Evolving market factors demand strong Side A coverage by Ty R. Sagalow

It has been more than a year since the economy went into an out-and-out tailspin. Tough economic conditions have taken their toll on Main Street and Wall Street alike, and the timetable for recovery is unknown.

The state of the economy is affecting all of us—especially the directors and officers of corporate entities. With some commentators predicting more financial turmoil on the horizon, the promise of corporate reimbursement (indemnification) of legal bills, settlements and judgments against corporate directors and officers, past and present, becomes uncertain. This scenario warrants the most comprehensive Directors and Officers (D&O) liability coverage available in the market.

Without strong so-called "Side A coverage," insurance for non-indemnified claims, directors and officers might risk not only their standing in the company; they might risk their own personal assets as well. Whether part of a robust comprehensive D&O policy or as a standalone Side A D&O contract, such policies can provide coverage when their organization cannot indemnify directors and officers because of corporate governance, statutory restrictions, the type of claim made (e.g., shareholder derivative claims) or simply the financial inability to pay.

Why does this matter? Business headlines say it all: fiscal concerns, bankruptcy, corporate crime. In addition, if you recall the stock options backdating scandal, you probably know that shareholder derivative actions are now on the rise. And, for retired independent directors trying to enjoy their retirement years in peace, a non-indemnified major D&O claim against them for actions taken years earlier can be especially damaging.

It is notable that Side A D&O coverage in the United States has grown more competitive in recent years—and not a moment too soon. By expanding the scope of protection offered, insurers are trying to help organizations provide the most comprehensive coverage to their directors and officers.

Thus, with increasing exposures, it is paramount that Risk Managers and Chief Financial Officers explore all possible options for the most suitable coverage, including broad Side A coverage features as well as special coverage for retired independent directors.

The most innovative organizations are marketing the most advanced D&O offerings as there is just no telling when the economic conditions of the past year may lift. Until that time, the smartest companies are keeping their most valued executives securely covered.

The Directors & Officers market: one year on by Louise Dennerståhl

It has been more than a year since the financial markets collapsed. We have seen companies go down, mass redundancies and the financial breakdown of both markets and even countries. But I want to know how this has impacted the Directors & Officers insurance market. For example, are companies buying more Directors & Officers liability policies? Are there now fewer insurance carriers in the D&O market?

From what we have seen, the big corporations, already long-time buyers of this insurance product, have continued to buy - which was to be expected. Personally, I was expecting to see a significant increase in the small/midsize segment though that has not happened. As I wrote in a previous blog, Directors & Officers liability insurance is not regarded as a commodity product outside of Asia. But it should be, and, in my opinion, it should be one of the central pillars of any commercial insurance cover sold. I wonder, if this is because we have not been able to make it easy for small and midsize companies to buy Directors & Officers insurance? With the insurance industry increasingly modernising and expanding their online selling capabilities, it will be interesting to see if a more direct route between customer and insurer will have an impact on these potential buyers.

Thinking back to a year ago it is also interesting to see what has happened to the wider insurance market. At the height of the crisis the future looked grim for Directors & Officers insurers. And it goes without saying that there have been claims, specifically in the US. However, we have not seen insurance carriers pulling out of this segment, or dramatically restricting covers. In the financial institutions segment D&O rate increases have been seen, but in the commercial space things have been more stable. The commercial segment is still competitive and in good health, and new carriers are looking to enter the market; it looks like the insurance industry has learned to stay in for the long haul and not look at this product with a short-term view. This is good news for both the buyer and the seller of Directors & Officers liability cover, don't you think?

International & Multi Insurance Programs should not be seen as a tick boxing exercise for insurers by Paul Schiavone

In my last blog I discussed why International and Multi Insurance Programs can be seen as a regulatory and compliance issue for insurers. Now it’s time to discuss why they should not be seen as just a way for insurers to ensure their compliance.

This is certainly not the case in Argentina, and it is not beyond the realms of possibility that this could be the case in other countries as well. All parties to the D&O contract, (the insureds, the broker and the insurer) have much to lose if local insurance regulations on the issuance of foreign underlyers are not followed.

Directors and officers of parent companies and all subsidiaries in foreign jurisdictions should be cognizant of the insurance rules and regulations in their respective jurisdictions and they should question their brokers about these requirements. If not, directors and officers run the risk of one day finding themselves with an insurer who may claim inability to pay a covered loss because the insurer did not issue a required local underlyer. The time for the directors and officers to find out that they needed a local underlying in order for a claim to be paid is NOT after the claim has been made against them.

Clearly, the legal requirement to put together locally compliant International D&O Programs is an issue for the insured, the broker and the insurer. The good news however, is that the risk of any type of sanction or fine arising from non compliance can be greatly reduced by all parties working closely together in the structuring of compliant global insurance programs.

Why are we seeing these cases now?.Well, in my view for the following reasons:

1. local regulators are becoming more vigilant in enforcing their insurance laws and collecting fines and penalties;
2. more claims are being brought against D&Os of subsidiaries on a more regular basis;
3. in these times of financial restraint, governments will be on the look out for additional tax income.

Regarding local D&O claims, a recent Aon report from January 2009 cited fifteen D&O claims against subsidiaries of international parent companies over a two year period.

To avoid this potentially messy situation, I would urge that you fully understand the needs of the insured and the broker to ensure compliance with local regulatory requirements before participating in any such insurance.

As some of you may know, Zurich has, for some time, been developing and providing key risk insights around the structuring of international programs – as a key element to this, we are issuing local foreign underlyers in territories where local insurance law requires and in territories where there are customer demands.

New law in Germany that will affect D&O policies worldwide by Nicole Weyerstall

The German Bundestag recently signed off a change in Article 93 II in the German Aktiengesetz, which is the German equivalent of Companies Act in the UK. This law applies to all public companies with the legal form ‘AG’, whether they are listed or not.

The new law says that if a company takes out D&O insurance covering risks resulting from an executive director's activity for his/her company, then this coverage needs to provide a minimum deductible equal to at least 10% of any loss with an annual minimum of 1.5 times of the director’s annual fix salary.

This new law is effective from 5 August 2009 for all new D&O policies. All existing D&O policies will have to adhere to this law from 1 July 2010.

The impact for the worldwide D&O business is unclear, particularly where companies operating largely overseas are exposed through a smaller subsidiary operating in Germany as an ‘AG’. As the new law applies to the corporation that places the coverage, this could mean that AGs which are covered under a foreign D&O policy might not be affected.

However, experts agree that we must assume that the law change applies to all AGs, independent of their status as the primary policy holder or as only a subsidiary. In short, we need to make sure that we implement the correct deductible on all D&O policies of German AGs whether it is the head office or a German subsidiary.

The deductible applies only to the financial loss and not to defence costs. The deductible only applies to Insured versus Insured claims, which is the majority of D&O claims in Germany.

For instance, if there is a claim against an executive director, the company’s D&O insurer pays the defence costs as before. However, if the claim is upheld and covered, then the director has to pay his deductible and, depending on the total amount of the loss, the D&O insurer will have to pay the rest. The total limit of a company’s D&O policy will not be reduced but follow after the deductible has been paid by the director.

Crucially, it is mandatory for the company to apply deductibles on the D&O policy; they have no right to insure it or to reimburse their directors. Although, interestingly enough, the new law does not prevent directors from purchasing private D&O coverage to cover the deductible. Every director can purchase his own personal D&O policy as long as he is the policy holder and pays the premium himself.

In any event, the key point is that time is fast running out for German companies or their subsidiaries looking to buy new D&O policies - they have less than two months to adhere by the legal requirements stipulated by this new law.

It isn’t just the insurer who can run afoul of local regulators – you can be implicated too by Paul Schiavone

There is no longer an argument in the D&O market as to whether or not local policies are necessary in order to provide a customer a truly “global” D&O insurance program. However, we get brokers asking us questions such as “Isn’t all of this International Program and Multinational Insurance Proposition (MIP) discussion simply a regulatory and compliance issue for insurers? This doesn’t really affect customers and brokers, does it?” The short answer is yes in part and no in part.

Firstly, I’ll look at the case for saying "Yes".

The requirement to issue local underlyers* to provide customers a truly global program is rooted in the local insurance law, to which all insurers are subject. So “Yes”, the development of international programs is a compliance issue for insurance companies. Insurance laws (in many territories) basically state that insured property located and insured persons residing in the respective territory must be insured through an insurance policy issued in the territory by an insurance company authorized to carry on insurance business in the territory. Therefore there is a legal requirement upon the insurer to either have a local license to carry on insurance business in the territory and/or, as the case may be, to also issue a contract by an affiliated company in the local territory.

Up to this point in this discussion, the broker appears correct; but here is the rub, if an insurance program is not locally compliant what is the penalty and who suffers?

In the past many suggested that only the insurer would run afoul of the insurance regulator being subject to a fine or loss of insurance license, but this was not the case in two recent examples.

In the first example, an insurance broker in Switzerland purchased a statutorily required professional indemnity insurance policy from a “foreign insurer” that was not admitted to sell the product in Switzerland. The Swiss regulator did not accept the insurance contract because it was sold by a non-admitted insurer. The Swiss regulator subsequently refused to admit the insurance broker into the federal register for insurance brokers, thus prohibiting the broker from practicing in Switzerland. It is understood that the approach taken by the Swiss regulator would be the same for any covered risk in Switzerland regardless of the underlying business being performed or the coverage type.

In the second example, Argentinean authorities imposed a total fine of 23 times premium for an unauthorized (non admitted) Life Insurance transaction with a “Foreign Insurer”. The Argentinean authorities fined an individual insured 8 times the premium and an insurance intermediary (broker) 15 times the premium for illegally transacting life insurance business with a non-authorized foreign life insurer. It should be carefully noted that although this case relates to a life insurance product that this law explicitly applies also to non-life business.

It is fair to say that Zurich has taken a market leading approach in this area, particularly for D&O, to ensure that we are selling globally compliant insurance products to our customers. In my next blog I’ll look at why International Programs and MIP should not be seen as a compliance box ticking exercise for insurers.

* An underlyer is a local D&O policy issued for the D&Os of a subsidiary of the parent company. This policy is issued on accordance with and to comply with local insurance laws.

Is a one stop shop enough to protect against international risks? By Louise Dennerståhl

Are all directors and officers aware of international risks? In the past the Parent Company would buy insurance in the home country that provided protection worldwide. But those days are long gone as international regulators are now showing a heightened interest in corporate transparency, accountability and compliance.

Additionally, there is an increased awareness within companies about corporate compliance and premium tax issues. Markets are evolving at the same time as tax authorities and regulators are getting tougher. Regulatory and tax authorities talk to each other more than ever, and have treaties on mutual and international assistance, including judicial assistance. Examples of countries that prohibit non-admitted insurance are growing: Brazil, China, Japan, India, Malaysia, Mexico, Turkey, Thailand, France and Italy to name a few.

As a result of these developments, in order to ensure that companies are covering their global D&O exposures around the world, parent companies now need to consider purchasing locally admitted Directors & Officers insurance policies. This means that the one-policy global solution that has been purchased for so many years is now no longer a satisfactory solution anymore.

Placing an international program is more time consuming, has to start much earlier and requires more work from the company, broker and the insurance carrier. But once the program is in place the renewals will get easier.

When arranging a programme, the insured and brokers should also be asking important questions to ascertain the suitability of the insurer to provide these international programs. For instance can the insurer demonstrate international experience? Do they have a global network of professionals who truly understand international businesses? Can they provide local policies that adhere to global standards, worldwide uniform and cost effective procedure from policy issuance and claims handling? Can they issue local policies that conform to local insurance and tax regulations?

These are just a few of the questions that need be addressed and investigated. The due diligence process to get the right insurer on board to provide international programs may seem complicated but, unfortunately, there is no other way and there is definitely no option to go back to what was the norm.

Past performance does not guarantee future returns by Paul Schiavone

When GM, the traditional barometer of how well the US economy is doing, filed for bankruptcy protection, we need to ask ourselves how bad it is out there for D&O underwriters.

And how bad is bad? The recent press reports and stats characterizing the US and European markets paint an alarming picture.

Just last week, the FT reported that corporate bankruptcies are set to increase by 35 percent based on a report from Euler Hermes.

Looking at the US market alone, we have seen 4,941 companies made insolvent in the first three months of 2009 - an increase of 56% on the same period last year. There were over 41,200 commercial bankruptcies in 2008 and this year, the forecast is for over 62,000 - as cited by Advisen.

The Wall Street Journal in February stated that "By various estimates, US companies are poised to default on $450-$500billion on corporate bonds and bank loans over the next two years."

Europe is not immune to this either. A recent Creditreform research confirmed that Western Europe saw more than 150,000 company collapses in 2008. And many pundits believe the worst is yet to come for Europe.

According to Bloomberg credit insurers (who cover suppliers against non-payment by customers) in Germany have raised premiums by as much as 20% in 2009 and may increase more as defaults rise amidst the financial crisis; in 2008 claims on German credit insurance policies rose 54%. In the UK claims on UK credit insurance policies rose 51% in the last quarter of 2008.

As a D&O underwriter we have always focused our attention on financial stability, which is good. We have generally looked at three years of past performance to determine whether a risk is acceptable or not. But this present financial crisis has turned this old way of underwriting on its head. As they say in the investment community 'past performance does NOT guarantee future returns', which is a mantra we should all be adopting in today’s climate.

We've all seen companies that have years of a proven track record can go from financial stability to financial instability within the course of a one year policy period, due to say inability to receive refinancing or the triggering of debt covenants.

What should underwriters be doing in this unprecedented financial climate? I think we should spend less time on past performance and more on the financial future of a company. What we should be asking now is what a company's financial looks like in a year from now or two years from now. Will the company need refinancing, a rights issue or a new debt offering? If yes, will they be able to get these in the present financial environment? If they do need it, but can’t get it, what will happen to the company?

D&O underwriters must also not fall into the trap of just looking at the insured’s financial stability – which is difficult enough. We must also review the bankruptcy exposure of our insured's:

• Critical supplier
• Major customer
• Bank
• Counterparty
• Joint venture partner
• Minority interest investments

A financial failure from one of these other parties can have a drastic impact on your insured. A good example of this is what is going on in the auto industry around the world. Your D&O insured may not make a single car but they are a major supplier to the industry. If the auto company fails, your insured will also fail.

Additionally, it is not longer simple to just ring fence companies into retail, banks/financial institutions, media, IT or transportation industries. The financial crisis of today is not a problem for one or two industry sectors but for all industries globally.

D&O claims can come from many areas when a company files for bankruptcy. People tend to first think about shareholder claims, but actually one of the main sources of claims against D&Os when the company is in bankruptcy is from bankruptcy trustee/receiver. A typical allegation from a D&O claim brought by a bankruptcy trustee is breach of fiduciary duty. That being said we certainly do see shareholder claims as well as claims brought by customers and suppliers.

In short, this is a tough time for the D&O underwriters and the need for vigilance is an understatement.

Tag words

Bankruptcies, credit insurers, underwriters, D&O, claims

Why aren't we seeing an increase in class actions in Europe? By Louise Dennerståhl

It is well-know that class actions in the US cost companies and D&O insurers a lot of money. Therefore, there has been a tendency to focus much attention on the exposure in the States for companies that have a public listing in that market. Consequently, companies, and insurers, have been less worried about the rest of the world exposure as class actions in the past hardly existed outside of USA.

However, it would be myopic to think that class actions only affect the US. During the last decade alone, we have seen class action regulation creeping into Europe; there have been highly publicized claims brought against EADS and Shell in the Netherlands for instance.

In the UK, you may have seen the Times story covering Deloitte's report whereby new rules in the proposed Finance Bill this year are likely to result in finance directors in Britain facing fines if they or anyone in their teams commit errors when collating company accounts. We will be monitoring this development closely as it will be the first time finance directors in the UK will be made personally liable for 'careless inaccuracies'.

As class actions are set to become more visible in Europe, I would urge all Directors and Officers to be asking these three important questions: Will we see the same legislation as we have seen in the US? If not what are the differences? Will we see a magnitude of claims now?

Being Swedish myself, I was looking at the Swedish class action legislation that was introduced in 2003. As a result of this legislation, we have seen three types of actions now in Sweden:

• Private Class Actions - any person or entity can initiate such a class action provided they have a claim of its own and is a member of the group
• Organisational Class Actions - certain organisations can bring class actions without having a claim of their own. It is consumer or labour organisations that can initiate such actions provided that the dispute is between consumers and providers of goods and services.
• Public Class Actions - an authority appointed by the government can act as a plaintiff and litigate on behalf of a group of class members. The purpose is to allow authorities to pursue claims of public interest.

When this legislation came into force the market predicted that we would see an upsurge in the number of claims on the D&O side. But interestingly, the market has been proven wrong; we have not at all seen the expected increase that we had feared.

Based on the developments in Sweden alone, I think we can safely assume that the claims action system introduction in Europe has not yet led to an increase in litigation in the same way as we have seen and continue to see in the US. This is most likely due to the basic legal systems being different between Europe and US. But what will the future hold for us in this space?

This is an issue that is close to my heart and I expect to be blogging about the different litigation trends in the different European countries over the coming months. But I would like to hear your views on why you think we have not seen an increase in litigation in Europe and what, indeed, the differences are between the US and Europe.

Tag words

D&O, class actions, claim, regulation, litigation, Directors and Officers

Changing litigation trends in Canada by Paul Schiavone

Your responses to our first webcast were encouraging; many of you thought it was informative, direct and to the point; and overall a huge success.

We received some excellent questions from the participants of the webcast both during the live show as well as afterwards. One particular question we received during the live webcast focused on D&O securities litigation in Canada.

I would like to address this issue with a bit more depth.

In Canada, the substantive common law (with the exception of Quebec) is equally influenced by US and UK/Commonwealth jurisprudence. Securities class actions being brought against directors and officers is a fairly new phenomena in Canada. The up-tick in filings of securities class action of late is due to recent changes in provincial securities law in Canada. In fact, Ontario was the first province to amend its Securities Act to broaden its scope to allow for plaintiffs to use the class action as a means to sue directors and officers.

One of the key changes made to the Provincial Securities Acts of Canada was to no longer require plaintiffs to prove reliance on misrepresentations or omissions when they allege they have been harmed by actions taken or inaction by a company’s directors and officers. This change in the law has proven to be the main driver for the increase in class action filings in Canada against directors and officers there.

In 2008 there was a substantial increase in class action filings in Canada. 2008 saw a total of nine securities class action being brought in Canada (source: NERA Report “Trends in Canadian Securities Class Actions: 1997-2008 – January 2009). This is well above the average of four securities class actions over the previous three years. Of course nine securities class action pales in comparison to the total number of securities class actions brought in the US in 2008; however, the increase of 125% from 2007 to 2008 indicates that the Canadian plaintiff’s bar is now taking advantage of the recent changes in Provincial Securities Acts.

Of course there still remain limitations to the Canadian class action method as compared to say the US. As an example, unlike the US, the majority of civil cases in Canada are heard before a judge alone without jury and judge trials, more than jury trials, have historically led to lower damage awards. With the exception of Quebec, the "loser pays" rule applies, in a similar fashion to the UK. Basically stated, if the plaintiff brings an action against a director and officer and is unsuccessful (ie, loses the case) the plaintiff will be responsible to reimburse the defendant directors and officers for their costs of defending the action. As you can imagine, this has a significant effect on stopping frivolous law suits being brought against directors and officers in Canada.

What is becoming evident is that the changing litigation trends in Canada have made life more perilous for directors and officers of Canadian companies. The trends indicate a growing number of securities class actions. Although the number of securities class actions in Canada may not near the number we see in the US, if you are a director or officer of a Canadian company embroiled in such a law suit, the results can be just as damaging both personally and professionally.