In this podcast Danny Hojnowski, SVP at TransRe, discusses everything from market conditions, Cyber, D&O, E&O and even Crypto.
Can’t listen now? Read the transcript (edited for brevity and clarity)
What is your biggest D&O claims lesson?
It was back in my facultative days at TransRe, around 2007. E-Trade Financial had a nasty D&O claim, the renewal was approaching, but so was the financial crisis. I thought about getting off multiple times. It was my first $2.5 million claim, which was the most we did back then. It was my biggest claim to that point, and everything in my instinct told me I should probably not renew. I read in their 10-Ks and 10-Qs they were giving out loans for yachts. What could go wrong? But we did a fair amount of business with the ceding company. I probably should have pared back and cut the line in half, but I stayed with $2.5 million, and within four months E-Trade was potentially bankrupt. I like to say the typical tail on public D&O is 5-7 years. We had a reserve up on that one within 18 months, and we paid full loss. I learned a lot, specifically to trust your instinct when underwriting. You need to be willing to have that tough conversation with your client and say, ‘I get the overall relationship, but I can’t go down this road with you.’
What did E-Trade do wrong?
It was a D&O claim because E-Trade overleveraged themselves by offering loans. In addition to lending on yachts, E-Trade allowed customers to leverage their brokerage accounts. They were also in the mortgage business. When everything blew up their stock dropped, investors filed a suit and next thing you know, it was a limit loss.
What were the allegations?
That the Directors & Officers should have had better foresight and should have hedged themselves better. They should not have made so many loans to people who could not afford to pay them back. In hindsight that makes a lot of sense, but back then almost every bank was doing the same thing. They all fell into the same trap, which is why we had some serious D&O losses in 2008 – 2009.
If this was a securities class action, aren’t the investors suing for money from the company they own?
In theory yes, but in fact they collect the money from the company’s D&O insurers. And it typically isn’t the investors who get the money – it’s their lawyers. There is a pattern of behavior – when a company’s stock goes down, a class action is filed alleging some kind of securities fraud or wrongdoing. These days ‘wrongdoing’ can be anything. Matt Levine of Bloomberg said, ‘everything is securities fraud’.
If you look back historically, we used to have 150-200 securities class actions a year. In 2016 to 2019, we had almost 300 cases a year, excluding merger objections. It really became ‘anything is securities fraud’. Boeing’s plane crashes, Peloton had a treadmill that a baby climbed on and was injured – they are securities fraud. You suffer a cyber breach – that’s securities fraud. The plaintiff’s bar argued anything that happened that had an adverse effect on a company’s stock was fraud and filed class actions to see what stuck. Is it right? It depends. If there is gross mismanagement, then they should be held accountable. That is why D&O insurance exists. However, recent excesses go beyond that, with overzealous attorneys pursuing almost everything.
The allegation is the officers have violated their duty of care?
An officer has a duty of care and fair representation to shareholders. As Levine says ‘you are allowed to screw up. You just have to tell us, the shareholders, when you screw up, while you’re doing it’. If things are disclosed properly, there shouldn’t be a claim. It really comes down to the disclosures. If they aren’t proper, you run into problems. Silicon Valley Bank is a perfect example. No one thought they might go out of business, but they weren’t aligning their assets and liabilities correctly. You could not tell what was going on from their financial statements. That’s a legitimate D&O suit in my mind.
Should we have seen Silicon Valley Bank’ problems coming?
That would’ve been really tough. You had some of the smartest FI underwriters out there who looked at SVB a year ago and thought everything was fine. I think a lot of what happened with SVB was a traditional run on the bank. You had a very concentrated group of depositors, most of them venture capitalists and private equity backed companies. Back in the day, a run on the bank meant you had to go line up and get your money out. Now it’s push of a button, the money is gone, and you could pull it out within a day. SVB did not match up their assets and liabilities the way they should, and their downfall was a traditional run on the bank.
Will this change how you look at other financial institutions?
We are talking to all our insurance clients and their FI underwriters about what they’re doing. We hear they are asking a lot more questions. Who is your customer base? Are they all owned by the same venture capital firms? How many have deposits above the FDIC $250,000 limit? How are you hedging your interest rate risk? The market has quickly figured out what went wrong and is now underwriting to that risk. The challenge is that a D&O policy lasts a year. There are other regional banks who might be in trouble and you have a policy in force. There’s nothing you can do until the policy comes up for renewal.
What are your thoughts on First Republic? (recorded on May 1)
They are going to JP Morgan, and the deposits will be fine, which is the most important thing. There is already a securities class action lawsuit. The shareholders and bond holders of First Republic are close to being wiped out and they are filing against the D&O policy for recovery.
Will that work?
I don’t want to talk against my book, but something this big is likely to progress, especially with headlines around banks being seized. I think more likely than not there will be some sort of settlement.
What would happen if they didn’t buy D&O?
The Directors & Officers would be on the hook themselves for any potentials.
Do you think they would really go after individuals?
I have been doing this for over 20 years and I’ve seen it happen once or twice, where there was such egregious behavior that they pursued individuals. Those were Enron and WorldCom, which had D&O cover, but they blew out the top. Even if individuals don’t have cover, the company does, and for the outside directors, but if there is blatant fraud, you would be able to go directly after the directors themselves.
Does insurance create its own outcome? By existing, does it attract the lawyers?
There is some truth in that. If you’re a plaintiff lawyer and you know a company buys a $500 million tower, it’s a lot easier to go after that $500 million insurance tower versus trying to seize a CEO’s house.
If you cut insurance coverage by 50%, do you think claim costs would go down?
No. I think it would need a considerably larger reduction to get claim costs down. The plaintiff’s bar has made such a good living pursuing D&O claims that the genie is out of the bottle. I don’t see that stopping anytime soon.
Does this exist anywhere else in the world?
A little bit in Australia. They are starting to pull together some securities class actions. We have seen some collective actions in London, but not on the level that it exists here.
Stock market exist everywhere. What is their different legal theory for D&O wrongdoing?
I think it is more of a cultural issue rather than a specific D&O issue. If you look at GL losses, auto losses, umbrella losses, we in the US are much more litigious than anywhere else in the world, and I think that’s what’s driving it. It’s not D&O specific, but I think that’s fair across all lines where in the US you’re just getting higher settlement after higher settlement.
So, we want to blame somebody else and take their money?
Pretty much. That’s a great way to distill it down simply.
What’s missing in other countries? Are lawyers not as powerful or are there other reasons?
I think it’s the way our courts work and the awards that have been made. Once you start down that road, it’s very hard to reverse. Other countries have never really started using formal class actions. Even individual actions here, people talk about social inflation all the time. You could argue how relevant it is in professional lines, but we see it all the time in our traditional casualty book. You have an auto accident and next thing you know there’s a $1 million claim with some sort of ECO claim that runs for $10 – $20 million hidden in there. Some of these claims are shocking, and in MedMal as well. We have gone down a road and the only way back would be a comprehensive litigation reform. With the political system we have right now, I don’t think that’s really at the top of anyone’s mind.
Is there D&O in crypto?
Yes. It’s very tough to cover. One of our standard treaty exclusions is cannabis and crypto, but some companies write crypto and we pick up a small amount. We are trying to be very careful, but there is an emerging market for crypto D&O coverage and crypto is here to stay, whether you like it or not. People sitting on the boards of these companies need coverage and the market is responding to that.
What sort of companies?
It can be token issuers. FTX collapsed and they had a small D&O tower. The towers on the crypto side are nowhere near traditional D&O because capacity is so scarce. Whereas you might have a $500 million tower for a decent size company such as traditional bank, a crypto company would be lucky to get $10-$20 million of capacity.
Is crypto D&O a natural test of our theory that lower D&O limits would reduce claims?
You know what we might see that, FTX might be the canary in the coal mine for that. FTX is a definite D&O loss but they have nowhere near the tower that some of these other banks that we have talked about have.
Are there any other losses or claims notices that you’re aware of?
Not so much on the crypto side, but as I said we don’t do much in that space, so I may not be the best person to ask.
Will we be talking about crypto more again in the future?
Yes. The crypto market is behaving much like the market for IPOs and SPACs did two years ago in the traditional D&O space. At one time you could put together an IPO tower with $1 million retention, a primary layer of $5-$10 million, with a 10 rate on the line and that would’ve been a big number. Two years ago, when D&O losses really started to run through, and the market started to correct itself, you were seeing people putting up $2.5 million excess of a $5 million retention for a million dollars. It was almost cost prohibitive. To attract someone to sit on your Board, they will mandate this coverage be in place – otherwise someone can go after their house. The coverage is almost forced placed by the board. You are getting the same thing with crypto. If personal assets could be at play, they will buy this coverage.
How did the SPAC IPO story play out? How did the marketplace behave?
It was a very tight market, and I was very concerned two years ago. As a reinsurer, I’m an aggregator of risk. I support many insurers who might all be writing similar, even the same accounts. With SPACs, my biggest concern was an insurer writes the private company D&O, another insurer writes the SPAC (public company D&O) and then a third carrier writes the de-SPAC (following the acquisition). If there was a big lawsuit, I might be hit on three separate policies written by three different insurers. It seems most of the SPACs will wind up and return funds to the investors. The D&O market will do very well on the SPACs, but a lot of the de-SPACs are struggling.
Can you explain the terminology?
A SPAC is a special purpose acquisition company, formed by a group of investors and publicly listed on a stock exchange. The SPAC is a shell that tries to find a private company to buy. Once the SPAC finds and buys that private company, it then becomes a public company. In other words, it’s a different way for a company to go public. A de-SPAC is what happens after the SPAC finds its target and completes the acquisition.
The D&O market writes a two-year policy for the SPAC and, once the SPAC buys a target, that policy goes into runoff and the go-forward company buys a de-SPAC policy.
So, SPAC D&O policies will be ok?
Yes, because the majority are returning money to investors, with no losses: ‘we went out, tried to find someone, the economy turned, here’s your money back.’
The de-SPACs worry me a bit more because the SPACs found private companies that were probably not ready to go public. Their financials just weren’t as good as they should have been. At one point there were ~300 SPACs looking for targets. That led to bidding wars, and overpayment. Many de-SPACs are trading well below the acquisition cost. A typical SPAC would start trading at $10, and many are now $1-$2, so investors are sitting on 80%+ losses. There are already a number of cases where plaintiff attorneys have sued both the SPAC and the de-SPAC policy. Case law very much leans towards the de-SPAC being on the hook for those, not the SPACs.
Is this what you expected?
If you asked me this question two years ago, I would have told you I was scared to death of SPACs because I was concerned that I could potentially be getting hit on three separate policies. Now it looks like it would be only the de-SPAC policy.
If we knew then what we know now, we might have written all the SPACs we could, but I don’t think that was foreseeable. It was new territory for us – although SPACs had been around for a while, not in the volume we had two years ago, and with very little litigation precedent as a reference point. As a result of what we know now, SPAC D&O has become cheaper, although there aren’t many new SPACs to buy the coverage.
Is cyber another innovative market that is gaining more certainty over time?
I think the cyber market has improved tremendously over the past few years. The market really stepped up and did a great job to make the insureds into better risks. Two or three years ago insureds could still buy insurance without multifactor authentication and with a bunch of open RDP ports. Someone might have charged them a bit more, but they would still have found coverage. Today, they can’t get coverage at any price. Our insurance clients are working with the insureds and brokers – they are scanning 60-120 days before renewal and saying ‘we are concerned about this’. As an industry we have made the underlying risk better. We have told insureds ‘this is the bare minimum to get coverage’. The underlying risks in my mind are much better than where they were two years ago when ransomware was so prolific.
Are there similar concrete, specific requirements to get D&O coverage?
Not really. Every insurer has a slightly different appetite. D&O coverage requires audited financials, but every public company has those. A cyber loss will come from someone trying to hack you. You don’t have that same foreseeability in D&O. For instance, Boeing had a plane crash that turns into a securities class action suit as well. It’s just tougher on the D&O side.
Would it be possible to improve other markets? What about Lawyers E&O?
Lawyers E&O is an interesting market. TransRe has been in that market 40+ years. You look at the scope of work that larger law firms are doing, how complex it is, the dollar amounts involved in these cases and it’s been a really tough line of business for us. Once you get into the high excess layers, it’s performed much better. On the primary side, just with how complex the work that they’re doing and the dollar’s involved, if you get a claim it’s going to run you a fair amount of defense costs just to unravel what may have happened, much less be able to tell them in advance what’s going to happen. Also, you have lawyers fighting other lawyers, with no-one willing to settle or admit wrong-doing. We find costs tend to spiral quickly in large law firm cases.
Is Large Lawyers E&O claims administration/claims adjustment more difficult?
Absolutely! It is all lawyers, everywhere. They can be the best client, because they know everything, or they can be the worst because they always think that they’re right. When you get to settlements it can be tough. Those cases linger on a bit longer, running up bigger defense costs.
Are there tough jurisdictions for lawyers that always come up?
Most of the large lawyers operate multinational. For mid-size to small firms, the same jurisdictions (CA, NJ, TX) always come up.
Florida is tough for property and auto liability claims, yet it isn’t clear those two things should be linked. Is that also true in professional lines?
With professional lines you have more sympathetic juries, which means bigger awards. You do have real issues with hurricanes and how those are adjusted, and you have the auto market that’s very difficult as well. If we use a traffic light (green, yellow, red) I would call Florida more yellow than red on the professional side.
Finally, how did you get into the business?
I grew up in Bayonne, NJ. I didn’t know what I wanted to do when I went to college. I majored in English lit and philosophy, not the best things to get a job in 2001. I thought about going to law school, but I moved home and started playing rugby. One team-mate worked at Everest Re as a D&O underwriter and another was a broker at Aon. They got me an interview and I had my first job as a facultative D&O and E&O underwriter with Everest.
It was a job opening that came up and totally random, but I loved it and it has been my whole career. What I like most is the people. That is likely true of any business, but re/insurance is a relationship business, and I don’t think that’s ever going to change much. Some of my best friends are in this business. People I met in this industry were in my wedding party. I don’t come to work every day to run through spreadsheets. That does happen some days, but for the most part, I’m going to talk to my friends and I’m going to enjoy it. That’s really what has kept me in the industry.