D&O and E&O - Is There Any Good News?

1. D&O and E&O - Is There Any Good News? John Lewandowski, FCAS, MAAACNA Insurance Company 2004 Casualty Loss Reserve SeminarLas Vegas - September 13, 2004

2. D&O POLICY CHARACTERISTICS

3. Coverage/Profile - What is D&O and E&O? 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. D&O’s have liability for misrepresentations and omissions • in a public offering registration statement filed with the SEC • in connection with any purchase or sale of securities 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… D&O coverage often includes Employment Practices Liability.

4. Make-up of D&O Market Public cos. represent the largest share of the market Distribution of Insureds by Segment By Ownership Type For Profit by Account Size Small: Assets < $100M Mid: $100M < Assets < $1B Large: $1B < Assets < $10B Very Large: Assets >10B

5. Typical (Large Public Co.) D&O Program Structure • Program size typically excess of $50 million, up to $200 million+ • Limits offered range from $5 million to $25 million per carrier, many carriers on any one program • Retentions range from $100K and up! • Pricing varies widely from account to account, typically based upon : • Sector/industry group • Size –Market Capitalization, Assets • Recent activities – IPO, M&A • Financial Condition – consistent performance • Financial Rating • Corporate Governance – management quality, board independence

6. Some Past Drivers of D&O results (1997-2002) Increasing Coverage/Reducing Premium Expanded capacity/larger limits offered Expanded coverage, entity coverage eliminated pre-set allocation Free/automatic Reinstatements Multi-Year contracts, with significant discounts and no re-underwriting Increasing Claim Costs – Frequency and Severity 2001 – IPO Allocation filings 2002 – Filings against Analyst and Investment Banks; Wave of Corporate Meltdowns Begins – Enron, MCI Worldcom, Tyco, Global Crossing 2003 - Mutual Funds – Late Trading/Market timing M&A Activity – Banking, Insurance Deteriorating Investment Market

7. Historical Avg. Policy Limits - Public Co. D&O Limits in Thousands

8. Current State of the D&O market • Through Year-End 2003 • Market saw reduced capacity (limits), increased retentions • More players on each program, pricing less competitive • Large rate increases - more than 150% were common • Coverage restrictions – eliminate investment banking, entity coverage • Elimination of multi-year deals • 2003/2002 Securities Class Action Lawsuits Decline by 22% • 2003/2002 Market Capitalization Losses Decline by 72% • And Beyond….. • Once again, swift changes in the market in 2004……….

9. D&O CLAIM CHARACTERISTICS

10. Historical Legislation Impacting D&O Suits 1933/34 Securities Acts D&O Liability for misrepresentations, omissions in public offerings, statements 1995 PSLRA Intended to prevent abuses of securities class action lawsuits. Heightened Pleading Standard 2002 Sarbanes-Oxley Act Blackout trading barred CEO and CFO certifications. Faster insider trading disclosure Increased Audit Committee duties. Increased SEC review More criminal penalties and fines

11. D&O Securities Suits (Through August 2004) Source : Stanford Research

12. D&O Claims Characteristics Some interesting Public Company D&O statistics*…. • Half of all suits against D&O’s are filed by Shareholders • 24% of claims brought by employees • 36% of all claims are class actions • Low Frequency - average of 225 securities suits per year (excl IPO) • High Severity – average settlement of $20 million • Most active District Court is S.D. New York • Most frequently sued Sector is Technology • Most frequently sued Industry is Biotechnology & Drugs • Most resolutions achieved through settlement, not judgment *Source : Tillinghast D&O Report and Stanford Research

13. Significant D&O Claims

14. Major Factors For D&O Claims • Scope of Policy – is it a claim, a wrongful act? • Ground-up Nature of the Claim • Possible Defenses – exclusions, warrants, application. • Policy structure, coverage and wording

15. Criteria Used to Establish D&O Claim Potential • Alleged Damages - “Plaintiff-style” damages • Length of Class Period – number of shareholders • Insider Holdings • Historical Stock Performance • Underlying carriers – who is lead on Claim? • Venue – circuit, pleading standards, judge • Attorney firms – both Plaintiff and Defendant • Industry – Telecomm., Pharm., Energy – any trends? • Procedural steps – Consolidated complaint, motion to dismiss • Lead Plaintiff - Institutional Investor • Insured’s stamina/motivation

16. Key Takeaways • Principal exposure is from Shareholders Class actions against Public Companies, Private Company litigation less common. • Pricing for D&O must recognize Size and Sectors as important factors, but not sole factors – all are not equal. • Last few years witnessed emergence of non-traditional claims (mega-torts) in addition to traditional issuer fraud cases. • Settlements are not keeping pace with filings, there is a large backlog of cases.

17. Is There Any Good News? • Lessons Learned from the past…….. • Keeping pace with the next possible mega-tort by identifying industries/markets in distress is critical. • Reserving for D&O is multi-faceted and requires a continuous evaluation during the lifetime of the claim. • Strong working relationship between Claims, Underwriting and Actuarial is important since traditional actuarial reserving methods do not work.