Insurance: protecting your board

As new regulations reshape the governance landscape across the globe, we look at the increasingly complex world of director and officer (D&0) insurance

Insuring directors and officers against lawsuits is getting awfully complicated. Foreign exposure is escalating as global governance standards evolve and many nations, especially those in Europe, implement a range of new laws and disclosure regulations. Expenses are rising as disgruntled shareholders increasingly tack on ‘tag-along’ lawsuits when they file securities class action litigation in the US, driving up the cost for defense attorneys. This is in addition to the recent emergence of the first class action suits in Europe, as well as the regulatory bent of President Barack Obama’s administration and a newly emboldened SEC, which has vowed to step up enforcement in the wake of the Bernie Madoff scandal.

‘There are lots of emerging issues,’ admits Michael Turk, senior consultant and D&O insurance expert at Towers Watson. ‘A lot is changing in both exposure and the necessary coverage, and corporate officers and directors need to be on top of that.’

The changing foreign landscape is on the minds of many directors. What the Sarbanes-Oxley Act of 2002 did to the regulatory structure of the US, a number of foreign laws are doing elsewhere. This greatly complicates insurance coverage and indemnification for any company with significant operations outside the US. As a result, many of those tasked with securing insurance have no clear picture of what is needed. Legislative acts affecting environmental liability, disclosure and other regulations have gone into effect in Canada, the EU and Australia, among other areas, in recent years.

Increased enforcement
Meanwhile, the SEC has stepped up enforcement of the Foreign Corrupt Practices Act, with a record number of cases being launched in 2009. Many experts expect that record to be eclipsed this year. ‘We’ve seen a gradual yet steady rise in the regulatory enforcement of laws that focus on the business practices of multinational companies,’ says James Proferes, vice president and international underwriting manager for D&O liability at Chubb Specialty Insurance.

Multinational companies are facing scrutiny overseas, especially in relation to compliance with securities and environmental laws, and to what Proferes describes as ‘business practice activity’, which includes such areas as anti-trust laws and pay-to-play activities.

‘This risk used to be organizational, but the dynamic has evolved to regulatory authorities more frequently targeting executive officers in criminal prosecution of these activities,’ says Proferes. ‘The challenge for directors is to ensure proper controls and practices are being implemented throughout the organization. There is a higher standard of care and attention required by boards in the face of this shifting risk environment.’

To that end, companies are increasingly supplementing worldwide D&O coverage at the headquarters level with local D&O policies, as many countries require the insurance policies that pay to fund domestic settlements to comply with their own insurance regulations, and often to be written locally. The trend has really developed over the last three years: in 2009, Chubb saw the number of local D&O policies increase by more than 30 percent from ‘a meaningful base,’ Proferes says. Turk says he’s seeing some customers buy as many as 100 different local D&O policies to address the risks, though that remains ‘more the exception than the rule.’

In the US, litigation normally covered by D&O insurance is becoming more complex. Though the number of shareholder lawsuits is not escalating dramatically, the cost to defend them is, says David Bradford, executive vice president of Advisen, an insurance consulting firm. That’s because plaintiffs in class action suits over the last five years have been increasingly filing multiple suits, tacking on shareholder derivative suits and Employee Retirement Income Security Act (ERISA) suits in addition to the underlying action.

Tag, you’re it
‘Securities class actions and shareholder derivative suits typically are covered under D&O policies; ERISA suits usually are not,’ Bradford says. ‘They are covered under fiduciary liability policies. But defending multiple suits simultaneously, regardless of the types of policies involved, contributes to the complexity.’

These tag-along suits can be especially costly because the complicated and expensive discovery process usually doesn’t commence in a securities class action suit until a motion to dismiss is adjudicated. The cost of sorting through the thousands of emails involved in a case alone can drive up discovery costs.

The regulatory vigilance of the SEC also means increased attorney fees. D&O policies don’t cover criminal penalties, but they do cover the cost of defending against criminal prosecutions.   

Despite all these changes, however, experts say the cost of D&O insurance has not yet spiked for much of corporate America. That’s partly because the industry is still absorbing previous rate hikes; in the post-Enron era (2001-2004), D&O rates shot up more than 100 percent on average.

‘It remains a very competitive marketplace,’ says Kevin LaCroix, an attorney and partner at OakBridge Insurance Services. ‘Right now, for most buyers, it’s a relatively advantageous time to buy.’

That’s not the case for some of the companies hit hardest by the financial crisis, however. LaCroix estimates that pricing for some commercial banks has risen by as much as 100 percent, from possibly $5,000 per million to $10,000 per million. And Turk says that many are still waiting to see what impact the accumulated financial losses and resulting lawsuits will have on premiums in the years ahead.

‘Most people might expect a hardening of the market but it remains relatively flat,’ he says. ‘That’s primarily due to a lot of capacity in the overall insurance market. And, although the market has been flat for the last year, that’s after five years of decline.’

Overall, investors filed 910 securities lawsuits in 2009, up from 804 in 2008 and about 600 in 2007, according to an Advisen survey. Securities fraud cases represented about 340 of the cases in 2009, up 22 percent on 2008. Securities class action suits represented 234 suits, and some 216 breach of fiduciary duty claims were filed in 2009, up 37 percent on 2008. Financial firms were named in nearly 40 percent of all securities lawsuits filed in 2009.

Awards and settlements averaged about $32 million in 2009, with the highest class action settlement for the fourth quarter of 2009 being the $400 million paid to settle a suit against Marsh & McLennan. This grew from allegations that the company received hidden contingent fees in exchange for steering customers to insurers that rigged bids.

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