The market for directors' and officers' reinsurance will continue to expand, as legal and regulatory environments change, but competition is fierce. Mark Baylis reports.

Providing directors' and officers' (D&O) cover is hardly the most glamorous of jobs, but it has been a dramatic growth area for the insurance and reinsurance industries over the past three decades. There is every reason to believe that this expansion will continue, because it is a natural response to political, business and legislative trends worldwide.

In the late 1980s and early 1990s, premium levels for D&O took off, sometimes doubling in volume annually. Even in the current soft market, where rates have fallen by around 35% over the past three years, total premium income continues to increase. Although there are no reliable figures for the size of D&O cover, it is estimated to have reached $2 billion premium income in the United States last year and, at a conservative estimate, $500 million in the rest of the world. Specialists consider that this is only the beginning.

The pattern and nature of D&O reinsurance is as varied as the circumstances and inclinations of individual buyers. Most experts agree that excess of loss is pre-eminent, especially among well established primary insurers. Many new entrants, however, have entered into alliances with reinsurers, and buy from them on a quota basis. Others reinsure as part of a liability treaty.

Driven from the US

"Demand has traditionally been driven in the US, but other countries are catching up," says broker Mark Wood, executive director at the Aon Group. "There are many other markets which have tremendous potential, especially in the Far East and Europe."

In an era of globalisation, the influence of the US legal system, and its propensity to litigation, is spreading internationally and with it the need for D&O cover. As more European and Asian companies acquire interests in the US, they face consequent exposure to that country's laws. Furthermore, the US has become established as the dominant international centre for raising capital. Individuals and companies who take advantage of this facility are liable under US law, and likely to come under the auspices of the Securities and Exchanges Commission (SEC).

As a result, executives of large companies around the world are being drawn into the web. Demand for D&O cover is also being generated by a series of legal and regulatory changes within individual countries, especially those that increase the rights of consumers and shareholders. Making corporations and their directors more accountable is a popular theme with elected governments everywhere, and this has increased the exposure of directors when things go wrong. Other factors include better developed legal infrastructures that make it easier for aggrieved customers and shareholders to go to court.

Germany - a sleeping giant

One country that many observers single out for growth potential is Germany, which has been something of a sleeping giant. When US insurers offered D&O cover they, at first, had little success. Such insurance was looked down upon, some viewing it as unethical. The German legal system provided further discouragement. As a general rule, it is the company that is sued, not its director or managers, except in very specific instances.

The trend of German D&O liability is, therefore, claims brought against directors by their own companies. Managers of stock or limited companies have a legal duty to prevent their companies from suffering losses. Until recently, companies were reluctant to take legal action against their own managers, but this is changing, partly in response to greater pressure from shareholders.

Above all, legal developments within Germany have accelerated change. First, in 1997 the supreme court ruled that companies' supervisory boards could be legally obliged to sue executive managers in order to prevent losses from the company and its shareholders. In one case, the supervisory board of an insurance company had refused to sue its chief executive following the loss of $50 million, much of it allegedly caused by poor investment activities. Secondly, new consumer and shareholder protection laws are planned, which are likely to heighten demand.

UK set for growth

Although a more mature market, the United Kingdom is another country where recent legal and regulatory developments, together with the election of a Labour government, have increased demand. As in Germany, the need for D&O has traditionally been dampened by legal protections for directors.

In the 1970s, the purchase of D&O in the UK was led by a handful of multinationals with operations in the US. As in Germany, however, more home grown drivers for growth are taking effect. The Companies Act 1985 listed 200 reasons why directors could be held liable. In 1990, further legislation explicitly stated that directors could buy insurance coverage for these liabilities, clearing up confusion that had previously existed. More recently, the Cadbury Report on corporate governance and the Greenbury Report on executive pay have changed the climate and increased demand.

At the consumer end, the growth of conditional ("no win, no fee") legal fees is certain to increase the exposure of directors to legal action from dissatisfied customers. If, as they promised when in opposition, the Labour government introduces new corporate manslaughter legislation, the current steady but subdued interest could take off.

Eastern promise

Probably the biggest potential growth area for D&O cover, however, is the Far East. South Korea, Japan and, with time, China are particularly hot markets. The recent financial difficulties may have actually helped demand. As companies feel the pressure, some going out of business while others turn in poor results, their directors are more exposed and in need of assurance.

"Creditors and shareholders are normally happy when they are being paid or the value of their shares is increasing," points out James Selz, underwriter at ERC Frankona in Munich. "On the other hand, if the company is not able to pay its debts and its shares are losing value, claims will be more likely.

"The bottom line is price."

Although the global market for D&O cover is undoubtedly on the increase, this has not been reflected in any hardening of rates; too many underwriters are jumping on the bandwagon. "As soft as cream cheese," is how one observer described recent premium levels, which fell by an estimated 15%-20% last year, and have dropped by more than a third since 1995.

It is a line of business that has become heavily commoditised. "The bottom line is price," says Dean Horton, a senior underwriter at Chubb Europe. "D&O is still near the bottom of the insured's list of priorities."

London the international centre

There is a thriving US domestic market for D&O, while London is currently the predominant international market, which remains overwhelmingly broker-led. "London is by far the best market for D&O reinsurance because of its expertise and flexibility," according to Mark Wood of Aon.

Many of the main suppliers are the London branches or subsidiaries of big US companies, such as Chubb, CIGNA, AIG and Reliance. Lloyd's is another major source, Archer Underwriting being one of the latest entrants. Underwriting director Michael Earp says that insurance is essential if directors and officers are to fulfil their obligations, and that the increasing tendency for courts to enforce greater personal accountability for managers has left directors more exposed.

"Without this insurance the prospect of a D&O claim could result in directors shying away from the key decisions that are critical to the success of the company," he says.

In addition to London and the US, certain continental European reinsurers are taking a growing interest in the market with Munich Re, for example, offering a dedicated team of legal, banking, finance and claims specialists to support its underwriting.

Future assured

So what of the future for D&O cover? This is one area of reinsurance where growth appears to be guaranteed, as the need increases internationally and awareness rises among executives. Thomas Wollstein, senior underwriter at Munich Re, comments: "While this is very difficult to estimate, it is safe to say that most markets have reached nowhere near even half their potential".

It is, however, very far from being a static product. To quote Mr Horton: "The product is evolving all the time in terms of giving coverage that is wide in scope, while also tailor-made."

The competition for business is intense and shows no sign of relaxation. Clients and their intermediaries are becoming more sophisticated. To succeed in this environment suppliers must be flexible, highly specialised in their knowledge but also able to accommodate the global needs of multinational companies. A good understanding of overseas legal systems - especially the US - is practically essential to D&O underwriters.

Some old timers warn that new entrants may have insufficient experience of the subject, and be lulled into a false sense of security by the low claims experience apparently enjoyed by D&O underwriters outside the US. "More and more people are getting into D&O, but they could find it's a baptism of fire," predicts James Selz.

For potential buyers, however, now is a good time to consider the options. The choice and range of cover available on the market is better than ever, and rates are low.

Mark Baylis is a marketing consultant.