Favorable underwriting results in the US directors and officers (D&O) liability segment are likely to put downward pressure on rates amid decreased demand, according to a new report by AM Best.
The underwriting performance of the US D&O liability segment has been favorable over the past three years compared to 2017-2020. In 2023, the direct loss ratio was 50.8%, the best in nearly a decade.
After more than a decade of soft market conditions, which resulted in underpriced D&O risks, a significant increase in pricing from 2020 to 2022 led to a notable decline in the loss ratio for monoline D&O business.
Strategic changes in underwriting practices suggest that the loss ratio may continue to decline in the near term. Insurers have avoided offering the high limits per individual risk that were common in the 2010s, contributing to adverse loss severity trends.
AM Best noted that insurers have also refined their risk appetites, focusing on classes they believe can be adequately priced in the current market. Insurers are now applying improved enterprise risk management (ERM) strategies, leading to smarter underwriting despite falling average premiums.
However, rising settlement and litigation costs, growing exposures from new technologies, and the expectation of further price declines in 2024 present challenges. These factors contribute to AM Best’s current negative outlook for D&O liability.
The segment's recent favorable performance is partly due to a decline in lawsuits against corporate officers related to initial public offerings (IPOs). Post-pandemic economic turbulence has caused IPOs to drop to their lowest levels since the Great Recession.
According to the credit agency, many IPO-related suits from the late 2010s and early 2020s are still moving through the courts. Social inflation continues to increase court verdicts and settlements, creating uncertainty about claims from accident years 2017-2020 and their impact on profitability.
Reinsurers are approaching certain D&O risks with greater caution, particularly financial institution risks. This caution may incentivize primary D&O underwriters to underwrite financial risks more conservatively, potentially improving long-term results.
Improving economic conditions could create a favorable environment for IPOs and mergers and acquisitions (M&A). However, declining prices could affect D&O liability insurers' results if IPOs and M&A increase.
Given recent strong underwriting results, the market is unlikely to hit bottom in 2024. The segment's best year since 2014 suggests little pressure for insurers to increase rates. The decline in market segment premiums over the past two years exemplifies supply and demand driving pricing.
Lawsuits from prior years continue to work their way through the courts. Higher costs attributable to social inflation and factors such as increased legal advertising and third-party litigation funding could lead to adverse loss reserve development, eroding current year profitability. Emerging environmental liability concerns, like PFAS or climate-related litigation, could result in more lawsuits against corporate directors and officers.
Geopolitical instability and supply chain disruptions could also trigger new lawsuits. If these factors increase loss frequency or severity, D&O underwriters may need to quickly adjust underwriting, pricing, claims handling, and legal strategies to maintain recent favorable performance.
“Following more than 10 years of soft market conditions, which left most monoline D&O risks underpriced, the significant increase in pricing from 2020 and 2021 in particular led to a notable decline in the direct loss ratio,” AM Best associate director David Blades said.
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