Directors’ & Officers’ Liability

1. Directors’ & Officers’ Liability Richard J. Castillo, ACAS Senior Vice President Zurich North America Specialties Claude D. Yoder, FCAS Vice President The Hartford

2. Pure Premium Pure Premium = Claim Frequency * Claim Severity

3. AGENDA • Frequency • Severity • Monitor Prices • Rating Variables • Questions

4. Historical Securities Fraud Class Actions Source: Stanford Law School Securities Class Action Clearinghouse

5. Claim Frequency Assumed Securities Claims: 250 - 300 Approximately 10,000 - 11,000 Companies Frequency of claims 2.5% - 3.0%

6. Claim Costs by Type Claimant Class Median Average Payments to Claimants: Employees/Unions/Physicians 40K 245K Shareholder/Investors 4.9M 17.2M Defense Costs Employees/Unions/Physicians 30K 105K Shareholder/Investors 450K 1.05M Source: Tillinghast - Towers Perrin “2001 Directors and Officers Liability Survey”

7. Some Large Settlements *Market Cap Drop in Cap #Settlement Cendant 33.7B 11.8B 3.525B Bank of America 95.4B 32.3B 490M 3Com Corporation 22.4B 13.5B 259M *At Beginning of Class Period # Source: Stanford Law School Securities Class Action Clearinghouse

8. Assumed Cost Per Mil Frequency = 2.5% - 3.0% Securities Class Action Severity - Assume Policy Limit Assumed Cost Per Mil = 25K - 30K

9. Average Price Per Mil by Industry Source: Tillinghast - Towers Perrin “2001 Directors and Officers Liability Survey”

10. MONITORING PRICES

11. Objective • Measure the premium adequacy of all new and renewal policies written in the current year against all new and renewal policies written in the prior year • New business can be monitored • No “rate change” • Rate adequacy • If exclude new • Understate increases in hard markets • Understate decreases in soft markets • Miss multi-year renewals

12. Process • “Normalize” premiums to account for varying coverage parameters • Contrast w/Benchmarking and base rates • Reliance on judgment for class relativities, other parameters

13. Process • XYZ Corp. Expiring Renewal Premium $100,000 $300,000 Limits $10 million $20 million “ILF” 1.0 2.0 “Normalized Premium” $100,000 $150,000 Rate Change 50%

14. ILF Limit Retention Attachment Point Part Of/Quota Share Arrangement Exposure Base Term Industry Group Public or Private Prior Acts Exclusions Side A only Pre-set Allocation Coinsurance Rating Factors

15. Rating Factors • Public vs. Private • Public company exposure is mostly class action suits • Private company exposure is mostly EPL • Term • Multi-years now annual • 3 year terms had been commonplace 2 years ago • 2.25 factors • Today – “unwinding” the discount

16. Rating Factors • Class of Business • Class relativities rely on judgment • Data available, but very limited (see class action suits) • Side A Only • Recent phenomenon • Reaction to “Enronitis” • Removes large portion of risk • D and O reimbursement only, no company reimbursement • Bankruptcy and derivative cases

17. D&O Example

18. D&O Example • Price Change Effects • Renewal • Non-renewal • New

19. D&O Example • Renewal • Easiest to quantify • Non-renewal • Most subtle • Effect from prior policy “dropping off” • New • No actual price “change” • Presence of new policy does change rate level

20. Asset Size PROS • Easy to Obtain/Verify • Correlates with Exposure to Loss • Accepted by Industry/Insured CONS • Quality of Assets? • Correlates - NOT a Proxy • Asset Size - Not Market Cap

21. Average Limit Purchased Source: Tillinghast - Towers Perrin “2001 Directors and Officers Liability Survey”

22. Public Vs. Private Loss Drivers Public D&O • Severity - Securities Class Action Suits • Frequency - Employment Related (usually within SIR) Private D&O • Severity - Private Placement Suits (Securities usually excluded) • Frequency - Employment Related (usually insured)

23. Shareholder Stock or Public Offering Inadequate/Inaccurate Disclosure Fraud (including Accounting) Restatement of Earnings Employee Wrongful Termination Discrimination Harassment Breach of Contract Common Claims by Claimant

24. How is D&O Loss Handled Under: • Deductible/Self Insured Retention • Coinsurance • Pre-Set Allocation ASSUME: Loss = 25M SIR = 1M Coinsurance = 20% Pre-Set Allocation = 20% Policy Limit = 25M

25. Self Insured Retention • Covered Loss = 25M • Insured Pays 1M • Insurer Pays 24M

26. Coinsurance • Loss = 25M • Insured Pays 20% (5M) • Insurer Pays 20M

27. Pre-Set Allocation • Loss = 25M • Pre-Set Allocation = 20% • Loss Not Covered = 20% (5M) • Insurer Covers 20M • Similar results as Coinsurance except in the case of an Insured Bankruptcy.

28. Charge for Entity Coverage • Early 90s First Offered - Customary Charge = 10% • Late 90s - Thrown In • Today - Big Losses for Insurance Companies/Big Bucks for Plaintiff Bar Firms (Looking for Entity to Kick in Beyond Insurance Proceeds) • Average Allocation to Entity Used to Be 30%-35%

29. Other Rating Considerations • Change in Auditors • Severability • Insider Stock Sales • Leverage Ratio • Financial Condition • Quality of Balance Sheet • Sarbanes Oxley?

30. Sarbanes-Oxley Act • New certification requirements • CEO’s and CFO’s must sign • Reviewed financials and not misleading • False certifications mean fines up to $5 million and imprisonment up to 20 years • Audit services • Accounting firms not to provide other services • E.g. consulting, legal, etc. • Audit Committees • Must be independent • Cannot be employed by affiliated co. of issuer

31. Sarbanes-Oxley Act • Rotation of lead auditor • Statute of Limitations • Increased to 2 years/5 years from 1 year/3 years • Effect of lengthening class periods plaintiffs allege • Insider sale limitations • Prohibition of loans to D’s and O’s • Disgorgement of ill-gotten profits • Increased SEC budget

32. QUESTIONS?