Full circle

Directors' and officers' liability insurance was first developed when the world economy slumped in the 1930s. Graham Buck reviews how the cover is

The market for directors' and officers' (D&O) liability has now been in existence for 75 years; its origins going back to the Great Depression. Lloyd's responded to the new duties and responsibilities imposed on directors and officers with a product at a time when corporations were not permitted to provide indemnification. Two years into the latest era of credit crunch and emergency state rescues for financial institutions, the market for D&O is very much one of two halves.

Commercial organisations with reasonably strong risk profiles are still able to take advantage of soft market conditions. A report issued early in September by Willis Group Holdings found that buyers of D&O from the London market typically enjoyed premium reductions of around five per cent from a year earlier in the second quarter of 2009.
The broker expects similar conditions in the third quarter, and even companies that have been hurt by the recession or have highly-leveraged balance sheets experienced, at worst, no more than a slight increase in premium.

By contrast, financial institutions worldwide have faced much harder market conditions with double digit rate rises of 40 per cent upwards applied to D&O renewals this year. Many believe that these tougher market conditions could soon begin to extend to non-financials also.

"The financial crisis and stock market volatility have led to a number of high-profile D&O claims, insolvency proceedings have multiplied and will probably remain a feature of the unstable economic conditions for some time," comments Emmanuelle Tardy, senior vice-president of the financial and professional practice (FINPRO) at Marsh. "If these translate to multi-million losses for insurers, then history tells us that the market will harden."

Tardy cites a volatile business environment, public outrage at corporate scandals centred on boards' remuneration, and a newly found, largely politically-motivated willingness to bring moral scruples to the fore. These factors, coupled with greater accountability, will fuel new legislation and regulation around the world, she predicts.
"Post-recession, the threat of legal actions, of legal defence costs, fines, and possible imprisonment sentences will, rightly or wrongly, be weighting on many business leaders' minds."

According to Richard Highley, a partner of law firm Davies Arnold Cooper, there also continues to be clear distinctions between the D&O markets of North America and this country. "The broker-client relationship is very different in the US, where there has been a flood of claims due to securities legislation," he says. "And where there are claims, there are also high premiums and a continuing close relationship between brokers, their clients and D&O underwriters."

By contrast, the UK has still witnessed relatively few claims. This makes D&O more of a "hard sell", with even many of the FTSE 350 companies still less than fully conversant with the product. The absence of the same close relationship means companies here often follow their brokers' recommendation when buying cover - and the absence of claims means there is too often a problem when one does arise.

This is in marked contrast to the accounting profession, which regularly faces claims particularly in a recession, says Highley. "This means there is an ongoing relationship between auditors and insurers. The ICAEW (Institute of Chartered Accountants in England and Wales) steps in to help with the process - and there are generally no problems."


Until mid-2007, and the onset of the credit crunch, D&O cover for financial institutions was "exceptionally broad in scope" reports Julian Martin, practice leader for the FINEX D&O at Willis. This trend has reversed in the last couple of years, with insurers seeking to add restrictions such as cutting back the cover provided for investigation costs.
A typical D&O contract comprises three sections: Side A responds to directors' and officers' personal liability where the company is unable to provide indemnification, thereby protecting their personal assets.

Side B cover applies when the company can indemnify and thus protects the company while Side C, referred to as entity cover, responds to claims brought by shareholders. Side C has regularly been used by companies to provide balance sheet protection, for which, pre-crisis, they paid little additional premium. Martin reports that the majority of shareholder claims against financial institutions brought in the US both name individual directors and also the company, so Side A, B and C are all invoked and payments are correspondingly much higher.

"At the moment, a great deal of Side A cover is being purchased in the US; indeed some insurers will only offer Side A to financial institutions. The same applies here in the UK for those institutions with US shareholders. "While cover continues to be available, underwriters are now looking at each application far more closely and D&O carriers are also reviewing the extent of cover they are willing to offer."

In particular, the Regulatory/ Investigation Costs Extension has cost D&O insurers dearly. Cover is invoked when the Securities and Exchange Commission, Financial Services Authority or similar regulatory body requires directors and officers to justify and explain their conduct. The wording for this extension has become more restrictive and insurers are also no longer willing to offer maximum capacity.
"The crunch has given rise to so-called Madoff and Stanford exclusions, which some insurers have been applying to D&O cover for banks and other financial institutions - along with other restrictions such as the reduction, or sometimes removal, of Side C cover," adds Adam Barker, UK general and underwriting counsel for HCC Insurance Holdings' subsidiary HCC Global Financial Products.

This means that companies' ability for "building towers" on Side A, B and C has become more constricted, and often additional capacity is available only through building up Side A. Barker adds that underwriters have mixed views on whether banks that have been the subject of government bail-outs represent a better or worse risk than those that have managed to survive without a rescue.

"State intervention is, by its very nature, a red flag," he observes. "If the government is intervening, the institution is probably facing significant financial difficulties.
"This does not necessarily imply wrongdoing by management; merely that and form of state intervention will lead to stakeholders asking the question 'how did we get here?' On the other hand soft intervention may reduce the possibility of claims."


The banks can at least be thankful that the future of American International Group (AIG) is looking more assured than it was 12 months ago. AIG has traditionally been the sector's main provider of D&O cover and, says Martin, the consequences of the group going under would have been disastrous.

AIG's survival also goes some way to explaining why, for commercial companies, D&O policy wordings remain broad with new entrants coming into the market and new Lloyd's syndicates adding to available capacity. The new names include Argo, a relatively recent start-up that is competing aggressively.

Many of AIG's competitors are clamouring to take some of its D&O business, but Martin says the group has been pricing renewals at whatever level is needed to retain them. "Even where it has lost accounts it is keen to regain them," he adds. AIG UK has recently moved to put some distance between it and the recent troubles of its parent, announcing that the company will re-brand as Chartis over the coming months.

This keen competition means that companies with strong risk profiles continue to enjoy a strong negotiating position and can dictate rate cuts. Indeed, one major D&O insurer, Zurich, has commented that while it regards an across the board rate increases of six per cent to eight per cent as justified, they will not be imposed while the current soft market conditions persist.

"It's reasonable to expect that insurance capacity will contract if the global recession continues, which may lead to more pressure on terms and conditions," says Tardy.
"However, D&O is a profitable class of business for many insurers, and one that has, historically, attracted new capacity, a factor that has consistently fuelled competition."
Another issue of concern for UK D&O insurers is in the field of environmental liability. Although legislation has been enacted that requires companies to clean up their act Highley observes that the Environment Agency has not aggressively pursued prosecutions against companies that flout the regulations.

"If the Agency was to change its approach and enforced the legislation more rigorously, many more claims would result," he comments. "There is, in particular, considerable impetus for the climate change regime to be enforced, so change could result in more claims against directors."

One crumb of comfort for insurers is a general absence of new legislation on the horizon to cause serious concern, although as Barker notes with a new government likely next year "the horizon is not very wide."

"The new Companies Act and the Corporate Manslaughter Act are significant, but for D&O insurers the most significant forthcoming events will be the results of Lord Justice Jackson's review of UK litigation costs and an increase in third party litigation funding," he suggests.

The preliminary version of the Jackson report was published in May and his final recommendations are expected by the end of the year. If these lead to a shifting of the cost burden away from the claimant, it will have a massive impact on claims adds Highley.

"While we don't want to end up like the US, the absence of legal aid for commercial actions prevents many valid claims from being pursued," he says. How would he sum up the likely state of the D&O market post-downturn? "It will look much the same, only better," he suggests. "Policies will have to respond to claims if insurers want to retain their market share. But rather like the professional indemnity market for construction risks, it may also be a market with fewer players."

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