Reinsurance Boot Camp on Pricing Techniques Professional Liability – Director’s & Officers

1. Reinsurance Boot Camp on Pricing Techniques Professional Liability – Director’s & Officers John Lewandowski, FCAS, MAAA August 9, 2007

2. D&O Profile • D&O Individual Account Pricing Model • Frequency Model • Severity Model • Additional Considerations • Loss Cost Model • Results • Next Steps

3. D&O Profile - Coverage • Directors & Officers Liability Policy – provides coverage for claims arising from the “wrongful acts” – i.e., any act, error or omission -- of insured persons while serving in their capacity as directors or officers. Expanded to included Entity coverage for “securities claims.” D&O coverage is simply a specialized type of Errors & Omissions coverage, often referred to as Management Liability. • Management Liability product line typically also includes EPL, Fiduciary Liability (PTL), Fidelity, Financial Institution E&O • Errors & Omissions Professional Liability Policy – provides coverage for claims involving alleged “errors and omissions” arising out of professional services rendered by the insured, e.g. banks, investment advisors, insurance companies, mutual funds…

4. D&O Profile - Claims • Some interesting D&O statistics for Public Companies* • Half of all suits against D&O’s are filed by Shareholders • 21% of claims brought by employees • Shareholders are claimants in 49% of claims • 60% (or more) of all suits are accounting-related • 36% of all claims are class actions Securities Class Actions • Low Frequency – typically less than 200 suits per year (excl IPO) – Public Co. • High Severity –mean settlement of $50-60 m, median of $5-7 m – Public Co. • Most active Circuit courts are Southern District of NY (2nd) and California (9th) • Most frequently sued Sector is Technology (30% of cases) • Most frequently sued Industry is Biotechnology & Drugs • Most resolutions achieved through settlement, not judgment *Source : Tillinghast 2006 D&O Report and Stanford Research

5. I. D&O Profile - Claims • Class Action Securities Suits Represent Vast Majority (> 85%) of Loss Dollars Paid by Public Company D&O Policies Source : Stanford Research

6. D&O pricing model • Current approaches to Public D&O Pricing • Typically market based pricing and/or outdated base rates • Often Vendor supplied models and parameters • Heavy reliance on judgment rating – lack of statistical support for pricing • Public D&O Securities Pricing Model • Get “Back to Basics” - Frequency/Severity model • Public Company focus – excludes Not for Profit or Private Cos. • Class Action Securities Suits only • Ready access to publicly available data including Stanford Research and Company Financial data

7. II. Frequency Model • Financial information for 1999 through 2005 • Stanford Class Action Securities filings for same time period • Predictive modeling (GLM) • Uses Historical data to construct a statistical model that will be predictive of the future • Dependent variable - claims, losses • Weight – exposures, premium • Independent variable – market cap, revenue, stock volatility, etc..

8. II. Frequency Model (cont.) Considered 24 rating variables, 7 were included in final model • Sector/Industry Group • Market Capitalization • Stock Volatility • Net income / Revenue • Change in Revenue • Change in Market Capitalization • Volume traded / Shares Outstanding

9. II. Frequency Model (cont.)

10. III. Severity Model • Closed Claim study of 760 settled securities claims • From ground-up settlement data, but does not include defense cost! • Manually adjusted to incorporate settlements exposing D&O policies –exclude fines, disgorgement • Trended settlements to current loss cost levels • Claim Severity Distribution based on firm size (market capitalization) • Severity model recognizes differing loss exposure in excess layers due to potential investor loss (size of firm). • Modeled relationship between firm size (market cap) and mean/median loss using weibull curves • Once mean and median were determined, assumed loss distribution was lognormally distributed

11. III. Severity Model (cont.)

12. III. Severity Model (cont.)

13. IV. Additional Considerations • Dismissal Rate –some of the filed suits will be dismissed • Based on Tillinghast report, PLUS journals and Advisen data • Recognizes global settlements and recent trends • Defense Costs - provision for defense reimbursement applied to lognormal severity µ parameter: • 10% if settled • 5% if dismissed Profit and Expense loadings –set based on local practice

14. V. Loss Cost Model • Final loss cost components: • Loss cost for dismissed claims • Loss cost for non-dismissed claims • Risk load – percentage of standard deviation in layer

15. VI. Key Takeaways • There exists a strong relationship between company financials and securities class action claim frequency. • There exists a strong relationship between company financials and securities class action claim severity. • Predictive modeling can be used to interpret these relationships.