CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Directors’ & Officers’ Liability Peter J. Schultheiss, FCAS Vice President Zurich North America Specialties Joseph Reschini Actuarial Assistant The Hartford

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 AGENDA Frequency Severity Monitor Prices Rating Variables Q&A

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Pure Premium Pure Premium = Claim Frequency * Claim Severity

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Historical Securities Fraud Class Actions Source: Stanford Law School Securities Class Action Clearinghouse

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Claim Frequency Assumed Securities Claims: Approximately 10, ,000 Companies Frequency of claims 2.5% - 3.0%

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Claim Costs by Type Claimant ClassMedianAverage Payments to Claimants: Employees/Unions/Physicians40K245K Shareholder/Investors4.9M17.2M Defense Costs Employees/Unions/Physicians30K105K Shareholder/Investors450K1.05M Source: Tillinghast - Towers Perrin “2001 Directors and Officers Liability Survey”

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Some Large Settlements *Market Cap Cendant33.7B Bank of America95.4B 3Com Corporation22.4B *At Beginning of Class Period # Source: Stanford Law School Securities Class Action Clearinghouse Drop in Cap 11.8B 32.3B 13.5B #Settlement 3.525B 490M 259M

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Assumed Cost Per Mil Frequency = 2.5% - 3.0% Securities Class Action Severity - Assume Policy Limit Assumed Cost Per Mil = 25K - 30K

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Average Price Per Mil by Industry Source: Tillinghast - Towers Perrin “2001 Directors and Officers Liability Survey”

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 MONITORING PRICES

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 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

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Process “Normalize” premiums to account for varying coverage parameters Contrast w/Benchmarking and base rates Reliance on judgment for class relativities, other parameters

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Process XYZ Corp. ExpiringRenewal Premium$100,000$300,000 Limits$10 million$20 million “ILF” “Normalized Premium”$100,000$150,000 Rate Change 50%

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Rating Factors 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

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 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

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 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

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 D&O Example

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 D&O Example Price Change Effects 1. Renewal 2. Non-renewal 3. New

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 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

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 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

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Average Limit Purchased Source: Tillinghast - Towers Perrin “2001 Directors and Officers Liability Survey”

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 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)

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Common Claims by Claimant Shareholder Stock or Public Offering Inadequate/Inaccurate Disclosure Fraud (including Accounting) Restatement of Earnings Employee Wrongful Termination Discrimination Harassment Breach of Contract

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 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

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Self Insured Retention Covered Loss = 25M Insured Pays 1M Insurer Pays 24M

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Coinsurance Loss = 25M Insured Pays 20% Coinsurance (5M) Insurer Pays 20M

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Pre-Set Allocation Loss = 25M Pre-Set Allocation = 20% Loss Not Covered = 20% (5M) Insurer Pays 20M Similar results as Coinsurance except in the case of an Insured Bankruptcy.

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 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%

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 Other Rating Considerations Change in Auditors Severability Insider Stock Sales Leverage Ratio Financial Condition Quality of Balance Sheet Sarbanes Oxley?

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 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

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 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

CAS Seminar on Reinsurance – Philadelphia, PA June 2-3, 2003 QUESTIONS?