Tammi Dulberger John LewandowskiFrançois MorinBoston, MANovember 11-13, 2002

What’s Going on With D&O?

2002 CAS Annual Meeting

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Agenda

Background

Market Overview

Drivers of D&O

Summary

Questions

Background

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What does a Directors and Officers liability policy cover?

Original Intent

Cover the Directors and Officers of the organization Provides coverage for claims arising from the “wrongful acts” of

insured persons while serving in their capacity as Directors or Officers

Typical D&O policy consists of two sections Personal coverage (Side A) Corporate reimbursement coverage (Side B)

Until late 1995, allocation of loss between the Directors and Officers and the entity itself Allocation was either negotiated or predetermined Insurance contract covers only the loss allocable to the Directors and

Officers; Insured covers the loss allocable to the entity

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What does a Directors and Officers liability policy cover?

Broadened Coverage Beginning in 1995

Cover extended to include the entity in addition to the Directors and Officers (Side C) Directors & Officers share the policy limit with the entity Insurance contract covers 100% of losses; insured pays 0% after

retention Additional coverages granted such as Employment Practices Liability,

Fiduciary Liability, Errors and Omissions Broader coverage terms

— Lower merger and acquisition thresholds— Waiver of applications and signed warranty statements— Multi-year contracts— Extended reporting period

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What does a Directors and Officers liability policy cover?

Move Toward Coverage Changes Beginning in 2001

Reintroduce allocation Control insurers’ cost Restore contract to original intent of coverage for Directors and

Officers

Pull back additional coverage grants for lines like Employment Practices and Errors and Omissions by unbundling contracts

Restriction in coverage terms (cease multi-years, raise M&A thresholds, tighten notice provisions, require signed applications and warranty statements etc.)

Increased demand for A-side only cover

Market Overview

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4.7 4.75.0

6.0

7.5

0

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1998 1999 2000 2001 2002

The U.S. D&O market is growing toward $7.5 billion

Growth DriversGrowth Drivers

Increasing rates, particularly significant in some segments among publicly traded insureds

Increased penetration among private companies through 2000, potentially reduced in hard market going forward

Broadening and contracting coverage

Increasing rates, particularly significant in some segments among publicly traded insureds

Increased penetration among private companies through 2000, potentially reduced in hard market going forward

Broadening and contracting coverage

Estimated Direct Written Premiums

Source: A.M. Best; industry press, Tillinghast estimates. Note: These are midpoints of a rangeof estimates, e.g., 2000 base range is $4 billion to $6 billion. As D&O financial results are combined with other liability coverages in the Annual Statement, precise figures are not available.

$ Billions

0%6%

20%

25%

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Assumed % change in Price -5 +6 +20 +30Assumed % change in Exposure +5 0 0 -5

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Public insureds represent the largest share of the market

Distribution of Premium by Segment

Source: Tillinghast D&O Survey, Tillinghast estimates.

Not for Profit10%For Profit

Private10%

For Profit-Public80%

By Ownership Type

EPL28%

D&O60%

Fiduciary12%

By Coverage Type

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Very Large20%

Large25% Mid-

Market30%

Small25%

Merch/Real Est/Oth

14%Util/Petrol/Mine/Ag

10%

Fin Svcs/Commun

12%

Mfg/Trans/Const

19%

Tech/Pharm/Health45%

For Profit by Account SizeFor Profit by Industry

Source: Tillinghast D&O Survey, Tillinghast estimates.

Distribution of Premium by Segment

Technology, pharmaceutical and health sectorsrepresent a disproportionate share of the for-profit market

Small: Assets < $100MMid: $100M < Assets < $1BLarge: $1B < Assets < $10BVery Large: Assets >10B

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The D&O market is highly concentrated, with 2 players writing over half the business

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2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

12.

13.

14.

15.

AIG

Chubb

Lloyd’s

Hartford

CNA

ACE

Admiral

Old Republic

Zurich

Genesis

Rock River

XL

Gulf

Great American

AEGIS

CompanyEstimated 2000 D&O

($ Millions)

All other

Total

Share of Market

Source: Tillinghast D&O Survey, Tillinghast estimates.

100%

$1,000

1,000

600

190

180

150

140

140

130

130

120

110

100

90

60

860

$5,000

20.0%

20.0%

12.0%

3.8%

3.6%

3.0%

2.8%

2.8%

2.6%

2.6%

2.4%

2.2%

2.0%

1.8%

1.2%

17.2%

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Growing D&O loss levels have caused certain players to exit the market and others to strengthen reserves

7/99 - Chubb acquires Executive Risk

9/00 - Hartford acquires Reliance’s D&O staff and book

10/00 - Kemper enters D&O market

11/00 - Fireman’s Fund acquires ERC’s not-for-profit D&O book

7/01 - AIG reintroduces coinsurance

7/01 - ACE D&O Report headline, “Size of D&O Settlements Exploding”

7/01 - Trenwick announces D&O reserve strengthening

8/01 - SVB Syndicates (Lloyds) announce significant losses due in part to “a sharp increase in lawsuits against US company directors”

Continued exit by smaller, less profitable writers may result in a further concentration of business among

larger players

Continued exit by smaller, less profitable writers may result in a further concentration of business among

larger players

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Roughly 20% of D&O business is reinsured with non-affiliated entities

Top Buyers of Reinsurance (Estimated 2000 Ceded

Premium)

Top Buyers of Reinsurance (Estimated 2000 Ceded

Premium)

AIG 300

Lloyd’s 150

Hartford 100

Zurich 60

Great American 50

Gulf 50

CNA 35

Admiral 35

RSA 25

Chubb 25

AIG 300

Lloyd’s 150

Hartford 100

Zurich 60

Great American 50

Gulf 50

CNA 35

Admiral 35

RSA 25

Chubb 25

*Based on total other liability claims-made premiums reinsured with non-affiliates. Source: A.M. Best, Tillinghast calculations.

Reinsurance of D&O Premiums

2000 DWP: $5 Billion

Retained:$4.0 Billion

Reinsured:$1.0 Billion

Drivers of D&O

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Timeline of significant milestones in the D&O Market:1933/34 Securities Acts

Securities Act of 1933, Section 11: Directors and Officers are liable for misrepresentations and omissions in a public offering registration statement filed with the SEC

Securities Act of 1933, Section 12: Directors and Officers are liable for material misrepresentations and omissions in written materials or oral communications in the sale of securities

Securities Exchange Act of 1934, Section 10b: Directors and Officers are liable for any misrepresentation or omission in connection with any purchase or sale of securities. This includes both public offering sales and after market sales.

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Timeline of significant milestones in the D&O Market:1995 PSLRA

Intended to prevent abuses of securities class action lawsuits

Not intended to eliminate all litigation, only frivolous

Safe Harbor provision to protect Forward-Looking Statements

Heightened Pleading Standard Pleading must include specific details of materially false and

misleading statements or failure to disclose statements that would constitute a fraud

Stay of Discovery while a Motion to Dismiss is Pending

Lead Plaintiff - Largest financial interest

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Timeline of significant milestones in the D&O Market:2002 Sarbanes-Oxley

Black-out trading barred Directors and Officers cannot trade securities received for their work,

where the trades take place during black-out periods in which employees cannot also trade the company stock.

CEO and CFO certifications

Executive loans prohibited/Freeze on extraordinary executive funds or payments.

Executive pay forfeited for restatements For the 12-month period following the first filing with the SEC of a

restatement required due to misconduct relating to material noncompliance with financial reporting requirements

Faster insider trading disclosure Securities transactions by directors, officers and owners of more than

10% of the company securities must be revealed to the SEC and the public within 2 business days of the transaction, instead of the current time frame of 10 days after the first month in which in the transaction occurred

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Timeline of significant milestones in the D&O Market:2002 Sarbanes-Oxley (cont.)

Closer auditor management Public companies may not use their outside auditor for specifically

listed non-audit services, unless de minimus The lead audit partner of the public company accounting firm must be

rotated off the audit after auditing the company for five consecutive years

Liability ensues for any officer, director or representative thereof who fraudulently influences, coerces, manipulates or misleads the company’s outside auditors

Increased Audit Committee duties

Increased financial disclosures

Increased SEC review

More time to sue

More criminal penalties and fines

Increased Accountants and Lawyers’ responsibilities

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Starting in the mid-1990’s, the D&O industry entered into a soft market

Expanded capacity/larger limits offered

Expanded coverage, entity coverage eliminated pre-set allocation

Blended programs including D&O and E&O, with significant discounts

Broker forms and lack of applications

Free/automatic reinstatements

Bilateral discovery - under-priced ERP’s

Multi-year contracts, significant discounts and no ability to re-underwrite

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The stock market bubble of the late 1990’s had profound effects on the D&O market

Stock volatility/Earnings pressure to compete

Increased number of IPOs, mostly Internet stocks

Increased market capitalization, many times earnings

New entrants, naïve capacity

Readily available reinsurance capital

Top-line focus

Increased M&A activity

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The current landscape of the D&O market has changed significantly over the last 12 to 24 months

Increased claim frequency and severity

Significant increase in frequency and severity of large securitiesclaims (delayed impact of PSLRA ’95) and EPL claims. Severityincreases will hit XS reinsurers hardest.

Slowdown in economy Will reduce investment income and may further increase claimfrequency (securities and EPL).

Significant rate increases Market in “Payback” mode. Many insureds seeing 10% to 50% (or more) rate increases in 2001

and 2002. Focus on underwriting discipline Stricter underwriting necessary to restore profitability to a line hit by

a recent surge in claim costs (coverage restrictions, terms andconditions, unilateral discovery).

Move back to underwriter forms, away from broker forms. Pricing more transactional than relationship driven.

Increasing capacity limitations Some market withdrawals. Limited capacity for technology,biotechnology and healthcare industries.

Many players on each program.

Reintroduction of coinsurance Retreat from full to 80% entity coverage limits exposure; givesinsured stake in settlement negotiations.

Single year policies 3-year policies, prevalent from 1997 to 1999, are now rare. Increased price responsiveness. No reinstatements.

Description/D&O Market ImplicationsDescription/D&O Market ImplicationsTrend/DevelopmentTrend/Development

Source: Tillinghast – Towers Perrin analysis; industry press

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“Best practice” companies are most likely to remain profitable in a rising cost environment

Underwriters that understand their insureds Close/frequent monitoring of insureds’ financial results Significant information disclosure required during application/underwriting

process

Active loss mitigation/risk management programs Ability to manage both securities and human resources claims

Corporate Governance reviews by outside parties

Active retention management on EPL

Strong broker relations

Active actuarial participation Understand drivers of loss costs - size and segment key drivers Create architecture around the pricing of a risk vs. market pricing

— Reevaluate the expense base used in rating— Update Increased Limit Factors and Deductible Factors— Ensure data integrity— Keep pace with trend

Understand company’s case reserving philosophy Regular open dialogue between claims, actuarial and underwriting

Summary

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Key takeaways

Results vary significantly across market segments Not-for-profit and private, for-profit business present a different type

of D&O exposure than public for-profit companies Public exposures, however, show mixed results, with larger insureds

looking unprofitable Previously clean segments now looking much different (utilities)

D&O premiums are in a rapid growth phase Fueled by significant price increases (estimated 20% in 2001; 30% or

more in 2002)

Rapidly rising claim costs have also been a prominent feature of the D&O landscape Historical average increase approximately 10% through 1999 Rate of increase may have doubled since then Hard data not available

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Key takeaways

The implications of primary insurers’ lack of profitability are Weaker players will continue to exit the business, possibly resulting in

increased industry concentration The most profitable players will be those embracing loss mitigation/risk

management programs and disciplined, data-driven underwriting approaches

Implications for reinsurance partners Excess reinsurance will require extra care in underwriting, as will

reinsurance of books with heavy concentrations of large public risks Leveraged effects of inflation on excess positions present unique

challenges Profitable reinsurance opportunities may exist in the market -- the

challenge is finding the right cedents— Mix of exposures (I.e. size and industry of insureds)— “Best practice” underwriting, pricing and loss

mitigation/management… and the right reinsurance structure and terms