Director & officer liability insurance – tips for selecting the ‘right’ policy limit, retention and insurer
April 2014 | SPECIAL REPORT: MANAGING RISK
Financier Worldwide Magazine
Three of the most common questions we hear from purchasers of D&O insurance policies are: How much insurance should we buy? What is the right amount for our retention? Does it matter what insurers we use on our program?
Each of these questions is important and can make a significant difference in a claim situation. Here are some tips that may help answer these questions.
Selecting the right policy limit
There is no foolproof way to determine the ‘perfect’ amount of D&O insurance to purchase for any particular year. That said, there are many factors that can inform insureds as to the proper amount of insurance they need to feel comfortable:
Claim studies. Perhaps the most scientific way to determine the appropriate D&O insurance limit is to consider a claims study by NERA, Cornerstone or a similar economic consulting firm. These studies consider the mean and average settlement values for class action settlements controlling for factors such as market cap, industry, and insider and institutional investor holdings. The studies project a range of probable losses for various stock drops based on historical trends. For example, if a company’s stock dropped 20 percent, the expected loss would be X. If the company’s stock dropped 40 percent, the expected loss would be Y. While these studies can be informative, they cannot predict the size of a future stock drop or whether the losses relating to such a drop will fall within historical trends.
Benchmarking studies. Benchmarking studies provide an insured with information about what limit the insured’s ‘peer companies’ are purchasing. Again, this can be helpful, but there is no guarantee that the insured’s peer companies are purchasing the right limit. Moreover, such studies are typically limited to one broker’s experience, which may or may not include a statistically significant sampling of peer companies.
What the directors want. Sometimes, directors or officers will insist on a certain amount of insurance regardless of any claim studies or benchmarking data. Failure to provide the desired limit may mean that the company will be unable to attract or retain directors or officers.
What the insured can afford. What the insureds can afford is another very real factor in determining what limit insureds should purchase.
Public perception. Some companies fear that a high D&O insurance limit may attract lawsuits or increase the size of settlements. Most studies do not support this conclusion.
When deciding the appropriate limit to purchase, insureds should also consider that defence costs are usually (but not always) included within the limit of liability. Thus, insureds also need to factor in the cost of defending a lawsuit when determining the appropriate limit.
Selecting the right retention
Selecting the right retention is a complicated decision. Generally, an insured should select a retention that is above what it takes to resolve a typical ‘cost of doing business’ type claim but below the point where satisfying the retention would have a significant negative impact on the insured’s operations. Within that range, the insured must balance the cost of a policy with the lower retention amount against the cost of a policy with a higher retention amount. One thing to keep in mind is that retentions rarely go down. Thus, moving to a higher retention will likely be a permanent choice.
Selecting the right insurer
Beyond the limit and retention, selecting the right insurer for a program is vitally important. Here are some factors to consider:
Terms and conditions. Perhaps the most important factor to consider when deciding which D&O policy to purchase are the terms and conditions of the policy itself. Terms and conditions in D&O policies are not standard. An insured who saves a few dollars in premium by selecting an inferior policy may find themselves ‘penny-wise but pound-foolish’.
Claims handling. Never forget that you purchase a D&O policy to pay claims. Different insurers handle claims very differently. Before deciding to purchase a D&O policy, it is important to know the insurer’s reputation for paying claims. Insureds may also find it helpful to know whether the insurer has its own experienced claims staff or whether it uses outside law firms for its claims.
Financial ratings. The financial strength of an insurer is important. One way to determine the financial strength of a company is to consider its rating from A.M. Best or a similar rating agency.
Longevity in the industry. Some insurers try to time their entry and exit from particular areas of insurance to coincide with the hard and soft market cycle. While such an insurer may be able to offer lower prices during ‘good times’, it is typically better for an insured to work with an insurer who will remain in the market in both good and bad times.
There are a large number of D&O insurers to choose from. Although price is always important when selecting the right D&O policy limit, retention and insurer, price is only one factor to consider and it is usually the least reliable factor in determining the right policy limit, retention or insurer for insureds.
D&O insurance is often the last line of defence for the personal assets of a director or officer. As such, directors and officers cannot leave to chance whether this multi-million dollar asset will protect them if their company fails to provide advancement or indemnification. Directors and officers who assume that they are protected just because their company has D&O insurance may find out the hard way that their protection is inadequate.
By taking the time to consider the right policy limit, retention and insurer for your risk transfer needs, directors and officers can greatly improve the chances that their D&O policy will protect them when they need it most.
Thomas H. Bentz Jr. is the leader of the D&O and Management Liability Insurance Team at Holland & Knight. He can be contacted on +1 (202) 828 1879 or by email: email@example.com.
© Financier Worldwide
Thomas H. Bentz Jr.
Holland & Knight