Tag Archives: D&O insurance

What SPACS Mean for R&W Exposure

The rapid rise to fame of special purpose acquisition companies (SPACs) brings with it a host of uncertainty and risks along with the promise of fortune. In the U.S., 274 SPACs were launched in 2020, and so far in 2021 about $100 billion has been raised, according to the Wall Street Journal. Such is the growing appeal of SPACs that the Securities and Exchange Commission took the unusual step in March of warning that it is “never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment.”

In addition to warning against basing investments solely on celebrity endorsements, the SEC recently issued further guidance on the booming SPAC market, and many believe that increased scrutiny will continue, with further regulation coming. From an insurance perspective, much of the focus has been on the risk exposures of executives and directors involved in the deals, resulting in an explosion of D&O insurance demand. Although many of the risk exposures remain the same as those in traditional M&A deals, lack of historical data has fueled uncertainty over future litigation possibilities. Perhaps the biggest difference in SPAC risk exposure is the speed with which deals must be completed. As with other areas of the mergers and acquisitions market, the use of representations and warranties (R&W) insurance can offer real benefits to both buyers and sellers to help manage these risks.

Managing the risks

The use of R&W insurance has become a standard feature and a valued tool to facilitate deals in the private equity (PE) space over the last several years, with myriad benefits for both sides of the transaction. Participants in SPAC transactions should also consider R&W insurance once a target has been identified and work is underway to complete the de-SPAC merger. 

The risks to be insured on a SPAC transaction are not radically different from a PE deal – for the buyers, the exposures are largely the same.  However, there is one significant difference in SPAC transactions that may drive risky behaviors: deals are being done against the clock. 

One of the key attributes of SPACs is that deals must be completed within a two-year time frame, which imposes considerable pressure on the founders to find the target and close the merger. In a typical PE deal, despite months – sometimes years – of due diligence and the seemingly good intentions of both parties, it’s not uncommon for M&A issues to arise under sales contracts—often after the ink has dried. The aggressive timeline of a SPAC transaction only heightens these risks. Some parties may be tempted to cut corners in the due diligence process and SPAC sponsors are well aware that discovering bad news might derail the deal. 

This time pressure can also mean that SPAC sponsors may make concessions during the negotiation of the purchase agreement, because they have an incentive to close the business combination and don’t have a fiduciary duty to the investors. In most cases, sponsors are able to sell their shares soon after the deal is done, so they are less interested than other investors in the target’s long-term performance. This last issue can, and in some cases has, been resolved by making sponsors hold shares in the SPAC longer so that their interests are more aligned with other investors.  The more interest the sponsor has post-deal, the deeper they may dig to understand the target, and the more invested they may be in the due diligence process.

How R&W can make it happen

In simple terms, R&W insurance hedges risk for both buyer and seller. When evaluating coverage options, working with a team of underwriters experienced in executing deals under tight time constraints can give SPAC acquirers certainty that they will have insurance in place when they sign a deal. 

Equally important is choosing an insurer  that has a deep bench of underwriters with depth and breadth of experience across sectors, as they will be able to highlight any soft spots in the diligence that need to be addressed to ensure meaningful coverage.

See also: Startups Must Look at Compensation Plans

There is also competitive pressure for targets. Having R&W insurance can be an advantage to the targets in an auction process, making them attractive to investors. Should there be any misrepresentations or breaches post-closing, the seller is liable for losses for the period of time set out in the agreement. To cover any legacy liabilities, a portion of the proceeds from the sale are typically held up in escrow, handcuffing sellers from using those funds. When a target has R&W insurance, it removes the requirement to have an escrow and the sellers can realize the entire proceeds of the deal on closing. For a purchase in the hundreds of millions of dollars, the ability to liberate a 10% escrow with an insurance policy is very attractive. 

While the risk profile for a SPAC target is not critically different from that of any other business requiring R&W insurance, the abbreviated timelines involved on SPAC deals and their shorter track record makes it harder to predict outcomes. Just as a celebrity relies on their reputation to secure endorsements, so too must an SPAC sponsor seeking investor and target company trust. R&W insurance serves as an important tool to facilitate these fast acquisitions, transferring risk to the insurance company and keeping reputations intact.

The ‘B’ Word: Bankruptcy and D&O

We have to talk about the “B” word. No one wants to go there. But as COVID-19 continues to wreak havoc throughout the world, we are seeing more companies headed toward bankruptcy. Although the stock market continues to soar, the underlying U.S. economy is sputtering. Bill collectors are still open for business, and certain companies, especially those that were in precarious financial positions before the pandemic (think certain retail chains and energy companies hit with the double-whammy of the virus and the oil crisis), are suffering.  

Bankruptcy presents a host of problems for directors and officers. Although litigation against the company is stayed during the bankruptcy process, suits against individuals are typically not. As company indemnification dries up, D&O insurance is the last line of defense for executives. So, it is important to understand how that insurance may/may not respond to protect directors and officers.  

How are D&O Insurance Programs Typically Structured?

Public companies typically purchase traditional D&O insurance coupled with additional dedicated Side A limits of liability.  

A quick refresher…traditional D&O insurance has three main insuring agreements. Side A is coverage for directors and officers personally in the event claims are made against them and the company cannot legally or financially provide indemnification. Side B is coverage that protects the company to the extent it indemnifies directors and officers for claims made against them. Side C is coverage for the company when it is named in a securities claim. 

The dedicated Side A limits that “sit on top” of a traditional D&O tower of insurance are typically written on a “Difference in Conditions (DIC)” basis. If the underlying traditional D&O insurance does not respond to an A side claim, to the extent covered by the DIC insurance such insurance will “drop down” and begin to pay on behalf of directors and officers.  

It is important to review the terms and conditions of your D&O policies to ensure they will respond properly in the event of bankruptcy.

Traditional D&O Insurance Considerations in Bankruptcy

There are a number of provisions within a traditional D&O policy that can have a material impact on the way a policy does or does not respond in the bankruptcy context.

The first such provision is the change-in-control clause in the policy. This provision details the instances in which the policy will automatically convert into a tail period; meaning that, from the date of the change of control until the end of the policy period, the insurer will only cover claims for wrongful acts that occurred prior to the change in control date. The most common change in control trigger is the sale of the company to another company. In some D&O policies, however, bankruptcy triggers a change in control. Most companies will want this trigger deleted from their policy as they will want coverage to continue, uninterrupted, throughout the bankruptcy process. Companies typically purchase a multi-year tail program to trigger at the end of the bankruptcy process.

As traditional D&O insurance covers multiple constituencies (e.g., natural persons and corporate entities), how are policy proceeds accessed during bankruptcy? If there are no claims outstanding and no claims are made during the bankruptcy proceeding, this question does not need to be answered. The D&O insurance goes unused. If, however, there are claims against the company and individual insureds that have triggered (pre-bankruptcy) or do trigger (during bankruptcy) the insurance policies, the policy and its proceeds may become an asset of the debtor’s (the company’s) estate. As such, directors and officers may need to petition the bankruptcy court for access to such insurance proceeds to pay their defense costs.  Additionally, the insurer may request a comfort order from the court.

It is very important that the D&O policy have a carefully thought out “Order of Payments” provision. This provision is an indication to the court considering the petition (and to all insureds) that:

  1. the intent of the policy is to first and foremost protect individual directors and officers; and 
  2. particularly in the event of a bankruptcy, A side claims should be given priority and paid first.

Next, we turn to exclusions within the policy. In this time of market upheaval (both in the broader financial markets as well as in the D&O insurance market), insurers have been attempting to add insolvency-related exclusions to D&O policies. Although there are arguments that can (and will!) be made under the bankruptcy code that these exclusions are unenforceable ipso facto clauses, these exclusions are very dangerous and should not be added to policies if there is any way to avoid them.  

Additionally, it is important to review the entity (or insured) versus insured exclusion. This exclusion is designed to prevent collusive behavior between insureds. In other words, the company cannot sue an executive and expect insurance to pay unless that suit is brought in specific situations. As creditors’ committees are common plaintiffs in bankruptcy actions and are often acting “on behalf of the companies,” it is imperative to have a full bankruptcy-related exception to the entity versus insured exclusion. 

See also: COVID and the Need for Devil’s Advocates

In all instances, the retention (deductible) applicable to an A side claim should be nil, and the policy should respond first dollar. To ensure that defense costs are quickly advanced to individuals ensnared in litigation, the policy should have clear wording that, in the event the company fails or refuses to indemnify for any reason (including financial insolvency), the insurer will advance such amounts to the insured individuals, dollar one.

Finally, the policy should include bankruptcy waiver language. This language is a contractual promise that both the insurers and the insureds agree to waive and release (and agree not to oppose or object to) any request for relief from any automatic stay or injunction as to the policy proceeds.

Side A DIC D&O Insurance Considerations in Bankruptcy

As with the traditional D&O program, it is important to review the Side A DIC bankruptcy-related terms and conditions. 

The insuring clause will indicate if and when the Side A DIC insurance will come into play in a claim. This insurance is similar to any excess insurance in that it will respond to A side claims if the underlying limits of liability are exhausted. The DIC feature provides that, even if the underlying insurance is not exhausted, the Side A DIC insurance can drop down and begin paying A side claims if the underlying insurance fails to do so. Most Side A DIC policies enumerate the instances in which it will drop down. From a bankruptcy perspective, the key trigger is that the policy will drop down in the event any underlying traditional insurer fails to pay because the bankruptcy court has imposed a stay order upon the policy proceeds.

In line with the recommendations made with respect to the traditional D&O policy form, the following should be considered:

  1. Some insuring clauses include “any source” language. This language indicates that the policy will not trigger if the individual is entitled to indemnification from “any source.” This language is less favorable than language that allows the policy to trigger as soon as the individual is not indemnified by the company itself.
  2. Although we cannot recall a Side A DIC policy that has a bankruptcy change-in-control trigger, stranger things have happened, so double check your policy.
  3. On the most difficult risks, we can imagine even Side A DIC insurers introducing bankruptcy exclusions as part of the underwriting process. For companies that are teetering, if this exclusion is ultimately enforceable, it defeats the purpose of the purchase. To avoid coverage disputes over the exclusion, every alternative to the exclusion must be considered.
  4. Some A Side DIC policies have an “order of payments” provision that is unique to debtor-in-possession scenarios. The provision simply states that claims for wrongful acts occurring prior to the company becoming a debtor in possession have priority over claims for wrongful acts occurring after such event.
  5. Strong bankruptcy waiver provisions should be included.
  6. If the lead Side A DIC policy is followed by excess policies, each one should contain a DIC through DIC endorsement. This endorsement requires excess DIC insurers to drop down and fill any gaps that may be left if an underlying DIC insurer fails or refuses to pay loss.  

Final Thoughts

One of the largest concerns we have seen from insureds is limits adequacy/management. It is important to remember that the D&O limits you purchase could, if the bottom falls out, be the limits you have available to you in bankruptcy for any and all claims associated with the bankruptcy. We have witnessed unfortunate examples of companies that had NO expectation that bankruptcy was even a blip on the horizon one year ago and that now find themselves in the midst of it and unable to secure additional D&O limits. As most of us have learned in one way or another from COVID; “NEVER SAY NEVER – ANYTHING IS POSSIBLE.”   

We have seen claims in which defense costs get out of hand and limits are eroded to the point where there is little if any money left for settlement. This can obviously occur if the limits of liability purchased are too low. It also happens in conflict of interest (whether actual or potential) situations where insured individuals want separate counsel. 

See also: State of Commercial Insurance Market

With respect to conflicts, do the directors and officers agree that they should be entitled to separate counsel only in the event of an actual conflict of interest, or do they require language in the D&O policy (and discussion with the insurers) that any potential conflict of interest warrants separate counsel. As noted above, limits go quickly, and expectations should be set up-front. Remember, in a bankruptcy situation, the D&O insurance is the last line of defense for the individuals. 

Finally, and from a practical standpoint, and not unique to bankruptcy scenarios, it is important to make sure that, if an insured requires panel counsel to be used, the company and its directors and officers are comfortable with the panel list before a claim comes in.  

The time to prepare for these issues is now.

What Every Director Needs to Know

We often get called into corporate calamities where “heavy water” is starting to overwhelm the bilge pump of the corporate yacht. Especially in situations like today, where the markets are stuck in bear market territory, where the oil markets have collapsed, where the coronavirus rampages through the U.S. and where gross uncertainty exists regarding our transportation system and supply chain. We have lived through the financial crisis, regulatory messes and, most importantly, situations where organizations have simply lost the faith of the customers and investors.

Often, directors and officer who have to figure out what to do to “save the ship” must at the very same time try to figure out if they have enough directors and officers (“D&O”) liability insurance to weather the storm and protect them from plaintiffs’ lawyers circling the sinking ship.

Nautical allusions aside, figuring out if your D&O insurance is good enough when you are about to enter stormy seas is not ideal. First, there may be no time to tinker with the D&O coverage. Second, and more importantly, if there is a problem with your coverage, or there is not enough of it, many carriers are reluctant to modify policy wording (to potentially “enhance” coverage), or they add limits of liability when a company is having financial difficulty because the carrier is worried about its potential exposure to directors and officers claims (whether they might be lawsuits or regulatory investigations). To many less-forward thinking carriers, doubling down (in some respect, even if it serves to protect their insureds) sometimes makes no sense.

Finally, despite years of heavy claim activity and many large frauds, bankruptcies and regulatory investigations, we often still see the same problems with policies and towers of insurance. Why? We honestly cannot say. Sometimes corporations and their boards do not focus enough on D&O insurance issues because they are frankly too busy with other issues. Sometimes D&O insurance decisions are based not on “substance” issues but on cost issues, which is generally not the right answer for many reasons. Much of the literature dealing with D&O insurance tends not to be broadly disseminated to the folks who need the information most, like corporate directors and officers. Instead, decisions are often left to risk managers and brokers who do not have much experience dealing with D&O issues at troubled companies.

Our goal in this piece is to place front and center the most important issues relating to such issues. This will allow directors and officers to understand what they need to know and what to ask when questioning management on D&O coverage. These are not the only issues that should be addressed when considering the scope and breadth of D&O coverage, but certainly are ones that should be at the top of any director’s and officer’s list. Truth be told, this advice should hold true for all companies and boards, not just troubled ones. The best time to fix D&O issues is when the sailing is smooth, not when the corporate yacht is about to sink.

Will Your Carrier Hang Tough With You When Things Go Bad?

D&O insurance is frequently purchased in a “stack” or a “tower” of insurance, led by a primary carrier and multiple excess carriers. The excess policies are usually written in “follow form” nature. This means, in most cases, they follow the terms and conditions of the primary carrier. For larger companies, there is both a traditional Side A, B and C tower (covering the entity and individuals) and a Side A tower, covering the directors and officers for non-indemnifiable loss.

Because neither insurance policy forms nor D&O carriers are fungible commodities, it is very important to understand who is the company’s primary D&O carrier, what coverage the carrier offers and whether the carrier “pays claims.” In many ways, the primary D&O carrier is like a critical vendor or business partner that the company cannot do without. The primary D&O carrier can sometimes be the most important business partner (and friend) a company and a director or officer can have. The hope is that, when the seas are rough, like in an insolvency or restructuring scenario, the primary carrier will be there to respond to claims and ultimately protect the personal assets of the directors and officers involved – even in times where indemnification or advancement is unavailable or refused by the corporation.

 A few points to consider:

1. What is the carrier’s claims handling and claims paying reputation? Is it business-friendly and coverage-friendly, or is the carrier known to try to find “outs” to coverage? Does the carrier have a free-standing claims department, or does it farm out claims to hyper-aggressive coverage counsel? And, if the company has multiple offices overseas, how does the D&O carrier handle cross-border claims or investigations? Through a bit of investigation, one can often learn from others (such as defense counsel or experienced D&O brokers) information that might indicate which way a carrier leans on these important questions. Obviously, the best carrier is one that will hang with the directors and officers even in the worst of times, and will not “run and hide” behind coverage defenses so it does not have to pay.

2. What is the carrier’s underwriting response to questions and potential modifications? What is the carrier’s responsiveness to requests to enhance coverage for the insureds? These questions relate to the prior question. Directors, officers, and companies want a business partner in their primary carrier, not a “silent partner.” Many of the better carriers often will consider (and implement) policy changes even days or weeks before a bankruptcy filing to clarify policy language for the potential benefit of the insureds. Those are the types of carriers that a director or officer wants on his or her side.

3. Do you have enough coverage? This can be the most worrisome aspect to any director or officer caught up in a corporate storm. Unfortunately, this is also an area that is confusing because there are often no clear or “right” answers as to what limits should be purchased.

The most important thing a director or officer can do in this regard is ask many questions of management. For a public company with $2 billion of annual revenue, $30 million of D&O insurance likely does not make sense. Similarly, for companies with substantial debt and perhaps not a lot of cash on hand, a low D&O limit also would not make sense. Very often, an experienced D&O broker can provide benchmarking, showing what D&O insurance is purchased by similarly situated companies. Thus, a company can look to a competitor in its space, or at its size, to determine what type and level of D&O insurance comparable companies have purchased. Finally, many larger companies with public debt or equity exposure can perform “mock” damages analyses to understand what a potential securities claim against them might look like from the perspective of damages and defense costs. The variable here is that the cost of a simultaneous regulatory or criminal investigation, as discussed below, can vastly skew those amounts.

Can a company increase the limits of its D&O coverage midterm, or even after bad news surfaces? This is a common question. The answer is that it depends on the facts and the circumstances of the particular situation. Sometimes the circumstances a company faces are not so dire, and carriers will cooperate with the company’s desire to protect its directors and officers by agreeing to increase the limits of its tower (for a price, of course). Other times, the situation may be so severe that a request to increase limits will be politely declined. The later polite declination proves our point. Directors and officers should ask questions up front regarding coverage amounts. They should not wait until the corporate ship starts to heel over to request higher amounts. By then it might be too late.

See also: What Effective Leaders Do in Tough Times  

Coverage for Regulatory and Criminal Investigations

Troubled companies often encounter a regulatory or criminal investigation (SEC/DOJ) at the same time they are facing civil litigation. This is the potential “double whammy” of defense costs, which often can run into the millions of dollars. Thus, directors and officers need to know what sort of coverage their D&O insurance provides for such investigations because, to the extent such investigation constitutes covered loss under the D&O policy, every dollar spent on investigations will generally reduce the overall limits available to ultimately settle the underlying litigation.

The rules of the road are well established in this area. Directors and officers are generally covered under the company’s directors and officers insurance for formal regulatory and criminal investigations and inquiries as well as “a formal criminal, administrative, or regulatory investigation against an Insured Person when such Insured Person receives a Wells Notice or target letter in connection with such investigations.” 

Corporations are generally not covered for their involvement in such situations, unless individual directors or officers are also simultaneously named in the investigation (these rules of the road are often different in the private equity space, which is beyond the scope of this article). Specialized policies in the D&O marketplace exist to cover regulatory and criminal investigations in those situations where only the company is named, though those policies are reported to be expensive. All other things being equal, a director or officer should ensure that he or she is covered for regulatory and criminal investigations and inquiries. These can be very expensive to litigate and defend, and the last thing the company and its board needs at the time is a loose cannon on deck.

Why Does the Insured Versus Insured Clause (and Its Carve-outs) Really Matter?

The insured versus insured clause has been included in D&O policies for a long time. It finds its genesis in a carrier’s need to guard against collusive lawsuits brought by one insured (say, for instance, the company) against another insured (like a director or officer), solely designed to get to the proceeds of the company’s D&O policy.

Indeed, carriers may have valid reasons for not wanting to cover these types of lawsuits. But there are other types of potential “insured versus insured” lawsuits that should be covered (and thus “carved out” of the insured versus insured exclusion) because they generally would not be collusive (and normally are just as hotly contested as suits brought by traditional third parties). Here is a list of certain types of lawsuits that we believe should be explicitly covered under the D&O policy (i.e., carved out) to protect the interests of the directors and officers.

1. Shareholder derivative actions

2. Suits that generally arise in bankruptcy when bankruptcy-formed constituencies, such as creditors’ committees, bondholder committees or equity committees, bring an action derivatively on behalf of a bankrupt company for alleged breaches of fiduciary duty by the company’s directors and officers.

3. Similarly, suits by trustees, liquidators and receivers against directors and officers. As we have seen from high-profile suits involving companies like Tribune, Extended Stay and BearingPoint, bankruptcy-formed constituencies and trustees have become much more aggressive and litigious over the years, and the threat of such suits simply cannot be ignored.

4. Whistleblower suits brought under the provisions of either Sarbanes-Oxley or Dodd-Frank.

What is Non-Rescindable Side A Coverage?

There are two general coverage sides to a D&O policy (leaving for another day the concept of outside director coverage). Coverage “Side A” is for non-indemnifiable loss, meaning loss for which a company cannot indemnify or is financially unable to indemnify. Under this side, the directors and officers are the insureds. Coverage “Side B,” on the other hand, is for indemnifiable loss. Under Coverage C, the company is insured for securities claims.

Side A covers a range of different scenarios. For example, under Delaware law (where many corporations are incorporated), a company cannot indemnify its directors and officers for the settlement of a shareholder derivative action. And in bankruptcy, a company often will be unable to advance defense costs and to indemnify its directors and officers for claims. Indemnification claims by directors and officers against the company may be treated as unsecured claims that get pennies on the dollar, or may even be subordinated in certain circumstances.

As several of the noteworthy “financial fraud”-related bankruptcies have taught us, having “non-rescindable” Side A coverage is very important. “Non-rescindable” Side A coverage means what it says. Even in cases where a carrier may challenge as false statements made by a potentially complicit CEO or CFO in the company’s insurance application for D&O coverage (attaching to such application, for example, financial statements that later need to be restated), non-rescindable Side A coverage generally cannot be rescinded for any reason, which should allow the directors and officers to sleep better at night. Directors and officers should know that non-rescindable Side A coverage is generally standard in today’s D&O marketplace, and thus primary policies that do not have such coverage should be immediately updated.

What is Side A Excess Difference in Conditions Coverage (and Why Is It So Important)?

As noted above, having non-rescindable Side A D&O coverage is critically important. Having “Side A Excess Difference in Conditions” D&O coverage can be even more important. Why? This coverage reacts in two different, wonderful ways to protect directors and senior management.

First, it acts as “excess” Side A D&O insurance, meaning, in English, that it sits above the company’s traditional tower of insurance and will pay Side A non-indemnifiable claims when the traditional tower is exhausted by either traditional indemnifiable claims or non-indemnifiable claims. For example, a company may have $50 million in traditional D&O coverage and $25 million of Side A excess difference on conditions coverage, where $45 million of that insurance has already been exhausted by the settlement of a simultaneously commenced securities class action and SEC investigation. In such a case, the directors and officers would still have $30 million of Side A insurance to deal with, for example, the settlement of shareholder derivative action.

Second, most Side A excess difference in conditions D&O insurance has something called a “drop down” feature, meaning that if, for example, an underlying excess carrier refused to pay its limit of insurance for some coverage-related reason, the Side A excess difference in condition carrier might have the contractual obligation to “drop down” and fill that layer. Thus, it is a critically important feature that potentially will help fill potential gaps in coverage. Also, note that most Side A excess difference in conditions policies have very few exclusions (e.g., most do not have an insured versus insured exclusion), so they can be particularly helpful to directors and officers.

See also: COVID-19: Moral Imperative for the Insurance Industry  

Does My Corporation Have Enough Side A Coverage?

In the olden days of D&O (meaning 10 years ago), it was pretty rare to have a large Side A tower of insurance. Companies may have had a large primary tower of insurance, but Side A towers over $100 million were a rarity.

Since the settlement of several large financial crisis cases, we have seen a steady rise in the settlement values of shareholder derivative actions. However, in the last three years alone, the value of these cases has skyrocketed in nine-figure territory on a regular basis. Why? Reasons vary from severity, to regulatory fines and penalties, to the opioid crisis to enormous cybersecurity breaches. One of the major factors in all tends to be a really bad event that caused both a stock-price plunge, along with a large fine or penalty. The resulting litigation is called event-driven.

Event-driven litigation puts pressure on the primary tower of insurance, which quickly gets exhausted, and puts an equal amount of pressure on the Side A tower, which will need to respond to the shareholder derivative action. We would strongly recommend that companies entering troubled water re-evaluate their Side A coverage before the bad event happens. Afterward, it may be way too late.

What is the Priority of Payments Clause, and Why Is It Important?

A priority of payments clause specifies how a carrier should handle competing claims on a policy’s proceeds. For example, most such clauses (some carriers call them “order of payments” clauses) specify that Side A claims get paid first, and then traditional Side B company reimbursement and indemnity claims get paid. Obviously, this approach is tremendously important to directors and officers who may need to defend themselves in securities class actions or bankruptcy-related or inspired litigation.

Some priority of payments clauses give the right to the company or a company officer (like a CEO or CFO) to “withhold” or “delay” payments made under Side B of a D&O policy until those payments are properly designated by the appropriate party. This type of discretion is potentially not a good thing. Why? Giving such potential discretion to the company or a company officer to withhold or direct payments under Side B of a D&O policy might be creatively viewed by some as giving the debtor in bankruptcy “a say” or “control” over the proceeds of the D&O policy. That situation could be used by a creditor or other bankruptcy constituency to control or delay payments to the directors and officers under Side A of the policy, again potentially leaving them without resources to pay their counsel. Varriers are very able to make policy reimbursement calls in bankruptcy settings, and the order of payments under a D&O policy should be left to them, not others.  

Making a Better D&O “Mousetrap”

Admittedly, some of the above items are a bit difficult to understand conceptually for the non-insurance professional, and, admittedly, directors and officers often have more pressing issues to deal with when trying to help their companies navigate through troubled waters. But, as we have seen time and time again in our practice, very often D&O insurance becomes the lifeline for directors and officers when companies face trouble.

How can a director or officer stay on top of these issues in the most efficient manner possible? Here are a few suggestions:

  1. Ask the right questions to the right people, like the company’s risk manager, CFO or general counsel, as to what is covered and what is not, and ask about the above limits of liability issues to make sure you are comfortable that at least these points are properly covered. Again, common sense often prevails here, and, if a director or officer does not like the answers he or she is getting, then corrective action should be demanded before it is too late to act.
  2. Make D&O insurance issues a board topic at least twice a year so that board members can stay abreast of coverage developments, options and modifications.
  3. Make sure management sends out the company’s D&O program and tower of insurance at least once a year for a “tune-up.” In this area, coverage options often change, and better coverage can often be obtained so long as the right diagnosis is made by qualified persons such as an experienced D&O broker or, sometimes, experienced outside counsel.

5 D&O Mega Trends for 2020

The range of risks facing company executives or directors and officers (D&Os) – as well as resulting insurance claims scenarios – has increased significantly in recent years. With corporate management under the spotlight like never before, Allianz Global Corporate & Specialty has identified, in its latest risk report, Directors and Officers Insurance Insights 2020, five mega trends that will have significant risk implications for senior management in 2020 and beyond.

1. More litigation is coming from “bad news” events

Allianz continues to see more D&O claims emanating from “bad news” not necessarily related to financial results, including product problems, man-made disasters, environmental disasters, corruption and cyber-attacks – “event-driven litigation” cases that often result in significant securities or derivative claims from shareholders after a share price fall or regulatory investigation related to the “bad news” event.

Plaintiffs seek to relate the “event” to prior company or board statements of reassurance to shareholders and regulators of no known issues. Of the top 100 US securities fraud settlements ever, 59% are event-driven.

One of the most prevalent types of these events is cyber incidents. Allianz has seen a number of securities class actions, derivative actions and regulatory investigations and fines, including from the E.U.’s General Data Protection Regulation (GDPR), in the last year, and expects an acceleration in 2020.

Companies and boards increasingly will be held responsible for data breaches and network security issues that cause loss of personal information or significant impairment to the company’s performance and reputation. Companies suffering major cyber or security breaches increasingly are targeted by shareholders in derivative litigations alleging failure to institute timely protective measures for the company and its customers.

The Marriott case – where the hotel chain announced that one of its reservation systems had been compromised, with hundreds of millions of customer records left exposed – is a recent example of a cyber breach resulting in D&O claims – one $12.5 billion lawsuit among several filings alleges that a “digital infestation” of the company, unnoticed by management, caused customer personal data to be compromised for over four years.

2. ESG and climate change litigation on the rise

Environmental, social and governance (ESG) failings can cause brand values to plummet. And investors, regulators, governments and customers increasingly expect companies and boards to focus on ESG issues, such as climate change, for example. Climate change litigation cases have been brought in at least 28 countries to date (three-quarters in the U.S.). In the U.S., there are an increasing number of cases alleging that companies have failed to adjust business practices in line with changing climate conditions.

Human exploitation in the supply chain is another disrupter and illustrates how ethical topics can cause D&O claims. Such topics can also be a major focus for activist investors whose campaigns continue to increase year-on-year.

Appropriate company culture can be a strong defense risk-mechanism. Many studies show board diversity helps reduce and foresee risk. Regulators are keen to investigate and punish individual officers rather than the entity, forcing directors into increased personal scrutiny to provide assurance that they did due diligence to prevent such cases from occurring.

See also: How to Deliver Tough Message on D&O  

3. Growth of securities class actions globally

Securities class actions, most prevalent in the U.S., Canada and Australia, are growing globally as legal environments evolve and in response to growing receptivity of governments to collective redress and class actions. Significantly, the E.U. has proposed enacting a collective redress model to allow for class actions, while states, such as Germany, the Netherlands and the U.K., have established collective redress procedures. The pace of U.S. filing activity in 2019 has been only marginally slower than record highs of 2017 and 2018, when there were over 400 filings, almost double the average number of the preceding two decades.

Shareholder activism has increased. Approximately 82% of public company merger transactions valued over $100 million gave rise to litigation by shareholders of the target company threatening that the target company’s board will have breached its duties by underpricing the company, should the merger succeed.

4. Bankruptcies and political challenges

With most experts predicting a slowdown in economic growth, Allianz expects to see increased insolvencies, which may potentially translate into D&O claims. Business insolvencies rose in 2018 by more than 10% year-on-year, owing to a surge of over 60% in China, according to Euler Hermes. In 2019, business failures are set to rise for the third consecutive year by more than 6% year-on-year, with two out of three countries poised to post higher numbers of insolvencies than in 2018.

Political challenges, including significant elections, Brexit and trade wars, could create the need for risk planning for boards, including revisiting currency strategy, merger and acquisition (M&A) planning and supply chain and sourcing decisions based on tariffs. Poor decision- making may also result in claims from stakeholders.

5. Litigation funding is now a global investment class

These mega trends are further fueled by litigation funding now becoming a global investment class, attracting investors hurt by years of low interest rates searching for higher returns. Litigation finance reduces many of the entrance cost barriers for individuals wanting to seek compensation, although there is much debate around the remuneration model of this business.

Recently, many of the largest litigation funders have set up in Europe. Although the U.S. accounts for roughly 40% of the market, followed by Australia and the U.K., other areas are opening up, such as recent authorizations for litigation funding for arbitration cases in Singapore and Hong Kong. Next hotspots are predicted to be India and parts of the Middle East. Estimates are that the litigation funding industry has grown to around $10 billion globally, although some put the figure much higher, in the $50 billion to $100 billion range, based on billings of the largest law firms.

The state of the market

Although around $15 billion of D&O insurance premiums are collected annually, the sector’s profitability is challenged due to increased competition, growth in the number of lawsuits and rising claims frequency and severity. Loss ratios have been variously estimated to be in excess of 100% in numerous markets, including the U.K., U.S. and Germany in recent years due to drivers such as event-driven litigation, collective redress developments, regulatory investigations, pollution, higher defense costs and a general cultural shift, even in civil law countries, to bring more D&O claims both against individuals and the company in relation to securities.

The increased claims activity, combined with many years of new capital and soft pricing in the D&O market has resulted in some reductions in capacity. In addition, there has also been an increase in the tail of claims. Hence, there is a double impact of prior-year claims being more severe than anticipated and a higher frequency of notifications in recent years. As for claims severity, marketplace data suggests that the aggregate amount of alleged investor losses underlying U.S. securities class action claims filed last year was a multiple of any year preceding it.

See also: Why Private Firms Should Buy D&O  

Despite rising claim frequency and severity, the industry has labored under a persistent and deepening soft market for well over a decade before seeing some recent hardening. Publicly disclosed data suggests D&O market pricing turned modestly positive in 2018 for the first time since 2003. However, D&O rates per million of limit covered were up by around 17% in Q2 2019, compared with the same period in 2018, with the overall price change for primary policies renewing with the same limit and deductible up almost 7%.

From an insurance-purchasing perspective, Allianz sees customers unable to purchase the same limits at expiration also looking to purchase additional Side A-only limits and also to use captives or alternative risk transfer (ART) solutions for the entity portion of D&O Insurance (Side C). Higher retentions, co-insurance and captive-use indicate a clear trend of customers considering retaining more risk in current conditions.

How to Deliver Tough Message on D&O

Relationships are the key to success in the insurance industry. Trust and respect go a long way when it’s time to deliver challenging news. For example, the firming of the directors and officers (D&O) market has led to tough conversations about increasing rates.

The best way to handle these conversations is to make sure your communication skills are in excellent shape – and that means both what you say and how well you listen.

How to announce a price increase to clients: Plan ahead and be clear

Preparation is key. Take the time to identify potential high-risk accounts early, with 90-day reviews. Our clients aren’t happy to hear their rates are going up, but it helps to have conversations early to explain the reasons for rate increases. With pricing down 50% over the last 10 years, a market adjustment has been due for some time. In fact, price increases in the current D&O market are a good sign for the industry’s long-term health.

Be sure to take the time to explain the main drivers for rate increases, which are being experienced by public companies, private companies and financial institutions, including large private equity firms and large banks:

  • The number of claims has risen.
  • Capacity has decreased with the departure of carriers.
  • Defense costs have risen, in part because of coverage expansions and increased loss costs.

Securities claims on a yearly basis are up, and, because there are fewer public companies now than there were 10 years ago, the chances of attracting securities litigation is even greater. We owe it to our clients to be open about the realities of the market and their impact on rates. Bear in mind: How we announce a price increase to clients and brokers will have a lasting impact on our relationships going forward. The markets that handle this communication effectively will be the ones that succeed in the long run.

See also: How to Be Disruptive in Emerging Markets  

Be transparent about how underwriters evaluate a risk

Underwriters base their risk evaluations on data. Reminding clients of the factors that contribute to their increased rates can help alleviate some of their distress. These factors include:

  • Financial strength
  • The class of business
  • Strength of the leadership
  • Business track record
  • M&A activity
  • Organizational structure
  • Claims history

While it’s important to be straightforward in explaining the facts underlying a risk evaluation, it’s just as important to demonstrate your understanding of your client’s position. We view our relationships with clients and brokers as partnerships, and we want to deal with people fairly and honestly and communicate our position.

Be effectively empathetic – and actively listen

It takes effort to be effectively empathetic. Saying, “I know this isn’t what you want to hear,” is not enough. Consider these steps to validate the reactions you will receive when it’s time to share not-so-good news:

  • Put aside your viewpoint
  • Validate the other person’s perspective
  • Examine your attitude
  • Ask what the other person would do
  • Listen

Be prepared to respond to objections

It’s only natural that bad news will meet resistance. Here’s how we suggest keeping the conversation on track.

  • Objection: Why is my rate increasing in the absence of a claim?
    Response: Rate increases depend on risk and current pricing, which is affected by increases in regulatory costs for financial institutions, in defense costs and in claim frequency.
  • Objection: I may have to go to RFP if rates increase.
    Response: We understand your position and wanted to give you an update early for our due diligence and your ability to market the risk with other carriers.
  • Objection: This account was written new last year. Why the increase this year?
    Response: Accounts are evaluated annually, and defense and regulatory costs increased over the past year.
  • Objection: Why are both the underlying and the excess rates increasing?
    Response: We know this news is hard to hear. The market is adjusting after a lengthy period of low rates. We’ve seen more price compressions for excess than for primary, which has created even more need for excess rate increases.

In our careers, we’ve come to anticipate that the marketplace will continue to change. It’s essential to keep your skills refined for when the time comes to have tough conversations.