Insurance: director protector

Major companies are becoming increasingly anxious to have insurance protection for the personal assets of their directors and officers (D&O).

Our experience shows that as the economy deteriorates, so the likelihood of litigation increases. US companies began either buying or increasing their ‘Side A’ coverage after the Enron and WorldCom scandals. That trend has now reached the UK.

Much of this demand is driven by the need to attract and retain high calibre candidates, who increasingly require insurance in addition to any indemnities which may be available from their company.

These Side A policies operate only when a company does not indemnify its directors. They provide an additional limit of indemnity or reimburse directors and executive officers when legal actions are not covered by typical insurance policies.

Class action contagion from the US and growing economic uncertainly have caused an unprecedented surge in the demand for management liability insurance among the UK’s top firms. Two years ago, only 10% of FTSE 250 companies were buying D&O insurance to protect the personal assets of their directors. Today, the figure is nearer to 50%.

In such an environment, companies tend to be less concerned about the price of cover than ensuring that the policy’s terms and conditions are fit for purpose. Increasingly, this includes a much greater emphasis on the personal liability of directors. But that is not to say that cover is necessarily becoming more expensive. D&O rates continue to decline as insurers vie for business.

What Side A coverage provides is an additional level of indemnity (or reimbursement) for directors and officers when lawsuits are not covered by typical insurance policies. This may include the insolvency of the insurer of the underlying D&O policy or the wrongful refusal to pay a claim by the underlying insurer.

It also provides coverage for directors of companies that become insolvent and thus unable to honour the indemnities they grant or where the company wrongfully refuses to provide indemnity.

In the US, class action litigation has risen by 58% this year ­ even before the events of recent weeks.
A study by our sister company NERA Economic Consulting found that if that pace of filing had continued, there would be nearly 280 filings by the year-end ­ the highest level since 2002 and more than double the 133 filings made in 2007.

Based on historical trends, we believe there is a strong likelihood that we will see an increase in litigation here in the UK. While the current economic problems began in the financial services industry, we are now seeing litigation in other industry sectors. We anticipate more litigation from disgruntled employees and shareholders. Enhanced scrutiny from regulators, which are collaborating across borders, has also increased the risks to top personnel.

An economy in recession is characterised by a slump in consumer confidence and a drop in levels of spending.

As a consequence, companies may experience problems with credit at both ends of their business: the creditworthiness of their customers will decline and the financial health of suppliers may also deteriorate.

Companies that miss their earnings projections because of trouble meeting loan obligations are likely to find themselves the subject of D&O lawsuits. This is particularly true in the US but also increasingly in other jurisdictions.

Despite the opportunities this presents to innovative insurers, there has been a note of conservatism in the London insurance market’s appetite for these types of risks.

There is a significant opportunity for insurers that can strike a balance between competitive pricing, cover and profitability. While rates for D&O continue to decline, it is uncertain how long that trend will continue.
However, we believe that this challenge will be met. The insurance industry is gearing up to meet the challenges faced by the directors of UK plc.

As those who sit on company boards become more aware of the potential increased level of litigation risk they face, demand for cover will certainly increase.

Managing D&O premiums

Directors substantially increase their risk of liability when their company raises capital or issues debt publicly. During the good times, litigation is rare. But if an investment or loan turns sour ­ if the share price falls or the loan is not repaid ­ the chance of litigation increases substantially and the directors may be at risk personally.

In addition to direct claims from shareholders, recent changes to UK company law have increased the ability of shareholders to bring derivative claims, when shareholders can force the company to sue directors. It is too early to tell what impact this will have but it represents a substantial change to the landscape of shareholder actions in the UK.

In an environment where D&O premiums could increase in some sectors, we are advising companies to develop relationships with their insurers and be able to show that they are taking a proactive approach to managing their D&O risk. This allows companies to take full advantage of the more competitive strain in the D&O market and minimise the rate of cover.

However, the premium a company pays is just one factor to consider. The terms and conditions of any cover are the key, ensuring that it is appropriate to the company’s circumstances. Not all policies are the same, and it is why most large companies seek expert advice as to which policy is most appropriate to meet their needs.

For example, many more companies are now arranging and considering Side A cover since it provides protection to directors with fewer exclusions, in addition to the benefits above.

Insurers look more kindly on companies that actively engage with them and are seen to be proactively managing risk. A good recent example was a company which had an increased cost of credit when renegotiating its debt facilities. This allowed underwriters to understand the situation fully and work with the company to ensure that this did not result in a large premium increase. Changes of that nature usually result in it being factored into premium rates.

In tough times, companies naturally look to reduce costs where they can. However, it is certainly not the time to reduce protection for directors and officers.

John Batch is the senior VP in Marsh’s financial and professional practice