The changing landscape: In writing directors and officers liability insurance, underwriters must be relentless in pursuit of more and better information, and disciplined in applying their knowledge. (Underwriting Insight: Property/Casualty).

The rewards for what an observer called the "infectious greed" of the last decade have been skyrocketing shareholder lawsuits and the emergence of directors and officers liability insurance as front-page news and must-have coverage.

The series of well-publicized corporate failures and mishaps--beginning with energy giant Enron Corp.--has focused attention on D&O, hitherto a reasonably quiet line of business. This examination is bringing internal and external reform, increased customer demand and, to those writing the business, sobering clarity of the full extent of risk they bear.

D&O coverage has been a major part of the risk management arsenal for companies since the early 1980s. It evolved from protection for leaders of Fortune 500 companies to include those who head for-profit and nonprofit organizations. Like most lines of insurance, it has been cyclical in both demand and claim activity.

However, a highly specialized securities plaintiffs' bar has formed over the past decade and is ready to jump in with a lawsuit for any negative development. Corporate America has fueled this frenzy with massive insider sales transactions, stock price drops following disappointing earnings announcements and even financial restatements. Throughout the 1990s, insurers were seeing increasingly large lawsuits, with a significant number in the high eight figures and a few multibillion-dollar suits such as the Cendant case, which settled for $3.2 billion in 1998.

Historically, successful insurers have thoroughly researched the industries of the companies they were interested in writing. That's even more important today.

It's just as important to differentiate the risk profile of each potential client in a meaningful way. Underwriters spend much time trying to identify which companies have strong, independent audit committees, a knowledgeable and involved board of directors and conservative accounting procedures.

Most underwriters probably can't see round-tripping revenue distortion or every off-balance-sheet transaction. What an underwriter can see are clues to asking the right questions. What's the attitude of the senior executives and managers? Does a chief executive officer who demands consistent growth and profit set the stage for unusual accounting practices that spiral into fraud? Could managers who respond to legitimate questions with a sense of arrogance be hiding something?

These days, D&O underwriting is an art--and a science--and there is no substitute for experienced underwriters who are relentless in their pursuits of more and better information and disciplined in applying their knowledge.

Amid deteriorating results, D&O underwriters worked to hone their skills, leading to positive developments for their return to profitability. Gone is the three-year policy in favor of the one-year term. Since a company's fortune can change in a single quarter, this allows the insurer to address a deteriorating risk more quickly. It also allows insurers to recognize improved results and better governance in an equally realistic time line.

Another important tool is appropriate terms and conditions. Insurers must be vigilant about erosion of policy language and reinforce that the policy is not meant to--and does not--cover deliberate illegal acts and fraud. Carriers also are taking a harder look at policy rescission and are more willing to rescind policies if they believe the insured committed fraud in obtaining the coverage.

Pricing also has increased and become more sophisticated. Self-insured retentions for smaller favorable risks that might have been $250,000 last year are now $1 million. In more troubled industries, or for larger risks, SIRs can be $10 million, $25 million or sometimes even as high as $150 million. Another increasing change is co-participation. Here the insurer splits with the insured the cost of claims--sometimes resulting in the insured taking 50% of the risk. This way, limits can be the same, but they're stretched upward by the insured's involvement.

Recent regulatory actions, including the Sarbanes-Oxley Act, should have a positive effect on the D&O actions related to securities law. But short-term, we've seen a bubble of lawsuits as companies clean their closets and push the skeletons out into full view.

Despite the turmoil, if D&O coverage is conservatively underwritten and properly priced, it should make a healthy recovery in terms of appropriate profitability for its underwriters and in its utility for corporate America.

Judy Blades, a Best's Review columnist, is senior executive vice president, Property-Casualty, The Hartford Financial Services Group Inc.