Volatile times call for best D & O coverage: dangerous scenarios can play out, so don't be complacent about your protection.

• Author: Rosenberg, Evan
• Position: RISK MATTERS

FOR DIRECTORS, the past few years may have been the best of times. But could the worst of times be lurking just around the corner?

Two independent consulting firms, Cornerstone Research and NERA Economic Consulting, both report a significant increase--to levels not seen since 2004--in securities class action (SCA) filings in the second half of 2007. NERA counts 207 filings in 2007, up from 131 in 2006. Furthermore, the severity of directors and officers (D & O) lawsuits continues to rise, with NERA noting that securities lawsuit settlements averaged $33.2 million for 2007--an all-time high and 46 percent higher than 2006.

This spike in securities litigation raises several questions for those who purchase D & O liability insurance coverage. Will the recent decline in D & O liability insurance premiums continue? More importantly, as a director, will your D & O coverage perform the way you need it to?

Stormy days ahead?

D & O liability insurance premiums have declined by nearly 37 percent since 2004, according to consulting firm Tillinghast. This decline in rates directly relates to the previously mentioned lull in securities lawsuits (although it is worth noting that the severity of lawsuits continued to increase).

Two predominant theories explaining the lull were forwarded in mid-2007 by Cornerstone Research. According to the "less fraud" theory, corporate reforms stemming from the Sarbanes-Oxley Act of 2002 have had the desired affect of reducing fraud, resulting in less litigation and a permanent shift to a lower level of litigation. Another possible cause for the decline in SCAs was the increase in options backdating cases, the vast majority of which were brought as derivative lawsuits, and which may have served to "distract" the plaintiff's bar from filing SCAs. Several of these cases settled for more than $50 million.

As my colleague Randy Hein correctly predicted in his article, "D & O Liability: Is This the Calm Before the Storm?" (Directors & Boards, Fourth Quarter 2007): "It's simply unrealistic to assume that the calm will continue indefinitely and that volatility has permanently disappeared from the marketplace. The only truly permanent condition is the potential to be sued." Since penning those words, the financial world has displayed a great deal of volatility.

Therefore, it is a certainty that the downward D & O pricing trend will at least stabilize as securities lawsuits climb back to "normal," historic levels. In fact, the...