Carrie Coolidge of Forbes magazine has cleverly defined the crisis in the Directors & Officers (D&O) market as being "in the midst of a perfect storm - a combination of high-profile cases, a weak stock market and continued scrutiny by Congress".

All this on the heels of a soft market where premiums have been low over the last few years coupled with an escalating number of D&O suits. According to Coolidge, "between 1996 and 2001, insurers' D&O losses increased by 640 percent, and the loss trend is expected to continue".

It's no wonder Lloyd's has retracted from the D&O market and others are reassessing the way they underwrite D&O exposures. It does not take a genius to figure out that with a 640 percent increase in losses combined with exceptionally low premiums in the D&O market, `a perfect storm' is brewing.

Last Tuesday, Maurice Greenberg, chief executive officer of American International Group, the most powerful insurance organisation in the US, announced his company is increasing its loss reserves by some $3.5 billion. Of that amount, 25 percent is to apply to D&O liability - illustrating just how poorly the D&O market has performed.

As a result of this trend I talked to a D&O underwriter in Bermuda about how the D&O crisis is affecting the way he underwrites. Mark Simons, vice president Financial Lines/Manager of Starr Excess Bermuda said that unquestionably the D&O market has changed in Bermuda. The quality of submissions and underwriting have reverted to the days when the market was hard in the late 1980s. Underwriters are demanding more data before they decide whether they want to participate on an account and if they do, under what terms and conditions. Simons estimates it is taking five times longer to underwrite an account than it did previously.

Noticeable changes in the D&O market began with the dotcom bust but escalated after the Enron debacle. As a result of the Enron fiasco, the Sarbanes-Oxley Act was passed (refer to Becky Ausenda's article entitled `Sarbanes-Oxley Act and how it affects Bermuda' in the Wednesday, February 5, 2003 edition of The Royal Gazette for an explanation of the Act). This act has proven to be a nightmare for the D&O marketplace because it has single-handedly increased the number of lawsuits for companies that are suspected of inflating their balance sheets in any way. Simons says claims being reported to his company in 2002 increased three times over 2001.

Consequently, underwriters are now asking for Corporate Governance updates, which are required by the Sarbanes-Oxley Act so they can make sure companies are in full compliance with corporate governance requirements. In addition because of the increased litigation, underwriters are asking clients to verify in writing how they are meeting corporate governance requirements. Should these statements prove to be untrue, underwriters have on record that these clients materially misrepresented the true financial picture of their company and therefore, have the right to rescind coverage.

Underwriters are also asking for details of company board members. Of particular interest to underwriters are the names and resumes of Audit Committee board members because underwriters want to make sure they are qualified to audit the records of the company. Gone are the days when the anonymity of board members was sacrosanct. If people elect to serve on boards, under the new corporate governance regulations, they must be willing to provide details about their qualifications and business dealings. Everything must be above board but more importantly, publicly available. Board members, as a result of corporate governance regulations are almost being held to the same standard as publicly elected officials.

Because of the increased litigation in the D&O area and the low premiums the market has generated over the past few years, Starr Excess Bermuda is looking for minimum premium increases of 50 percent. However, in some cases they have managed to renew accounts with 200 percent increases. Simons says the average premium increase across his company's D&O book of business is 182 percent higher than the year before.

Underwriters are also looking more closely at the market capitalisation of companies (the amount of shares outstanding multiplied by the price of the shares) to determine what their maximum exposure to a loss may be. They are using market capitalisations to decide what their optimal attachment point should be on an account. Consequently Simons says attachment points at Starr Excess have increased from $80 million to $105 million.

Another trend that Simons has seen in the last year is the increased demand for Side A coverage. Under Side A coverage the insurer agrees to indemnify (reimburse), including defence costs, directors and officers for their liability for any wrongful act. Side A applies where the corporation cannot indemnify its directors and officers. A corporation may not indemnify its directors and officers because it (1) is prohibited to do so by law, (2) is permitted to do so by law or by company bylaws but chooses not to do so, or (3) is financially incapable of doing so due to bankruptcy, liquidation, or lack of funds. This coverage is essential to have in the event of bankruptcy because this side of the policy will respond if the company does not have the financial assets to reimburse the directors and officers.

This trend is occurring because companies are looking for more qualified and sophisticated board members to make sure they are in compliance with corporate governance regulations. As a result, they are finding these directors will only serve on boards under the condition that their personal assets are not to become the assets of the company should the company become bankrupt. Therefore, these directors are demanding that companies purchase Side A Coverage. Simons says Side A Coverage now accounts for 30 percent of the new business his company has written this year.

Simons also says there is still plenty of capacity around for D&O business and as a consequence, clients are electing to increase the amount of capacity they buy but from various underwriters. Therefore, he has seen his average limit fall from $30 million to $22 million.

This is definitely an interesting time for D&O underwriters. Only time will tell how long it will be before the `perfect storm' reaches its peak and which underwriters will remain standing afterwards.

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Cathy Duffy is a Chartered Property Casualty Underwriter (CPCU) and is now a freelance writer. She is a former executive of Zurich Global Energy and has 15 years experience in the insurance industry. She writes on insurance issues in The Royal Gazette every Monday. Feedback crduffycwbda.bm