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Establishing D&O Insurance Priorities for Publicly-Traded Companies

For the Risk Manager or Chief Financial Officer of publicly-traded companies, buying Directors & Officers Insurance has changed over the past five to ten years. Many new insurers have entered the D&O marketplace, policy forms and endorsements have gotten more generous, and the pricing has come down.
10/12/2012

For the Risk Manager or Chief Financial Officer of publicly-traded companies, buying Directors & Officers Insurance has changed over the past five to ten years. Many new insurers have entered the D&O marketplace, policy forms and endorsements have gotten more generous, and the pricing has come down.

The Buyer’s Market is ending, but assuming that we do not run into a Mayan apocalypse, renewing your D&O policy(ies) should be fairly uneventful. The next year or two are expected to see a stabilization of terms offered and perhaps, some moderate increase in pricing. If your primary D&O premium has dropped more than the market average, you may see an increase if you want to stay with the same insurer. Retaining the very broad terms negotiated over the past few years for little if any additional premium, may now come with a cost.

It’s time to get “back to the basics” as to deciding what terms are important, and which coverage issues should remain priorities. The objective criteria for determining the most appropriate insurance terms need to be filtered down to stability, coverage terms and limits. We would like to discuss some of the issues to consider.

CONSIDERATIONS ON D&O INSURANCE LIMITS

Beyond benchmarking criteria, which has only a tangential applicability to loss exposures, the ultimate key to choosing appropriate limits, is the assessment of how much:
  • Financial damage you may cause your stockholders or others due to mismanagement errors or omissions;
  • Related plaintiff attorney costs that may ultimately be passed on to you; and,

Your 1st party defense costs: the expense of defending against D&O allegations, whether or not you are responsible for the other party’s damages and the plaintiff’s legal costs.

You want to keep in mind whose interests are being protected. Standard D&O insurance protects the Insured Individuals and the Insured Company with three key insuring agreements. The so-called Side C terms insure direct claims against the Company, but are usually limited to Securities-related issues. The Side B insurance reimburses the Company when it is allowed or required to indemnify its officers and directors for covered D&O defense expenses, settlements, and adjudicated amounts. These two insuring agreements are ultimately for the protection of the Company’s bottom line. The Side B and Side C coverages therefore provide financial protection to the Company and its stockholders.

The so-called Side A coverage is only designed to offer financial protection for the individuals who are not indemnified, because the Company is not allowed to, chooses not to, or is financially incapable of indemnifying its officers and directors. Although the Side A coverage of some D&O policies will pay first dollar (without a self-insured retention) when the Company refuses to indemnify (even though its bylaws may require such indemnification), the insurer will likely subrogate against the Company and require the Insured Person’s assistance. When the Company is fairly healthy, Side A Insurance provides little opportunity for risk transfer.

Now that the majority of public entities are buying separate Excess Side A policies, in addition to the standard so-called ABC D&O coverage, it is a good time to remind everyone that such insurance does not provide financial protection for the Company. To the extent that stockholders require or expect you to protect their interests, it may be necessary to re-evaluate and reassess the protection you have obtained through your Side A policies vs. your ABC D&O insurance policies, based on your directors’ and officers’ exposures to un-indemnifiable loss (as opposed to merely what others are purchasing and/or what was available for favorable pricing).

On the other side of the same coin, Side B risks can be greater than anticipated, especially if the Company’s indemnity duties to its officials include broad defense expense responsibilities. For example, if the bylaws or other corporate documents require the Company to pay attorney expenses and other legal costs until the individual has exhausted his/her defense options, the burden of proof is effectively shifted to the Company to demonstrate that it has no indemnity obligations. This can result in a major depletion of corporate assets. It may be more important to purchase additional ABC coverage if the stockholders expect more protection. On the other hand, if corporate bankruptcy is a significant possibility, further emphasis on Side A Excess insurance can be more critical.

Additional issues to consider as respects to insurance limits:

  • Management mistakes made during the economic recession may have gone unnoticed or difficult to differentiate from externally caused difficulties. However, over the past two years or so, many public companies have watched their stock values rebound. Some of these public companies find that their market capital is higher than ever before. There is consequentially more room to fall. Further, mild variations in market dynamics, many outside of the Company’s control, can now cause a significant stock drop. These issues can expose public companies to increased D&O risks. Stock drops at a time when there are increased assets, can be more detectable, a larger target for plaintiff attorneys, and harder to excuse by juries and judges.
  • Despite what may be considered a glut of attorneys, defense costs continue to rise substantially, putting increased pressure on insurance limits. A major reason for such increased time and expense, is the increased amount of computer-based information that is available and needs to be reviewed. Eight figure defense costs are no longer unusual events.
  • Financial inflation has been at low levels in recent years, but “social inflation” continues to rise. In the context of D&O risks, social inflation is a somewhat nebulous term. It can refer to the increased exposure to high claim amounts due to society’s willingness to find organizations and their vilified officials responsible for damages they appear to have caused their stockholders or other companies and persons. The jury’s willingness to find a Company responsible for major claims has increased. This changing societal mindset also gives the plaintiffs increased leverage to negotiate higher settlement amounts.
  • With broader coverage terms being provided on D&O policies, there is an increased potential for large claims that are payable under the policy. It would be a shame to have broader terms, but run short on the aggregate limit purchased.

Over the last several years, most public entities have acquired much broader coverage terms, even while reducing their D&O costs. Some of these improvements have been quite visible, such as:

  • Addition of Excess and Difference-in-Conditions (DIC) Side A policies to the D&O program structure, for the sole benefit of the officers and directors;
  • Enhanced international terms on the main D&O policy and additional locally-purchased policies for foreign-brought D&O claims;
  • Claim reporting required only after certain key executives are aware of the claim, reducing the chance for insurers to assert late reporting bias;
  • “Loss” definitions that specifically allow for certain fines and exemplary damages;
  •  More difficult-to-trigger wrongful conduct exclusions, potentially requiring the insurer to continue paying defense costs even though the officer or director may not appear faultless;
  • Significant give-backs to the Insured vs. Insured exclusions.
  • Less onerous policy provisions relating to misrepresentations that may have been made to the Insurer through applications and publicly available records.
If improvements in coverage terms in these areas have not been obtained during the soft D&O market, they are still likely to be cost-efficiently achievable, because such provisions have become so widely available. Accessibility of such enhancements should continue to be favorable, and at little or no added cost. However, further coverage improvements may now come with an added premium. Obtaining offsetting premium savings should be attainable, though it may be a challenge.

Besides reassessing whether all of the excess policies the Company purchases are still necessary, a key area where savings may be most readily found in a hardening D&O market, is with higher ABC D&O policy retentions. This can be especially relevant if the company has been carrying lower Securities-related and Non-Securities retentions than typical for its size. This may be the case for many companies who had been offered similar pricing at lower retentions in the past few years. Getting your hopes up, however, for substantial savings may be premature; many insurers view the main D&O risk as the catastrophe exposure and do not offer large deductible discounts.

Another alternative to consider is when broad coverages and significant limits are already available to your officers and directors via liberally-worded Excess & DIC Side A policy(ies). Cutting back on some of the broad Side A terms included on your ABC program, could be a reasonable tradeoff for premium savings.

A final and perhaps the most essential point: Checking the D&O market and considering other stable insurers who are offering reasonably broad coverage terms and favorable pricing can be worthwhile. There are still many insurers servicing the publicly-owned company D&O market. Not only will the marketing effort put pressure on the incumbent to offer reasonable renewal terms, it can reveal new insurers who have recently become more favorably attuned to your industry’s and company’s D&O risks and exposures.