parmalat in Europe. More recently, in response to the financial crisis, governments have increased their regulatory capabilities and invested in more robust and comprehensive enforcement, especially in the financial sector. Directors also may face exposure in a variety of areas including health and safety, pollution and the environment, competition and cartel activity, resulting in attention from numerous regulators with divergent agenda. In the UK, for example, regulators including the Financial Services Authority (FSA), the Office of Fair Trading (OFT) and the Health and Safety Executive (HSE) are increasingly focused on the conduct of top management. 7 Recent legislation such as the Environmental Liability Directive and the Corporate Manslaughter Act may put further pressure on UK directors and officers. Directors and officers of multinational companies are further exposed to investigations and regulatory actions coordinated across national borders by regulators in Europe, the US and elsewhere. 5 Spring 2012 Advisen Ltd. Sponsored by:

6 Of growing concern to directors and officers are allegations of violations of anti-bribery laws such as the US Foreign Corrupt Practices Act (FCPA) and the UK Bribery Act. Regulatory investigations and enquiries were identified as the risk that posed the greatest concern to their directors by 84 percent of respondents in a survey conducted by Allen & Overy and Willis. 8 Criminal actions Most countries have laws under which individuals can be charged for criminal activity for their actions as corporate directors or officers, with some countries such as Germany being especially inclined to use the threat of criminal liability to motivate director behavior. A report by Deloitte prepared for the UK Office of Fair Trading found that criminal penalties was first on the list of factors that motivate directors to comply with competition rules. 9 Of growing concern to directors and officers are allegations of violations of anti-bribery laws such as the US Foreign Corrupt Practices Act (FCPA) and the UK Bribery Act. Governments are increasingly prosecuting individuals, not just corporations, for violations of such laws. Since 2007, the number of individuals charged with FCPA violations has increased by 175 percent and the number of corporations charged has increased by 75 percent during the same time period. 10 In 2010 alone there were 74 FCPA actions brought by the Department of Justice (DOJ) or the Securities and Exchange Commission (SEC), compared to an average of 23 each of the previous six years. 11 The UK also has recently enacted the Bribery Act creating additional concern for directors and officers. This legislation is much broader than the FCPA as it also applies to private companies and personnel. In a recent example involving the FCPA, on December 13, 2011 US authorities brought charges against a group of former executives of German engineering company Siemans AG and its Argentine subsidiary for violating the act. These new charges come over three years after Siemens was charged and resolved with the DOJ and SEC for $800 million, constituting the largest FCPA penalty ever imposed. Bankruptcy-driven claims Insolvency already is a major D&O exposure across all Europe, 12 and the possible slide into another recession in concert with contagion fears as result of the sovereign debt crisis raises fears of a surge in corporate bankruptcies. This likely would result in an increase D&O claims, principally brought by bankruptcy trustees. It is the liquidator s responsibility to maximize insolvency proceeds, and they have the power to bring claims against the directors and officers for mismanagement, misrepresentation, fraud, or for allegations of directors conduct- 6 Spring 2012 Advisen Ltd. Sponsored by:

7 The D&O market is frequently discussed as if it is a self-contained insurance ecosystem, but its behavior is often driven by its relationship to the broader non-life insurance market. ing business for their personal profit rather than in the best interest of the Company and its shareholders. Outside the U.S., about 80 percent of lawsuits against directors and officers of companies in bankruptcy are brought by trustees on behalf of creditors. 13 Employee suits Suits by employees against a company and its directors and officers are the most significant source of D&O claims involving SMEs. 14 Employees have the right to bring claims against directors and officers as well as the company itself for employment-related wrongful acts such as harassment, discrimination, wrongful deprivation of career opportunities, wrongful dismissal and retaliation. The D&O Market D&O and the market cycle The D&O market is frequently discussed as if it is a self-contained insurance ecosystem, but its behavior is often driven by its relationship to the broader non-life insurance market. For the most part, the D&O line is supported by the same capital base as other commercial lines, and therefore is subject to the same ebb and flow of capital and the same overall market cycle. For the past several years the broader market has been mired in the soft phase of the cycle. The market has been overcapitalized, meaning that the supply of insurance capacity exceeds the demand for that capacity, which puts downward pressure on prices. Not even the record-breaking catastrophes of 2011 estimated to be $116 billion by Swiss Re 15 were sufficient to destroy enough of the excess capacity to move the overall market out of the soft phase of the cycle, though there are some signs of firming. Not every segment of the market always moves in unison with the overall market trend. Insurers allocate capital according to where the greatest profit potential exists at any point in time, and may elect to cut back in, or altogether discontinue their participation in, unprofitable segments. Such was the case for financial institution (FI) D&O in This sort of sectorspecific hardening, however, tends to be comparatively short lived. Rising rates attracts capital back into the segment, and the factors causing claims to rise often are temporary. FI D&O rates, for example, have fallen substantially from their highs in the immediate wake of the credit crisis. 7 Spring 2012 Advisen Ltd. Sponsored by:

8 Within the D&O market, conditions vary somewhat among the large public company, SME and FI segments. The appeal of D&O D&O is perceived by many insurers as attractive as compared to other commercial lines of insurance, despite heightened exposures and increased claims activity. The European market continues to grow estimated by Advisen to be 1.74 billion, up from 1.37 in 2008 and it is perceived as still profitable. As a result, the D&O market continues to attract new participants. This influx of new capacity continues to put downward pressure on premiums. Marsh reports D&O pricing falling 0-10 percent in Q in most European countries. 16 Within the D&O market, conditions vary somewhat among the large public company, SME and FI segments. Reinsurance broker Guy Carpenter characterizes the private company D&O market as fiercely competitive with the continual expansion in the number of insurance carriers, and the public company market as also competitive but to a lesser degree. 17 Underwriters are understandably concerned about the Eurozone crisis on the FI segment, but so far the reaction has been mixed. Overall the FI market remains competitive in most countries. The SME market The SME segment is both fast growing and highly competitive. Growth is being driven by concerns about regulatory scrutiny and employment-related claims. Marsh notes an increase in mid-market companies focusing on compliance in Germany, along with heightened competition among insurers in the SME segment. 18 Even in troubled Greece, Marsh characterizes the SME market as extremely competitive. 19 It is estimated that, in the UK, between 40 and 50 percent of SMEs presently buy D&O, 20 up from only about one-quarter in The FI market FI risks in distressed nations have seen rates double in some cases, 22 but elsewhere in Europe the market is flat to slightly lower for desirable FI clients. Advisen interviews with leading European D&O brokers in December 2011 found that competition continues to keep a lid on rate increases. Many FIs have seen primary layer rates stabilize, and have seen reductions in pricing for excess layers in some cases, according to Guillaume Deschamps, D&O Practice Leader for Marsh s FINPRO practice in continental Europe. He adds though that the current financial crisis could alter this trend. Both Deschamps and David Rogers, head of Willis broking team for U.K. and European FIs, noted that, even though rates are not increasing on average, underwriters are concerned about the possibility of losses emerging from the sovereign debt crisis, and are stepping up the scrutiny of some FIs Spring 2012 Advisen Ltd. Sponsored by:

9 In Germany, insurers have responded to a new law requiring large deductibles for individual directors under an organization s D&O policy with individual director policies. Product innovation A competitive market also leads to product innovation. Most major carriers now offer Side A DIC policies, which provide coverage directly to the directors and officers (rather than potentially sharing coverage with the entity) and provides broader coverage than the traditional ABC policy. Many insurers offer public offering of securities insurance (POSI), a type of coverage much more commonly found in Europe and especially the UK than in the US. Increasingly, insurers are moving away from one size fits all policies, and are tailoring coverage to better address legal systems and business practices by country. In Germany, insurers have responded to a new law requiring large deductibles for individual directors under an organization s D&O policy with individual director policies. Most insurers offer an array of coverage extensions to customize D&O policies to an organization s specific needs. As directors and officers of multinational companies become increasingly exposed to losses around the world, questions arise as to the best way to assure they are covered regardless of where a claim occurs. D&O policies typically provide worldwide coverage, but many countries require local policies. Additionally, a single global policy can cause complications with local premium tax requirements. As a result, a robust market has emerged for complex D&O programs that provide both global and local coverage, and have become a basis for competition for those very large insurers that are able to provide or arrange for coverage in countries across the globe. The Eurozone crisis and the future of D&O A major unknown for the D&O market is how the Eurozone crisis will play out, and how it will affect directors and officers. If the Eurozone crisis deepens, the immediate impact would be on FIs, but the damage could quickly spread throughout the European economy and spill over into the commercial D&O sector. The most likely scenario would be an increase in D&O claims due to a new round of insolvencies. Even absent the influence of the debt crisis, however, it is likely that higher premiums, more restrictive policy terms and conditions, and perhaps a reduction in capacity is on the horizon. Other lines of commercial insurance are beginning to see rates stabilize and, in some cases, they are beginning to rise. As rates improve in other lines, D&O will increasingly be viewed as less desirable, and capacity will flow to lines perceived as more profitable. Another year of severe natural catastrophes, which could drain excess capacity from the overall commercial lines market, would likely accelerate the process. This Advisen Special Report was written by Joshua Bradford, Associated Editor, jbradford@ advisen.com, and David Bradford, Editor-in-Chief, dbradford@advisen.com. 9 Spring 2012 Advisen Ltd. Sponsored by:

10 Notes: 1 Callum Brodie, Directors and officers : Under the spotlight, POSTonline directors-officers-spotlight 2 Turkey, Insurance Market Report 2012, Marsh 3 Insurance Journal, New Global Risks Create Need for Expanded Directors & Officers Liability Program (January 2012) insurancejournal.com/magazines/features/2012/01/23/23226.htm 4 Hirst, Scott, The Harvard Law School Forum on Corporate Governance and Financial Regulation Dutch Court Decision Impacts Global Securities Class Actions (February 2012) 5 Friederike Krieger, German managers need better D&O protection as litigation mounts, Commercial Risk Europe, 22 Sept Perry S. Granof, The Top 10 Non-US-Jurisdictions Based Upon Maturity and Activity, Williams Kastner, Professional Liability Underwriting Society (PLUS) International Conference Jane Harte-Lovelace and Sarah Turpin, D&O insurance in a global context: have you got it covered? KL Gates files/tempfiles/17e7fd5c-9b94-4c07-abed-18cfc04bc2ee/dando.pdf Directors liability survey: Directors in peril insurance and indemnity in risky times, Allen & Overy and Willis 9 Liability of Directors for Competition Law Infringements, Fasken Martineau 2 Sept Ropes & Gray LLP, Foreign Citizens Face FCPA Charges: The Siemens Fallout Continues (January 2012) unitedstates/x/159194/corporate+crime/foreign+citizens+face+fcpa+charges+the+siemens+fallout+continues 11 Best s Review World of Trouble (February 2012) 12 Europe s D&O Insurance Market, Financier Worldwide, 13 Creditforum Economic Research Unit, quoted in Protection for your business, peace of mind for you, Zurich NR/rdonlyres/E68D743B-E29B B9568D09235/0/DandOBrochureGLOBAL13April2010.pdf 14 Callum Brodie, Directors and officers : Under the spotlight, POSTonline directors-officers-spotlight 15 Charles E. Boyle, $370 Billion Econ. Losses for 2011; $116 Billion Insured, Says Swiss Re, Insurance Journal, March 28, Global Rate Changes - Typical Rate Change at Renewal - Q4 2011, Marsh Insurance Market Report aspx 17 January 2012 Reinsurance Renewal: European Professional Lines, Guy Carpenter january-2012-reinsurance-renewal-european-professional-lines/ 18 Germany, Insurance Market Report 2012, Marsh 19 Greece, Insurance Market Report 2012, Marsh 20 Callum Brodie, Directors and officers : Under the spotlight, POSTonline directors-officers-spotlight 21 UK Directors and Officers Insurance 2009, DataMonitor, 22 Portugal, Insurance Market Report 2012, Marsh, 23 Susanne Sclafane, U.S. could lead on rate hikes, even though Europe is crisis center Advisen FPN article html 24 Hirst, Scott, The Harvard Law School Forum on Corporate Governance and Financial Regulation Dutch Court Decision Impacts Global Securities Class Actions (February 2012) 10 Spring 2012 Advisen Ltd. Sponsored by: