Financial R&R: Alliant Financial Institutions Discuss Risk Issues Driving the Market

Intro (00:01):
Welcome to Financial R&R a show dedicated to financial insurance and risk management solutions and trends shaping the market today. Here are your hosts, Ron Borys and Ryan Farnsworth.

Ron Borys (00:14):
Hi, this is Ron Borys with the Alliant Financial Institutions team. I'm happy to be back here again today with Ryan Farnsworth and Steve Chappelle. Today we've reassembled to talk a little bit about what's going on in the marketplace. Obviously having Steve, as part of our team now enables and gives us sort of an opportunity to sort of really dive into some of the legal trends and risk issues that underwriters are focused on. And largely, what they're saying is driving sort of rates and sort of changes in coverage terms. So, with that Ryan and Steve, let's just get right at it. So, Steve, obviously this has probably been one of the hardest markets that we've seen in over a decade, certainly since the financial crisis and maybe even since 9/11, you know, underwriters are concerned about the capacity and the risk that's out there relative to the limits they have exposed. What do you think is driving their concern?

Steve Shappell (01:05):
Yeah, it's a frequency issue. As we have seen over the decades, right, insurers do a really good job of, you know, ratchet down their capacity to address the severity issue. But it's the frequency issue that they're struggling with the 400 plus suits a year. You know, attachment points and reduced capacity don't really give them the protection of the exposure to this increased litigation because they're getting hit with sheer numbers as opposed to the severity of capacity of a 10 million limit versus a 5 million limit. If it's twice, as many of those claims that's problematic to the market. So, it is largely driven by the frequency versus the severity. And then the astronomical costs, the cost in these claims and management liability claims increased so much over the past few years from five, six, $700 an hour, a decade ago to $2,000 an hour for certain claims and certain jurisdictions. So, that is one of the significant challenges that underwriters are trying to address in this hardening market.

Ryan Farnsworth (02:25):
And I think one of the things Ron and Steve, that our clients are really trying to focus on is the contract language is their ability to differentiate their risk in the marketplace as they talk with and speak with underwriters. Investors are trying to diversify their approach to investment, right? We've seen a SPAC-a-Palooza if you will, this year. There's been three times more SPAC launches this year than any prior year. And the gross proceeds from this year dwarf last year's activity by more than 4x, right? And we've seen a lot of facts, you know, special purpose acquisition companies or blank check companies come through the marketplace that have taken a lot of underwriters by surprise. Quite frankly, they've taken a lot of investors by surprise, but I guess we shouldn't be surprised about anything we see in 2020 anymore. Right, but there seems to be a lot of attention from the D&O underwriter. Now that this influx of SPACs has come across the market. Steve, how do you think an underwriter or a client or a management board, should approach what we've seen in the SPAC world recently?

Steve Shappell (03:34):
Yeah, it's a great issue, right? These special per-acquisition companies, SPACs, have exploded. So, five years ago, there were a little over 3 billion of SPACs across 13 different IPOs. This year so far, there are over, there's 34 billion, right? That is an unbelievable pace. And it's really concerning to the underwriters because we're all trying to anticipate what are the claims going to look like. Because the plaintiff's bar, as we all know is clever and we will see litigation while the litigation has not come at the same pace as kind of traditional shareholder class action litigation. We'll see these claims, right? There are going to be significant redemption issues for people who are making these investments in these SPACs. The proxy issues open up this enormous litigation exposure because of the number of disclosures that are made.

And every disclosure is going to be carefully analyzed under a microscope after the fact. Monday morning, quarterbacking of the accuracy and we're going to see those kind of claims come in. So, I think the underwriters are correctly worried and I think our clients and people and companies utilizing these facts are correctly exercising caution because you know, the good news with a SPAC. And I think one of the reasons the litigation will never explode as it has a shareholder class action litigation is the business judgment rule is going to be an enormous hurdle here. And when we talk with clients and SPACs, that's something to keep in mind. It's the business judgment rule that is valuable and courts do not want to just insert their judgment in replace of the boards, but it requires a high degree of this judgment to be exercised on these defenses. So, yeah, this is something that the three of us, I know have talked about and we're spending a lot of time on this and we will continue to spend a lot of time on this, analyzing the exposures and making predictions so that these policies that our clients are purchasing on these risks perform when these evolution of claims from the plaintiff's bar come about

Ron Borys (06:04):
Steve. Maybe we could just spend a couple of minutes talking about some changes in potential regulatory exposures. So, we obviously know that there's an anticipated change in guard in Washington. Over the last, call it three or four years, it seems like the regulatory environment has lightened up a little bit, under the current administration. Now there are obviously thoughts and concerns that some of that may come back. And certainly, as we know in many cases, whether it's under an asset management policy or other types of policies that there is coverage potentially for regulatory-type issues. Well, have you given any thought to that, and how should we be guiding our clients relative to the value of that coverage and how they should be considering those exposures?

Steve Shappell (06:49):
Yeah, I mean, for sure, with the new administration coming in, there's going to be greater regulatory enforcement, right? I think everyone anticipates it, there are many of us who have been talking about this, writing about it, and the regulation and enforcement from the federal government has reduced over the four years of this administration. There's no doubt about it. And so, we need to, and we are spending time thinking about looking at policies to make sure that as these regulatory enforcement actions and efforts and focus, increase over the next four years, we are not going to be caught flat-footed and our clients won't be caught flat-footed. So, that's a lot of what we're talking about we must anticipate that enforcement, as everybody is promising will increase. And our clients will be challenged. As a result, be looking to their policies for protection.

Ryan Farnsworth (07:52):
That's a scary thought, right? Because the SEC's division of enforcement just released their fiscal year 2020 report with over 700 enforcement actions, 1200 new inquiries and investigations at all-time record for discouragement and penalties, right? Almost 5 billion dollars. It's insane to think that even just to defend and respond to those types of inquiries is going to be costly for these companies. And we have the recent Supreme Court decision, the Loo decision. Steve, I would love to get your thoughts on that as well. That's also, I imagine going to play a significant role in how the SEC imposes penalties and returns, disgorged funds to investors. We haven't quite seen it play out yet. To that extent, there are a lot of points that D&O insurance holders need to pay attention to with respect to that decision.

Steve Shappell (08:44):
Certainly right. That decision gave some roadmap and some authority to the SEC some teeth, we've got to anticipate that this Biden administration is going to look to flex some of its ability to enforce remedies, fines, penalties and remedies on companies to fulfill. What I think most of us are anticipating is going to be a perception that we need to increase our efforts at enforcement and regulation. Even though to your point the SEC has really done a good job, even though we all anticipate there'll be more SEC enforcement regulation. The SEC has not been sitting around doing nothing, right. They've been incredibly active over the last few years.

Ron Borys (09:35):
Yeah, and it's funny, Steve, that's one of the big challenges that we have, right. Is clearly the underwriters are paying attention to this data whether it's this recently released data or the data that's released from Cornerstone with regards to filings of security class action litigation, and unfortunately in our business, right? As we all know, it's long tail business. So, underwriters appear to be trying to build their war chest today for litigation or losses that they anticipate over the next 2, 3, 4, or 5 years. But it's really frustrating for clients who look at it and say, well, why should I be penalized now for something that may or may not happen in the future? Right. So, it's a really interesting dynamic. And I think it's just something that we're going to have to continue to be out in front of and continue to provide as much transparency to our clients.

Like I said, there's a lot of data that's flowing throughout the industry right now with regards to rates and how rates should be tracked and trends. And I think unfortunately that data is being shared at a very high level. And as we know, our goal and focus is to differentiate our clients to really not allow those macro-level type thoughts and decisions impact each of our risks, which makes it more work for us sometimes. But I certainly think it's well worth it and certainly a more rewarding way to manage risk for our clients. Let's just talk a little bit about what clients should expect between now and the end of the year, and then obviously forward looking into the first quarter and 2021.

Steve Shappell (11:07):
Yeah. So, from a claim perspective we have seen looking, you know, we've talked a lot about some of this securities litigation. We've seen a tick down in securities litigation this year. Is it pandemic cause is it either events or other indications that have traditionally driven shareholder class action litigation like restatements? And so, it's not clear exactly what is the favorable claims environment right now. We're a little over a month from the end of the year, and we're about a hundred shareholder class actions less this year than last year, will there be a hundred in the last 45 days? Yeah, I don't think so. So, I think we'll, have, I'll save a bit of a reprieve, but the bad news is it's still 300 shareholder class action suits.

And when you take out some of the M&A litigation and you boil it down some of the traditional shareholder class action litigation, there's still a lot. There's a lot of IPO litigation and a lot of shareholder litigation, a lot of foreign entity litigation. So, from a perspective of pressure on markets between now and next year I don't think we are in a situation where we can anticipate that carriers are going to look at this perhaps favorable trend, even though I wouldn't call it a trend and it's time of the pandemic. And start to relax a little bit, to your point earlier I think we'll continue to see carriers very nervous. You know, we talked a little bit about the SPAC exposure and this explosion, right? Tenfold in five years of use of these special purpose companies. Those uncertainties are not things that are going to particularly drive carriers to relax and think that the market's softening and let's give some relief.

Ryan Farnsworth (13:01):
I think from a placement standpoint, Ron, and then Steve's clients should recognize as we talked about on the last podcast that this harder market was reinforced by the competition and the influx of capacity over the past 10 years. And the underwriters are showing discipline. We as brokers and our clients should expect to see the same stance from underwriters until we get to a point where they either feel more comfortable loosening those terms and conditions, or we can add additional capacity into the marketplace, that's going to try to compete. And I think until then we know the game plan, we know the playbook, right? To put it into a Shappell-ism right. We need to get with our clients early and often, and go through the process and ensure that we're differentiating risk the way that we can. That's why we're all here at Alliant.

That's why our specialty approach works in this market in particular. And why a lot of the things that we're seeing in the broader marketplace at least within our own book, you know, we look at our set of clients and say, okay, we're experiencing, we're writing through this market together, but we're blown away by some of the other disclosures that are released by another about the price increases that they're seeing because our ability to truly differentiate risk is providing our clients with more favorable results than what we're seeing in the marketplace. And that’s paired with conversations with underwriters' perspective clients, with our actual clients. And, it's just a re-enforcement of our specialty approach.

Ron Borys (14:39):
Listen, I will say, Steve, I realize we're into day four and you probably already have a million sorts of things on your list of agenda items. But one of the things that makes me really excited and one of the many things that you bring to the table and will bring to our clients is the research that you do on this stuff. I know a lot of our clients don't have the time or capacity to dig into cases and litigation, and it's really understand sort of what's driving behaviors, whether it's relative to their insurance renewals or another type of risk factors. So, I'm really excited for what you are going to bring to our team and to Alliant clients when it comes to that type of analytics and research.

Steve Shappell (15:23):
Yeah. Agree, Ron, and it's clearly one of the things that attracted me Alliant, is the commitment and actually the resources to do exactly what you just described. Right. You know, there's an impressive team here of claims and legal talent that I'll be working with who are very well versed in these legal developments and excited to make these contributions on research and analysis of these exposures, because it's a big deal. And we see it all day every day. The platform here at Alliant is going to allow us to really deliver this kind of detailed, legal and claims analysis.

Ryan Farnsworth (16:04):
You know, I speak for Ron as well as everyone else at Alliant Specialty. We're again thrilled to have you with us. We look forward to continuing to grow our business, differentiating our approach to clients and prospective clients and welcoming many more insurance brokers, claims professionals, and people who just want to help make a difference for their clients in this difficult market, into our fold in the coming months, we look forward to the next opportunity, we can have a conversation, provide some advice and some help through this crazy market that we're in. And we look forward to doing it with you and for additional information, please go to our website at www.alliant.com. Look forward to the next opportunity to speak with you. Thank you everyone.