D&O liability and insurance advice for board members
April 2011 | TALKINGPOINT | RISK MANAGEMENT
Carolyn Snow of the Risk Management Society (RIMS) moderates a discussion about D&O liability and insurance between Julian Elms at Catlin Insurance Company (UK) Limited, Chris Hewitt at Lockton Companies LLP, and David Siesko at Siesko Partners.
Snow: To what extent have personal risks increased for directors and officers (D&Os)?
Hewitt: The continuous increase in regulation and the accountability of D&Os globally inevitably increases their personal risk. Extradition is a good example of where the long reach of regulators across country boundaries demonstrates this. The soon-to-be-introduced Bribery Act in the UK is another.
Elms: Many of the personal risks faced have been in law for some years but have been largely unused to bring actions. However, following the global financial crisis fingers of blame have been pointed at management, and this has led to increased regulatory activity which has further placed management behaviour under the spotlight. Equally, new laws are being enacted to ensure higher standards. Areas of particular focus have ranged from anti-competitive behaviour, bribery and environmental, to corporate manslaughter and employment practices.
Siesko: D&Os in all industries – private, non-profit and public – face new regulatory exposures and increased enforcement from numerous government agencies. The Dodd-Frank Act in particular includes sweeping financial industry reforms. Conducting investigations and subsequent regulatory proceedings have increased expenses and potential personal risks to D&Os. Anti-corporate sentiment has also emboldened plaintiffs’ lawyers to try more cases and increase settlement demands.
Snow: What trends have you seen in the types of claims brought against D&Os? Are more claims arising from alleged breaches of fiduciary duty, for example?
Elms: Most straightforward D&O claims nowadays relate to breach of fiduciary duty, as you would expect given the current financial crisis. We would expect an increase now in recovery for actions taken during the financial crisis to ‘save’ companies, with shareholders disgruntled at decisions taken. With an increase in employment practice claims specifically against named directors, claimants seem to be increasingly aware that they should name directors individually in case no entity cover is purchased. Increased regulatory investigations, particularly arising out of the financial crisis, are not limited to UK regulators. UK companies that have ‘relationships’ overseas are increasingly being investigated by European and US regulatory authorities.
Siesko: A growing number of corporate and securities lawsuits arise out of fiduciary duty related to merger and acquisition activity. Often the goal of this litigation is to try to increase consideration due to an allegedly low valuation by the corporation. The availability of insurance coverage for amounts paid in settlement of ‘bump up’ claims is in question. Bump-up exclusions have proven effective in excluding these claims from coverage; however, without the exclusion, coverage may attach at least when it comes to the entity.
Hewitt: The claims experience continues to be around investigations. Fiduciary issues are often seen but accounting irregularities are becoming more frequent.
Snow: Have any ‘new’ types of potential liability emerged, which D&Os should be familiar with and concerned about?
Siesko: The SEC’s recent pursuit of SOX 304 clawbacks is of increasing concern to D&Os. SOX Section 304 provides that if an issuer “is required to prepare an accounting restatement due to material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws”, then the CEO or CFO must reimburse the issuer for certain incentive-based compensation. In SEC v. Jenkins, the court held that financial statement errors, even if unintentional, will put the earnings of CEOs and CFOs at risk. A carrier might attempt to rely on the ‘profit or advantage’ exclusion not only to deny coverage for the amount of any reimbursed compensation, but also to try to deny coverage for the costs of defending the claim.
Hewitt: There’s nothing necessarily new with regards to market changing issues, but we’re seeing a far more aggressive approach from the plaintiff lawyers in the pursuit of claims.
Elms: Be careful when doing business abroad in an ad hoc manner. It can lead to regulatory investigations overseas or criminal proceedings in less than favourable jurisdictions where claims can be politically motivated. The UK Bribery Act is coming for the UK and may develop into a thorny issue. Ensure risk management measures are in place and review agreements with agents and representatives overseas to provide the best possible protection. Possible concerns may arise from an increase in defamation style claims, particularly with IT usage.
Snow: Given today’s litigation landscape and the prevalence of securities class action lawsuits, can the costs associated with defending claims quickly soar to unappealing levels? How important is D&O liability insurance in light of such costs?
Hewitt: The D&O is predominantly a defend costs policy. Therefore it is vital that the scope of coverage in this area is comprehensive. We are continuously coming across policies which are lacking in this area.
Elms: Costs are always likely to be high as any director will want the best specialists in class action litigation to provide the best possible defence at a time of extreme stress. D&O insurers being familiar with the litigation landscape will know the right legal firms to employ in such circumstances. It is this essential help that will increase the chances of a successful defence and a low settlement figure.
Siesko: Defence costs are as high as ever as complex lawsuits last for multiple years. Discovery in particular can involve an immense amount of lawyer hours to wade through documents. These defence costs alone can erode entire towers of coverage. This expense does not include internal administrative costs and ‘pre-claim’ investigation costs typically excluded from the policy. Policyholders must often bear these internal investigation and administrative costs without coverage. Smaller corporate policyholders in particular suffer from these expenses. Given the uncertainties in the economy, D&O insurance is critical to protect personal and corporate assets during a potential economic decline.
Snow: What affect has the general increase in corporate regulation, and associated penalties, had on D&O liability insurance?
Elms: Investigation costs being made available under a D&O contract is one of the more recent innovations which is an example of insurers responding to this increased threat. Legal representation will again be necessary and no short cuts can be taken that would reduce expense. D&O policies in such instances no longer require the wrongful act trigger in order for payments to be made and often policies are no longer restricted on the amount that can be claimed in this regard. Sometimes policies are specifically modified to cover penalties when it is legal to do so.
Siesko: Pressure on rates and policy terms and conditions are a given in this high profile and currently volatile market. Carrier executive management also must place a renewed focus on customer service and claims resources in managing new regulatory coverages and exposures. Retaining personnel with the requisite claims expertise to address new complex regulatory issues and investigations generates organisational stress for carriers. The C-suite is particularly demanding of prompt and precise responses consistent with customer expectations to new regulatory claims made under these D&O programs. Most carriers recognise the level of expertise required, thus claims examiners with legal backgrounds are retained to manage these claims, communicate with customers and consult with underwriting.
Hewitt: It all depends on the coverage. Some fines and penalties are insurable and it is again important that such coverage is afforded in the wording. This area has certainly increased the claims costs to underwriters and erodes the limit of indemnity. These can be significant numbers.
Snow: Have you seen any notable changes in the pricing, coverage and terms of D&O insurance documentation? What are the key exclusions and endorsements within D&O policies?
Siesko: There has been tremendous pressure on insurers to decrease prices and expand terms. There are many markets willing to write D&O policies and some are willing to run at a loss in order to build up business. Many policyholders increased their D&O limits at the last renewal reflecting higher D&O exposures while at the same time taking advantage of lower prices. Exclusion language is being negotiated to insert ‘final adjudication’ requirements into the fraud, dishonesty and criminal acts exclusions in order to preserve defence coverage.
Hewitt: Despite the increase in the exposure levels for insurers, overall premium rates continue to fall. The reductions depend on the particular sector the insured is in. The coverage is also being expanded and clarified as new regulation and laws that increase the risk to D&Os are introduced.
Elms: There are many elements to D&O coverage but we can argue that increased competition and changes to company law has helped the product further evolve over the last 25 years. Exclusions are disappearing or being further diluted. For example, the ‘failure to maintain insurance’ exclusion is rarely used whereas the introduction of ‘Side A non reimbursement/difference in conditions’ policies are gaining in popularity. Other exclusions such as fraud, dishonesty and pollution have all been through significant change.
Snow: Can you outline some of the application, notice and reporting issues that insureds should be aware of?
Hewitt: If you are in any doubt about something that you think might be a circumstance to your policy, report it to your broker. The underwriters will use any opportunity to wriggle on a claim if there are grounds to do so. Late notice of claims is high on the list of reasons for insurers avoiding paying claims. Beware. Advise your broker – make it their problem as well.
Elms: This is an area that requires close attention from an insured’s standpoint and it is essential that when taking out D&O cover for the first time or moving to a new insurer that there is a comprehensive review of any potential claims or circumstances that may give rise to a claim that is within the knowledge of the D&Os of the company so that the insurer can properly rate and set the terms and conditions of the contract. Without this exercise being performed there may be future issues over whether non disclosure has occurred and that may lead to the policy not responding. It is essential for any insured to discuss continuity issues when moving insurers.
Siesko: Frequently insurers are using simple notice issues in order to disclaim coverage. Policy language has developed to include detailed notice requirements referred to as ‘a condition precedent’ to coverage. These requirements can be burdensome, and noncompliance can be dangerous. Risks of noncompliance are greater for insureds managing claims within an SIR as knowledge of an unreported claim is clear and reporting requirements may be more complex. Insureds should be aware of the obligations outlined in these provisions and insureds with a high volume of claims should ensure a reliable reporting system is in place. Often brokers are involved in claim reporting. If so, policyholders should work with a trusted broker and spend some time reviewing and discussing their notice procedures.
Snow: What predictions would you put forward for D&O liability risk and related insurance through 2011, and beyond?
Elms: Insureds are becoming more sophisticated and savvy as to the need for cover and this means more potential for claims to emerge as the understanding on how the policy works increases. Equally this will lead to more ‘Side A/difference in conditions’ policies being purchased as the highly personal element of cover will appeal to those who place their D&O insurance under the microscope. When stock market conditions improve there may well be growth in public offering insurance to protect directors/companies from prospectus misrepresentation as more companies float. Recent natural disasters could in theory affect the amount of available capacity once the full impact of the losses are felt by the worldwide insurance market in 2011 and beyond.
Siesko: As our globalised economy continues to expand, the need for D&O products incorporated into global insurance programs will increase into 2011 and beyond. With this increase, insurance carriers and brokers will be pressed to address D&O on a multinational basis. Conflicts of law and various regulatory schemes will challenge the integration of global insurance programs with local policies. In order to protect their interests and ensure seamless coverage, insureds must be vigilant in critically evaluating policy terms. At the same time, insurers and brokers must develop products and policy language which clearly address the needs of international organisations facing D&O exposures.
Hewitt: Is it realistic to see the continuation of the reduction in prices? With the current environment there is no reason this will not continue, however the reductions are thinner than previous years generally. There are still corrections in pricing to be achieved, so some big reductions are happening. I do however, caution clients with regards to the quality and longevity of the carriers that they choose to use as their insurer. Ask your broker the following questions: how long has this market been writing this business? What is their credit rating? What does the claims team look like? Do they have experienced claims handlers? And what is their track record on claims payment?
Carolyn Snow is director of Risk Management at Humana Inc and treasurer and director at RIMS. As director of operational and clinical risks at Humana, Ms Snow manages the corporate insurance program, including Humana’s captive and RMIS system. She is a member of the corporate acquisition team and served as a member of the core advisory group for enterprise risk management. On the RIMS board she has served as liaison to Conference Planning, Marketing and Communications, Quality and Technology. She also was Risk Manager in Residence at Ball State University and Temple University. Ms snow can be contacted on +1 502 580 3861 or my email: firstname.lastname@example.org.
Julian Elms is a class underwriter at Catlin Insurance Company (UK) Limited. He began his career at broker Stewart Wrightson in London in 1983 and became an underwriter in 1986 with AIG Europe before moving to CIGNA (now Ace) in London in 1994 . He was appointed their UK D&O manager in 1997 . Mr Elms joined Catlin in June 2004 as a class underwriter for D&O. He can be contacted on +44 (0)20 7648 8227 or by email: email@example.com.
Chris Hewitt is a partner at Lockton Companies LLP. He has 25 years experience in the insurance industry across both broking and, latterly, underwriting. Mr Hewitt has had involvement with major global commercial and financial institutions from both a broking and underwriting perspective. He provides invaluable insight from both the underwriter’s and broker’s viewpoints and has been involved in many high profile companies from a Directors and Officers Liability perspective. His experience and knowledge have proved to be invaluable in achieving comprehensive coverage and meaningful limits of indemnity for his clients. He can be contacted on +44 20 7933 2212 or by email: firstname.lastname@example.org.
David Siesko is the founding member of Siesko Partners, an insurance coverage and claims services law firm. He contributed over 15 years of his career to the development of the Claims and Customer Service division at Zurich Financial Services. In addition, Mr Siesko was associated with the London law firm, Lovells, during the early development of environmental law in the UK and EC. Mr Siesko has worked on major claim and legal issues for AIG, and early in his career, he represented industrial clients on labour and environmental issues. He can be contacted on +1 (212) 920-8390 or by email: David.Siesko@sieskopartners.com.
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Risk Management Society (RIMS)
Catlin Insurance Company (UK) Limited
Lockton Companies LLP