The directors and officers liability insurance (D&O) market is in a state of turmoil

The directors and officers liability insurance (D&O) market is in a state of turmoil. Vastly higher premiums coupled with restricted cover have come at a time when directors are under closer scrutiny than ever before. Charles Boorman gives the UK view

The current difficulties being experienced in the UK D&O market have been heavily influenced by the size and frequency of claims in the US. Various corporate calamities and resultant shareholder lawsuits have decimated the estimated $3bn US D&O premium pool. While September 11 has had little direct effect on D&O claims, it has acted as a catalyst in pushing the D&O market ever higher.

Investors have seen the value of their stocks fall through the floor amidst allegations of wrongful accounting practices. Incredibly, seven out of the largest 10 bankruptcies in history have occurred in the last 18 months. Directors are now very much in the firing line.

As one US Senator recently said, "We all know, based upon our legal system, that this is going to be abused". It has been known for law firms specialising in securities cases to instigate class actions against major US and foreign firms when bad news hits, in the hope that something will stick. It is big business: 12 claims have been settled for over $100m in the past 24 months and five for over $200m. Most are likely to have been paid out by insurers. The average securities class action settlement weighs in at a hefty $38m.

The situation in Europe is not as dire, because of the difficulty and cost involved in bringing shareholder actions. However, international companies with US shareholders are by no means exempt from the US legal system. Of the 488 securities class actions last year, 44 were against foreign companies, compared with just 12 in 2000.

Risk managers of companies without a US listing may be wondering what this has got to do with them. Unfortunately, their D&O premiums are on the increase for two main reasons.

  • Claims in the UK are growing in both frequency and severity. There are now a number of million pound plus UK claims currently being defended by insurers. The focus on corporate governance in the UK has been heightened by the high profile corporate disasters 'across the pond' and is likely to drive up claims activity further.
  • The UK D&O market is dominated by US companies, such as Chubb and AIG, who have been on the receiving end of an increasingly litigious US system. A recent AIRMIC-sponsored market overview suggested these insurers were 'inflating premiums worldwide on the back of poor US claims' and therefore, 'the rest of the world is picking up the bill for US corporate greed'.

    What can you expect?
    A risk manager of a US-listed international telecommunications company should not be surprised to be on the receiving end of 500% plus premium increases. A small, successful UK manufacturer with no US exposure could expect a 25% - 35% increase.

    On top of premium increases, there are likely to be a number of coverage restrictions.

    Allocation of defence costs restricted Some insurers give 100% allocation (essentially entity defence costs where it is named as a co-defendant). Most D&O policies, however, allocate defence costs on a 'best efforts' basis, which means that insurers will not pay the company's defence costs where it is named in an action with a covered individual. While one or two insurers still offer 100% allocation, it is likely that this coverage extension will be phased out.

    Higher company reimbursement deductibles For companies with a US exposure, deductibles have been increasing for claims where the company is agreeing to reimburse. While deductibles are still rare for UK risks, we may soon see them creeping in.

    War and terrorism exclusion This is not a market-wide phenomenon, although some insurers have introduced it as a direct result of September 11.

    Outside directorship liability restricted Insurers are increasingly reluctant to automatically cover directors when serving on outside boards. If any outside directorships are held with US registered companies it is likely insurers will want details before agreeing to include them in coverage.

    Failure to insure exclusion This would exclude claims aimed at any directors responsible for failing to maintain adequate insurance. In the past, there have been a number of such claims in Europe. Historically they have been covered, but are being excluded in some instances nowadays.

    Official investigations The cost of legal representation at official investigations are usually covered in full. Insurers are beginning to sub-limit this cover and exclude US investigations entirely.

    Retention waiver deleted For claims where the insured person successfully defended a case, the deductible has historically been waived. The clause that allowed this is now sometimes being deleted.

    Insolvency exclusion These are rare but are applied as a last resort for risks that are in severe financial crisis, where remarketing is not an option. Insurers may offer this cover on a 'buy back' basis, but will require positive feedback on how the company is going to improve its financial position.

    Extended reporting period (ERP) restricted Historically ERPs have been on a favourable basis, allowing the insured to invoke the clause if renewal is refused and alternative insurance is not placed elsewhere. Nowadays the additional premiums required are increasing dramatically, with concurrent reductions in the period of cover. In some cases, the ERP can only be invoked if the insurer refuses to renew the policy.

    No automatic acquisition cover Due to the number of claims relating to acquisitions, insurers are requesting information as and when acquisition activity occurs instead of providing cover on a blanket basis.

    Entity extensions withdrawn An entity extension undermines the intent of the policy to exist for the exclusive benefit of individual directors and officers, as the limits are shared with the corporation. In bankruptcy cases a court may rule that the entire policy limits go to the creditors as an asset of the company, leaving the directors and officers completely exposed. This extension is therefore being severely restricted.

    What can you do?
    Your recourse is determined by such factors as the size of your company, the industry, US exposure and financial results, but some tips apply to all.

  • Ensure your broker has specialist D&O personnel. In a difficult market it is essential to use D&O specialists with the technical expertise to ensure coverage is as full and competitive as possible. If you are unsure whether your broker has that expertise, get in contact with a specialist to review your current policy, and, if necessary, ask them to place the cover at renewal. There have been cases where a lack of technical understanding on the part of the placing broker has meant that a claim that would have been covered has actually been rejected.

  • Ensure your broker has access to the London market. If it only has access to a limited number of D&O insurers, there is a high chance that your premium or coverage is not as competitive as it could be.

  • Outline the areas of coverage that are most important to you and tell your broker to try and ensure they are included. For instance, in the past, there have been a few insurers that have given 100% allocation of defence costs. The number is diminishing, but a specialist broker should know which insurers continue to offer it. The same applies to other areas where coverage is being restricted.

  • Directors should be taking a vested interest in understanding their D&O policy. A specialist broker will be able to supply a D&O guide outlining their legal duties and the extent of your existing D&O coverage.

  • Ask your broker for clarification of the state of the market and any renewal issues (ie premium and coverage) at least three months before renewal. Clear communication between all parties is paramount.

  • Think about the importance of the insurer's security rating. If you insist on a triple A rated insurer your choice of carrier will be extremely limited.
  • Ensure that the information provided includes full disclosure. Your coverage could be rescinded if full information is not obtained. It is also beneficial to be as professional as possible. Insurers are concerned about the way the company is managed.

  • Focus on corporate governance. If your company has excellent corporate governance, insurers are likely to be less brutal when it comes to renewal.

  • Ensure that renewal information is completed and returned at least 45 days prior to renewal (60-90 days for large companies). This will enable the broker to obtain renewal terms from the existing market(s) in good time, and allow enough time to remarket the risk if necessary.

    Associated Business Lawyers in Europe (ABLE) have produced a helpful guide, Accepting a Directorship in Europe. This says that directors' liability has become a hot topic in most European countries. In France for instance, there is extensive litigation. The law there is changing so that, in addition to directors' criminal liability, the company can itself be criminally liable and may face penalties five times the amount faced by individuals.

    ABLE also warns that jurisdictions vary in their treatment of D&O liability insurance. Expatriate directors should check where the company indemnification clause is valid; in France, there is no indemnification against third party claims for breach of directors' duties.

    The autumn issue of AIRMIC's overview of risk management issues, Risk Directions, includes an interview with Damien Coates, Vice President with responsibility for management with AIG in London, on keeping directors protected. He says that insurers will want to see:

  • strong accounting controls, especially in relation to recognition of revenues
  • valuation of goodwill and treatment of intangibles and gearing
  • an effective and independent audit committee
  • clear controls relating to insider trading
  • good corporate communications policy to ensure transparency and timely disclosure of price sensitive information.

    You can download copies of Risk Directions at AIRMIC's website,

    Charles Boorman is business developer, Corporate Liability Unit, Aon Ltd, Tel: 020 7882 0417, E-mail: