The liability landscape for directors and officers has not become less risky, but a sudden softening of the market has made that risk harder to see in the pricing – and that gap is where the danger sits, according to Lesley Rowe (pictured), VP of executive solutions at Trisura, which writes this risk across the small and mid-market space.
Rowe said the shift in Canada is nuanced rather than dramatic. The litigation environment is not as active as the United States, and mechanisms like the Human Rights Tribunal tend to concentrate and moderate the employment claims that do arise, keeping awards short of the "nuclear" figures seen south of the border. What has changed, she said, is the economic backdrop: more financially troubled companies moving through windings-down, receivership or CCAA proceedings, which generates activity on the insurance side even when it does not immediately produce claims.
The more important change is in how the risk is priced.
"I don't think that the landscape has become less risky, but with the soft market it's becoming less visibly priced," Rowe said. That, she said, introduces complicating factors – chief among them the possibility that pricing is drifting below what the underlying exposure warrants, even if the results won’t reveal it for years.
The reason that possibility is dangerous comes down to how liability claims develop. Directors and officers cover is longer-tail, Rowe said, meaning claims can take years to develop and the losses on a given policy year are rarely settled in that year.
"You might not see it for years out. So it does take time to really see the trend," she said. By the time the market discovers pricing has been inadequate, the damage is already in the book, and the correction that follows tends to be sharp – terms tighten, and capacity leaves.
That capacity can leave in several ways, she said. Existing insurers may deploy less of it, an insurer may exit a class of business entirely, or a player may fold up altogether. When it dries up and fewer markets remain, the ones still writing can finally charge what the exposure costs. The catch, Rowe said, is that this makes the line look far more favorable than it is.
"That makes it appear very, very profitable when maybe you've just hit reasonable profitability," she said – which is precisely what draws new capital back in and seeds the next soft market.
That cycle, she said, is what produced the recent whiplash in D&O. The market appeared to reach adequacy in the short hard market, capacity flowed back, and existing players restored the limits they had pulled – and then it softened again, quickly. Adding to it, Rowe said, markets that normally operate in the larger, more complex or public-company IPO space saw that activity dry up and moved down into the mid-market, intensifying the competition there. "So we had a really sudden softening," she said.
The danger she foresees is a repeat of the cycle that drove the last hard market. If pricing turns more aggressive again, she said, the open question is whether it will cover the claims to come – and, as before, no one will know until those claims mature.
"Is that going to be adequate, and when will we figure out that that's not adequate?" Rowe said. She would have preferred the market reach adequacy and hold flat for a period, she added, but D&O proved too attractive an investment for capacity to stay disciplined.
Asked what she watches to judge whether the market has bottomed out, Rowe pointed to where insurers set the floor on their capacity. The signal, she said, is markets holding firm on what a given limit costs rather than chasing the business down. Some will hold the line on a $10 million limit; others will decline to write it at that price and offer $5 million instead, where they can price more aggressively against a smaller aggregate. When markets start insisting on adequate capital for the capacity they deploy, she said, that is the sign the softening is near its floor – and it may arrive at different times for different classes, holding longer on vanilla risks than on volatile ones.
The developer space is her current example of that volatility. Rowe said she reads the weekly Insolvency Insider newsletter tracking receivership and CCAA activity, and lately it has been busy.
"There's a lot of developers and development projects that are becoming insolvent," she said – a normally volatile segment made more so by the shift in the real estate market and the wider economy.
