Non-board executives are asking for more coverage as legal risks increase
A duly elected, appointed or recognized officer of a company, as defined in its bylaws or article of incorporation, is always covered when acting in the capacity of officer. But who else is covered, and when?
Rich Leavitt, a principal of William Gallagher Associates and the leader of its executive risk practice, says that while the director portion of D&O coverage is pretty clear, the officer’s part of the equation is often misunderstood. Corporate secretaries, governance and compliance officers and investor relations professionals are most often not duly appointed officers of the company and, therefore, are not always included under the company’s D&O policy.
Most carriers will extend coverage if asked, with no significant economic impact, and companies are increasingly requesting it for key employees. But extensions could dilute coverage for officers and directors and erode their limits.
Steve Shappell, managing director in the legal and claims practice in Aon’s financial services group, believes issuers are best served by fitting as many executives as possible into their pool of coverage. ‘Most of the non-traditional officer types likely to be extended into policies would rarely be sued and rarely be culpable,’ says Shappell, who cautions that they could have huge pressure exerted upon them by lawyers as they prosecute up the corporate chain. ‘Better to share insurance limits within the class of insureds, rather than split up a class of insureds and create conflicts.’
Joe O’Donnell, senior vice president, executive assurance at Arch Insurance Group, points out that insureds are becoming increasingly informed about their coverage and are thinking through director-level fraud exclusions. ‘It used to be that insureds wanted a fraud exclusion that provided the broadest possible coverage,’ he says. ‘Such exclusions required a final adjudication of fraud before the exclusion kicked in. However, an exclusion this unrestrictive meant the insurance carrier would find itself depleting the policy limits in funding the defense of black hats. White hats would then end up funding their own defense.’
Adopting an ‘in fact finding of fraud’ standard avoids that consequence. It allows companies or carriers to sever coverage for wrongdoers when it clearly appears that fraudulent acts have occurred. But dividing up the kind of coverage available to officers, directors and other key employees – or severing coverage for unadjudicated bad actions – can create unintended outcomes if the company faces regulators, prosecutors or lawsuits. Divided interests can pit groups of employees against each other or against the company. Employees whose coverage – and perhaps employment – has been terminated to help a company appear to be cooperating with investigators or regulators may find it in their best interest to turn against their (former) employer.
Gary Dubois, chief underwriting officer of specialty casualty for Liberty International Underwriters, says that while there was a trend toward an all-employee extension in the 1990s, it was just a reaction to a soft market. Blanket approvals are no longer the norm. Like Leavitt, Dubois counsels a reevaluation of key roles to assess which ones require coverage and to request specific policy extensions for these key non-officer positions.
Leavitt says indemnification is key. ‘Almost all D&O policies include a presumptive indemnification provision: it doesn’t matter if someone is an officer per se, if they are indemnified by the company,’ he says, warning that indemnification is poorly understood and without it the presumption works against you.
According to Shappell, there’s been a lot of interest in additional ‘side A limits’ for independent directors, but there may be more buzz than buy. ‘Most companies look at the risk and cost and don’t buy. There have been only a handful of situations where this was needed – exceptional situations like Enron and WorldCom. It’s expensive.’
Susan Miner, president of Nasdaq Insurance Agency-Carpenter Moore, disagrees: ‘With respect to independent director liability [IDL] coverage, we are seeing roughly 10 percent of our larger-cap companies seriously evaluate it, and an increasing number are adding a layer of IDL to their D&O programs.’
O’Donnell mentions the availability of difference in condition (DIC) policies, a facet of side A coverage that sits in excess of traditional A, B or C coverage. DIC is a separate contract that drops down in the event of a non-indemnifiable claim. For example, if an organization wrongly refuses to indemnify an officer, the insurance carrier for the company’s side A, B or C coverage could say this should be indemnifiable. DIC coverage could drop in to cover that deductible.
Shappell suggests that individuals ask a number of questions to assess their liability, starting with assessing the company’s promise to them. Are they covered? If so, are they indemnified? ‘Directors are comfortable asking for great indemnification, while others may not be as comfortable,’ he says. ‘Key people with titles like managing director or senior vice president need to look at the articles of incorporation to see if there’s mandatory indemnification.’
Next, assess what backs this up. Has the company bought insurance to guard against gaps in coverage such as insolvency? Check your policy to see whether you are limited to coverage on a co-defendant basis. Shappell says co-defendant coverage means that ‘if you are sued for your role in a disclosure of false information, you’re covered if you are lucky enough to have been sued with the CEO or CFO. But you are not covered if you’re sued all by your lonesome.’
Leavitt sees more companies employing general counsel, meaning more employed lawyer liability coverage. Evan Rosenberg, senior vice president at Chubb & Son, has also seen an uptick in employed lawyer coverage and some companies even trying to include it in a D&O policy.
‘We’d suggest employed lawyer liability coverage with a lower deductible and structured for what you need so you don’t dilute the D&O liability cover,’ says Leavitt. ‘Whenever we are asked to expand D&O coverage to include the corporation and all employees, for example, we have to ask if the board is okay with this. These conversations can be uncomfortable for the broker and the board.’
Severability is also important. A fraud committed by a CFO, for example, might be imputed to others insured by the D&O policy, costing them their coverage. Leavitt says most directors and officers have been intently focused on severability for the past few years: ‘Rescission and severability used to be the tightly held secrets of the industry, but they have become part of cocktail conversation over the past two years.’
According to Miner, severability can become an issue when, for instance, a general counsel is the whistleblower and litigation results, or if one insured party sues another. ‘This protects the carriers from collusion,’ she says, but most carriers will plug the resulting gaps in coverage with endorsements.
‘The devil is in the details’ when assessing needs and buying coverage, notes Miner, and everything is negotiable. She suggests that boards bring in independent outside counsel to assess the adequacy of their coverage and the treatment of conflicts.
