While much media attention has been given to the SEC considering eliminating quarterly reporting for public companies, there was a much more consequential decision made by the SEC recently with major implications for insurers.
Surprisingly, I have seen very little discussion about this change as it potentially eliminates major sources of liability for D&O insurers.
What exactly is this change? The SEC has removed its prohibition against public companies requiring arbitration for corporate lawsuits. This means public companies can change their by-laws to force any litigants to submit to arbitration rather than being able to file a class action.
If this practice became widespread, it would effectively end shareholder lawsuits. This would obviously be very favorable for D&O insurers.
I’m not a legal expert and, from what I’ve read so far, there are some other potential obstacles that might prevent corporates from mandating arbitration, but there appears to be momentum to overturn some of those obstacles as well.
Zero Loss Ratios???
In the short term, this change would be a windfall for D&O insurers. While it may be hyperbole to say loss ratios would actually be zero, they surely would drop tremendously. Arbitration tends to be favorable to defendants and also severely reduces the severity risk as it eliminates the potential for a jackpot award to a class.
However, this may only be a short term benefit. A future SEC Commissioner may decide this was a bad decision and reverse it so we may only be looking at a few favorable accident years.
I would be very careful in 2028 writing a policy that extends into 2029 without a provision that either limits exposure if the rules revert under a new administration or requires a supplemental premium to reflect the added risk.
When Good News Is Bad News
There is a flip side to this development though that is pretty negative for insurers. If losses disappear, eventually, so will premium.
Corporates will understand their exposure is much lower and demand massive price cuts. Would you rather write $1B NPW at a 90% CR or $200M at a 50%?
While the financially astute would argue the latter requires less capital, your average executive would be aghast at the loss of premium (not to mention the stranded overhead costs) and probably do stupid things to try to grow that $200M to $300M.
And we all know ultimately, that $200M would find its way back to a 90.
Competitive Knock-on Effects
The excess market would likely disappear first given the risk of excessive verdicts obviates the need for excess cover. While at least the primaries can keep their windfall profits for a year or two, excess premium will disappear at the first renewal.
I would also guess many D&O writers would try to chase business in other PL markets. “If we can’t write D&O, let’s try to double our market share in EPL!” The ripple effect would lead to higher combineds in adjacent PL markets.
So, this may be one of those be careful what you wish for. A few years of windfall profits followed by your market going away doesn’t sound very appealing.
There’s a lot still unknown, so I will keep this note brief, but I wanted to put this on people’s radar as it is potentially the biggest insurance story of the year.
I don’t think this will last long. The eighth commandment, and common law obligations not to cheat people are more fundamental than a regulation from the SEC. It is a regulation, not a law. Add in the litigious nature of the US… Matt Levine will once again be right that “Everything is securities fraud.”
With equities markets dominated by large institutions like Blackrock and Vanguard, they can exert enough pressure to hold directors accountable. At least, I hope that’s the case. 😉