Tag Archives: d&o

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.

Handling Transition to a Public Company

In any given year, many private companies are evaluating the potential transition from private to public ownership. An initial public offering (IPO) comes with a myriad of financial and operational concerns, ranging from public disclosure requirements to additional regulatory/compliance infrastructure, to confidentiality and trade secret concerns. One potentially under-appreciated area for consideration, for those companies considering an IPO, is directors’ and officers’ liability insurance (D&O). Recent claims trends and the March 2018 U.S. Supreme Court’s decision in Cyan emphasize the need to approach the D&O insurance topic with great diligence, and to obtain maximum protection for a company and its key executives. In our experience at Aon, key D&O topics for careful review include the following:

Beginning at the “all hands” initial kick-off meeting and through the road show, company executives are making decisions and representations that could create liability exposures. The private company D&O policy, which almost certainly excludes public securities claims, should not be so restrictive as to exclude pre-IPO preparatory and “road show” activity. Additionally, pre-IPO private company policies should contain carve-out language for “failure to launch” claims. The transition to a public company will also require clear policy language that determines how pre- and post-IPO allegations are addressed. Detailed negotiations of the “tail coverage” and “prior acts” coverage are critical to providing the appropriate protections for both the respective former private company and new public company boards and executives. IPO candidates should confirm that their current private company D&O program, with regard to terms, structure and limits, provides comprehensive pre-IPO coverage to provide a seamless transition to public company status.

Coverage Terms

Ensuring breadth of policy terms is perhaps the most critical component to a public company D&O insurance program placement. Maximizing coverage in the event of a claim is rooted in contract certainty and broadest and best-in-class terms and conditions. Unfortunately, inexperienced D&O practitioners can lead to debilitating coverage gaps and exclusions. It takes an IPO-experienced and detail-oriented brokerage tactician to obtain critical coverage enhancements. Coverage topics such as straddle claims, definition of loss and E&O exclusions can be the difference between maximizing policy proceeds and an outright claim denial. The D&O program coverage negotiations are multifaceted – the negotiations are not limited to the primary layer of insurance but, rather, involve numerous layers of negotiations with your excess insurers, including importantly your Side A insurers. IPO candidates should partner with detail-focused D&O professionals (which can include both brokers and outside counsel), to obtain maximum coverage.

See also: Why Small Firms Need Cyber Coverage  

Policy Structure

Public company D&O insurance can be markedly different in structure than private company D&O insurance. Two very common examples include the separation of limits (i.e., the D&O is no longer tied to other management liability coverages, such as employment practices and crime) and the addition of dedicated Side A difference in conditions (“DIC”) insurance. Additional structural considerations, such as entity investigative coverage, the inclusion of DIC limits within the “A/B/C” tower and the decision to run-off prior coverage or maintain continuity of a program are all structural items of critical importance to review prior to an IPO. IPO candidates should weigh the pros/cons of each approach and select a program structure that aligns with their unique risk factors and corporate purchasing philosophy.

Limits

Limits selection is not a “one-size-fits-all” question and can be influenced by various factors, including: expected offering size/market cap, industry risk factors, historical claims activity, merger/acquisition exposure, bankruptcy risk, a company’s risk retention capacity, limits availability relative to budget and board directives. Aon has several proprietary tools to assist clients in making informed decisions around the appropriate limits to purchase at the time of your offering.

Pricing

Undoubtedly, many insureds experience sticker shock when contemplating the potential cost of a post-IPO D&O program. This is particularly true in the post-Cyan world as D&O insurers consider separate state court retentions and pricing commensurate with increased ’33 Act state court exposures. This environment has led to 2018 D&O pricing (for IPOs) that, in some cases, is more than twice comparable deals in 2018. IPO candidates should prepare senior management and the board to anticipate a meaningful change as compared with the private company program with regard to D&O premium. Candidates should also work closely with their broker to align strategies to maximize the return on this premium. These strategies can include meetings with key national decision-makers at leading D&O insurers, risk/retention analyses regarding potential retention levels and competition via access to national and international D&O insurers. Partnering with a broker that has a proven ability to “make a market” for competitive D&O pricing is crucial to maximizing the marketing opportunity and obtaining competitive pricing results.

International

While this topic is germane to both public and private companies, the IPO process can be a catalyst to review broad D&O topics, including the need for locally admitted policies. In many countries, non-admitted insurance is problematic and would not be permitted to respond in the event of a claim in such a country. Particularly for D&O insurance, which is intended to help protect individuals’ personal assets, the certainty of available coverage within problematic countries is critical. All companies, particularly IPO candidates, should consider their international exposures and implement locally admitted policies as needed.

See also: The Fallacy About International Claims  

An IPO is an exciting but challenging time, for corporate issuers and their leaders. Partnership with subject matter leaders across several disciplines, such as accounting, finance, legal and insurance, can help a company execute a successful transition to public equity.

All descriptions, summaries or highlights of coverage are for general informational purposes only and do not amend, alter or modify the actual terms or conditions of any insurance policy. Coverage is governed only by the terms and conditions of the relevant policy. If you have questions about your specific coverage, or are interested in obtaining coverage, please contact your broker.

How Risk Produces Financial Success

The evolving environment across economics, demographics and geopolitics, paired with the continuing pace of technological change, is creating an increasingly complex risk landscape for all types of businesses.

We are continuing to witness increased connections of potential risk impact on organizations. Never has it been more critical for organizations to consider the relationship between building sustainable competitive advantages and adopting risk management best practices.

It is incumbent on organizational executives and key leaders to take steps to increase their understanding of the risks they face to adapt to the changing environment. In addition, technology offers tremendous growth opportunities in the form of operational performance, automation, new products and services, new and enhanced distribution channels and improved business intelligence. However, the use of technology also increases exposure to cyber risk, which is a key concern.

The impact of connected risk has been felt by many organizations. Increasingly, boards are being obligated, in the case of regulated entities, or challenged to be acutely aware of and understand the key risks their organizations face and how they are being managed. The ability to understand, manage and develop effective organizational governance and processes that encourage improved risk-based decision-making is imperative to an organization’s financial and operational well-being.

In pursuit of the strategic objective to deliver value back to stakeholders, most organizations seek to grow their revenue or drive operational performance and efficiencies within their operating model. Invariably, in today’s complex and evolving environment, there is a level of uncertainty created in the tactical pursuit of such initiatives. Understandably, a greater level of uncertainty equates to a greater level of volatility in financial performance.

See also: How to Use Risk Maturity Models  

Researchers at Aon continue to identify correlations between advanced risk management capabilities and higher stock price performance for publicly traded organizations. Reducing volatility via the implementation of robust risk management practices should be a core objective for organizational leaders, as research repeatedly shows that higher levels of risk maturity correlate to lower stock price volatility.

Factors That Distinguish Organizations With Higher Levels of Risk Maturity

Risk professionals have long recommended a structured enterprise-wide risk identification and assessment process for organizations to tackle current and emerging risks. The Aon Risk Maturity Index Insight Report, developed by Aon in close collaboration with the Wharton School of the University of Pennsylvania, identifies three key factors to successfully understanding and managing risk:

  • Awareness of the complexity of risk
  • Agreement on strategy and action
  • Alignment to execute

Increasing performance along these dimensions requires a robust process that focuses on:

  • the identification of strengths and weaknesses
  • strong communication of risks and risk management across functions and at all levels of the organization
  • building consensus regarding the steps to be taken

Having different functions and levels involved and integrated into an organization’s risk maturity assessment process provides the foundation for determining an organization’s current status along these dimensions and provides the foundation for identifying continuing improvement activities.

Aon and Wharton researchers found continued positive impacts on stock price performance and company profitability from higher risk maturity, underscoring the positive internal and external benefits that a robust and sustainable risk management program can deliver.

In addition to a cross-functional understanding of risk, the use of sophisticated quantification methods is another key characteristic exhibited by organizations with advanced risk maturity. Aon and Wharton research shows that organizations with higher levels of risk maturity successfully integrate the use of advanced risk quantification techniques and the utilization of those outputs in the risk decision-making process.

The Relationship Between Risk Maturity and Directors and Officers (D&O) Insurance Premium

Reductions in insurance premiums are another potential financial benefit from more mature risk management processes. This can occur through two channels. First, insurance providers are likely to lower insurance premiums for firms they view as less risky, as reflected in lower volatility. Second, better understanding of risk exposures and their drivers, together with the consistent development and application of risk appetite and risk tolerance concepts to decision-making, provides the information needed to make more informed decisions about which risks to avoid, mitigate or accept and which risks to insure.

By optimizing their insurance portfolio through more mature application of risk management processes, firms can potentially reduce premiums by avoiding or mitigating the most costly risks, choosing only the level of coverage that is necessary given the firm’s risk appetite and tolerances, and improving its bargaining position with insurers.

See also: Why Risk Management Certifications Matter  

What’s more, Aon and Wharton research finds that firms with higher overall risk maturity scores paid significantly lower premiums for D&O insurance. Just a 10% increase in overall risk maturity scores is associated with D&O premiums that are 2.6% lower than the premiums paid by similar firms. This direct benefit does not take into account the indirect premium benefits that also arise from lower volatility — and thus lower premiums in firms with higher risk maturity. When we calculate the total effects of higher risk maturity on D&O premiums, including the benefits from lower volatility, the premium reduction associated with a 10% improvement in risk maturity scores increases to 3.9%.

Conclusion

The implementation of enhanced risk management practices represents a tremendous opportunity for all types of businesses to reduce the volatility associated with the evolving risk landscape while also leveraging the associated benefits to their D&O insurance programs.

6 Areas to Watch in a D&O Review

Performing a directors and officers (D&O) insurance audit is a complex exercise that is made more difficult by constantly shifting language, new rulings and claim trends. While much of the policies’ language and terms have remained fairly constant over the years, here are six areas of new or renewed interest that buyers and their brokers will want to pay attention to.

See also: The Need to Educate on General Liability  

Cyber Exclusions: Because cyber-related litigation has been quiet, there is little case law at the moment testing courts’ interpretations of D&O policies, so it is difficult to determine the adequacy of coverage provided by existing policy language. Generally speaking, D&O policies are not crafted with cyber risks in mind, so many policies may contain problematic language, such as the definition of “wrongful acts.” However, some carriers are going in the opposite direction and are purposefully applying specific cyber-related exclusions to their policies with the intent of pushing the exposures to more appropriate cyber policies.

Cyber policies have still not quite adjusted entirely to modern cyber risk, and these exclusions are not yet industry standards, so buyers should — when able — avoid D&O policies that contain cyber exclusions. While most policies are absent of such language, many carriers have included somewhat watered down wording by adding “privacy events and/or invasion of privacy” within the broad bodily injury exclusions. While this language is not as crippling as an explicit cyber exclusion, buyers should still attempt to negotiate its removal.

Many professional liability experts also believe broadly worded terrorism exclusions may have the ability to negate coverage for cyber events with the belief that they will be classified as cyber-terrorism. To address the terrorism exclusion, buyers should ask the carriers to “except” (thus, carving back) cyber-related claims.

Lastly, while it may be obvious, brokers should advise buyers on the importance of placing separate cyber insurance while also highlighting the intricate coverage differences among them. The same level of attention that is given to grooming D&O coverage should be given to grooming cyber proposals/policies. This includes careful review of policy definitions, terms, conditions, exclusions, etc.

Professional Services Exclusion: Along with the contractual exclusion, the professional services exclusion is consistently cited as one of the most sweeping and problematic exclusions for insureds. Broad professional service exclusions typically preclude coverage for claims “for, based upon, arising from or related to” errors, acts and omissions while providing professional services. This exclusion is particularly problematic for service firms because almost any claim can be “related to” their providing of professional services. However, this exclusion is also becoming increasingly problematic for many businesses because so many businesses today provide some level of services (from consulting to technology services). For tech companies, in particular, this exclusion has the potential to preclude coverage for cyber-related claims, as many of the tech services provided may be considered “professional services” by the carrier.

When negotiating this exclusion, buyers should ask the carriers to replace the term “for, based upon, arising from or related to,” with, simply, “for.” Such an amendment effectively carves out the errors and omissions exposure the carrier intends to exclude while still preserving coverage for “true” D&O claims.

Conduct Exclusion: The conduct exclusions are one of the (if not the) most visited exclusions within D&O policies. While not much has changed in terms of recommendations to D&O buyers, we have noticed a number of carriers that still contain less-than-preferred language. To avoid coverage being denied for unintentional wrongdoing, the conduct should be specifically stated as “deliberate, willful and intentional.” Sufficient severability language should also be included to protect innocent directors.

The area where we still see many carriers lacking is in the “ruling language.” For purposes of providing coverage for innocent actors and claims without merit, the carrier should agree to provide defense costs until a final determination is made. More specifically, though, that final “determination” should be in the form of a “final adjudication in the underlying action.” While much of it may seem like a matter of semantics, final rulings/judgments are NOT the same as “final adjudication,” which is required by the courts. In addition, the language should specifically state that that determination be made in the underlying action to prevent the carrier from arguing that wrongdoing found by those outside the courts (such as regulators) nullifies coverage.

JOBS Act/Securities Exclusion: Startups and companies looking to raise equity have a new reason to be excited. The JOBS Act provides an avenue for significant growth without all of the time and compliance costs imposed by the strict reporting and disclosure obligations that come with an IPO. And with the new regulation A+, the ceiling has been lifted, allowing a significant capital raise while still remaining private.

Those same attractive features, however, also carry some increased risk. The potential for fraud (and accusations of fraud) is considerably higher because of the lack of transparency. Additionally, private companies purchasing D&O may find a somewhat hidden surprise in the broad securities exclusions that almost entirely eliminate coverage for crowdfunding-related claims.

While many insurers have been somewhat slow to react, many others responded expeditiously by either adding a separate endorsement or revising their exclusion to carve back coverage for claims that are related to securities and qualify under the JOBS Act. Any companies considering a crowdfunding campaign or raising any equity under crowdfunding regulations should exercise extra diligence when reviewing their D&O insurance to ensure the carrier has appropriately provided coverage for such claims. Without question, this includes smaller companies that may believe they are less prone to crowdfunding claims, which is false. The case against Quest from 2011 demonstrates that these claims can arise over seemingly simple fee disputes.

Lastly, organizations should also avoid any carrier-imposed sub-limits for crowdfunding-related claims, paying close attention to the adequacy of such limits when they are unavoidable.

Entity vs. Insured Exclusion: The insured vs. insured exclusion is almost as old as D&O itself. To alleviate some of the concerns related to the “I vs I” exclusion, many carriers today have adopted a more modern alternative replacing it with an “entity vs. insured” exclusion. While this substitution is preferred and does seem to solve many of the unintended consequences, it still deserves careful review. The most obvious carve-back that buyers and their brokers should seek is coverage for derivative claims brought on behalf of the organization. Because of their derivative nature, insureds should also negotiate a carve-back for bankruptcy claims brought by trustees and debtors in possession. Additionally, buyers should review the definitions of insured and organization/entity to ensure bankruptcy trustees and debtor-in-possession are also included as insureds.

Regulatory Proceedings and Investigations: Coverage for regulatory/administrative proceedings and investigations has always been of interest for buyers but remains difficult to obtain. Informal regulatory proceedings and investigations against the entity itself are the most difficult to insure against.

With cyber whistleblower claims beginning, regulators are capitalizing on their success with more “traditional” whistleblower claims, and coverage for government investigations is quickly becoming a topic of renewed interest. Over the past few years, many carriers have begun to provide coverage for informal investigations and regulatory/administrative proceedings against individual directors and officers. Additionally, private companies may be able to obtain coverage for formal investigations and proceedings against the entity itself. It should be noted that, for purposes of reviewing and grooming coverage, administrative/regulatory proceedings and investigations are not synonymous.

Some carriers have also been implementing standard coverage for FCPA fines/penalties against individuals. The ability to obtain a policy with such language does not necessarily mean the policy will respond, though. There are a number of additional items that require review, such as claim definitions that require “wrongful act” accusations to trigger the regulatory coverage (which should be avoided).

See also: What to Expect on Management Liability  

The Need to Educate on General Liability

In a perfect world, insurance buyers would understand their products just as well their insurance agents. This would save a few headaches for everyone involved, and it would probably streamline the process on all ends. However, the reality is that most business owners don’t understand the extent of the insurance products they purchase. Then again, no one should expect them to.

Insurance products are highly complex vehicles. Few business owners have the time to invest in becoming experts in the field or in the products they purchase. Even the best insurance agents spend years learning about the products they sell, many of which change frequently as the economy changes.

That being said, no business owner should simply buy a product without understanding the most important aspects regarding what it does and does not cover. In truth, a highly skilled insurance agent should never let them, either. Here’s where there can be a gap between how much insurance a business purchases and how much it actually needs, showing why educating business owners on the extent of their insurance really matters.

False Perceptions of General Liability Are Common

Many customers tend to believe their insurance covers more than it actually does. This situation could probably be applied to any insurance product, but general liability policies are often the most frequently misunderstood by buyers.

See also: What to Expect on Management Liability  

To put it simply, far too many businesses are purchasing less insurance coverage than they should. In a sense, many are taking a huge gamble, believing their risk exposure is less than what it actually is or that their preventative measures, such as employee training, can shield them from those risks. While risk prevention definitely helps, it’s ultimately far from the bulletproof shield many companies think it is. Most companies do it to help themselves get a better rate on their insurance, while maintaining the false perception that their general liability coverage protects them against a multitude of risks not actually defined in the policy.

As a company scales in size, so, too, does its likelihood of experiencing losses related to cyber liability, employee fraud, fiduciary liability, directors and officers (D&O) or workplace violence. Yet many companies seem not to realize their exposure.

This would, of course, be less troubling if companies were purchasing policies that actually covered those kind of risks. Overwhelmingly, they’re choosing to avoid those insurance products altogether. According to Chubb’s survey on private company risk, non-purchasers believed their general liability policy covered:

  • Directors and Officers Liability (65%)
  • Employment Practices Liability (60%)
  • Errors & Omissions Liability (52%)
  • Fiduciary Liability (51%)
  • Cyber Liability (39%)

Businesses aren’t failing to purchase enough liability coverage because they’re unnecessary risk takers. Most, it seems, simply have false perceptions about what their general liability will and won’t do.

A small business may think its general liability policy covers a server hack. Yet, lo and behold, when a server gets hacked and the ensuing liability claims start pouring in, that small business may quickly find itself underwater. In fact, the U.S National Cyber Security Alliance found that the 60% of small companies went out of business within six months of a cyber attack. This seems extreme, but the average cost for a small business to clean up after a hack is $690,000, according to the Ponemon Institute. How many small- or medium-sized businesses can easily absorb that kind of cost without insurance coverage? Not many.

Similarly, mid-sized companies may believe their general liability policy covers directors and officers, leaving the company with unnecessary risk exposures should an incident occur. If, for example, a company begins operating internationally and fails to effectively meet one of the federal regulations governing its industry, a general liability policy won’t help protect the company from impending lawsuits. Any directors held personally responsible may find their own personal assets at risk. Given what we learned from the Chubb survey, it’s quite likely that most directors may think they’re fine with the minimal coverage they receive from a general liability policy. A costly mistake, to be sure.

Who’s to Blame?

We’ll leave the finger pointing aside for now and settle on this: The customer is always right, but he’s not always well-informed. As every insurance agent knows, the amount of time it takes to fully understand an insurance product can be extensive. Business owners, in general, lack the time to invest in fully understanding the products they purchase. It should come as no surprise, then, that misunderstandings arise over what general liability policies actually cover and what risks they simply won’t mitigate.

See also: ISO Form Changes Commercial General Liability  

Insurance agents have a responsibility to use their knowledge to help business owners better understand and sift through those misconceptions. More needs to be done to help decision-makers understand what they are and are not getting from their insurance.

Helping businesses better understand the ins and outs of their general liability policy is a win-win all around.