Do directors need separate liability coverage?

Almost all public companies buy directors and officers liability (D&O) insurance, providing officers and boards with protection against claims not indemnified by the company. But when companies unravel, they often do so spectacularly– and given how a typical D&O policy is structured, directors may not be as well protected in the event of a complete corporate meltdown as they might like.

That’s where independent director liability (IDL) insurance comes in. A specialized form of D&O that’s sold separately, IDL protects only the directors and would pay out even if all limits within a company’s D&O policy were exhausted. D&O insurers like ACE, Chubb Group and XL Insurance have been offering these policies for several years.

One of the better arguments for buying IDL is the growing number of securities lawsuits being filed. As the credit crisis unwound, 2010 set a new record for securities litigation at 1,293 suits, according to Advisen. It also finds that in the first quarter of 2011, 362
securities suits were filed, representing a 47 percent increase over Q1 2010 – an indicator that securities suits this year might once again reach new heights.

For all the attention being paid to increased director liability, however, sales of IDL insurance remain relatively small. ‘IDL is more common than it used to be,’ says Kevin LaCroix, executive vice president of OakBridge Insurance Services in Beachwood, Ohio,
and author of the D&O Diary blog. He acknowledges, however, that IDL coverage is hardly part of every public company’s insurance portfolio.

Most D&O policies consist of three broad types of coverage: Side A, which pays for claims against directors and officers who are not indemnified by the company; Side B, which reimburses the company for indemnified claims; and Side C, which covers securities claims against the company. In a post-Enron world, most public companies have begun to buy extra coverage – or an additional Side A policy – to protect the personal assets of directors and officers, because Side B and Side C claims can quickly obliterate all limits.

Taking sides

Given that public companies have already indemnified and insured their directors, many believe the risks to the board are managed by Side A, but this is not necessarily so. ‘If the officers are on the firing line first, it’s possible the policy limits could be exhausted before the directors can draw on it,’ says David Bradford, chief knowledge officer at Advisen.

LaCroix calls IDL ‘catastrophe insurance’, noting that IDL policies are an option for ‘when all other sources of funding are no longer available’. Larry Racioppo, executive liability practice leader at Towers Watson, puts it this way: ‘The big advantage of IDL is that the limits are not depleted by corporate liabilities, either the acts of the entity or the wrongful acts of the insiders.’ Scott Godes, counsel at Dickstein Shapiro and author of the Corporate Insurance Blog, says the beauty of IDL is that the policies are marketed as nonrescindable.

‘When D&O claims get messy or expensive, insurance firms have remarkably creative lawyers who can find ways to deny coverage or rescind the policy,’ he points out. ‘I saw one advertisement stating that IDL is insurance for insurance – if the insurance company is marketing these policies as rescission-proof, that should be a good sign.’

IDL policies can be designed in two ways: they can either cover all the independent directors on a single public company’s board, or protect one individual for all the boards on which he or she serves. The latter type, which is issued to a specific outside director, is very rarely bought, says Dan Bailey, a member of law firm Bailey Cavalieri. Firstly, he notes, it’s difficult to decide who should pay for an individual director’s policy, especially if the individual sits on several boards; secondly, should there be litigation, the director with extra IDL insurance would have ‘a target on his/her back’ once plaintiffs realize that one individual carries far more coverage than everybody else.

As with any insurance policy, the chief downsides to IDL are its cost and the remoteness of the possibility that catastrophe will actually strike. Bailey points out that companies often hesitate to buy IDL coverage because of the cost. ‘IDL is less expensive than a standard Side A policy, but it’s still real dollars,’ he states. He also notes that it’s ‘a very rare event’ for an entire insurance program to be eroded by losses, leaving outside directors holding the bag.

That said, LaCroix maintains that companies need to consider the range of director expenses in a corporate catastrophe. ‘The chances of being held personally liable as a director may be very remote, but you still have to defend yourself, and defending yourself in these cases is very expensive,’ he says.

One-sided approach

Many companies contemplating worst-case scenarios decide to buy an extra Side A-only policy, protecting both officers and directors in the event the traditional D&O package is exhausted. In fact, in its 2010 D&O liability survey, Towers Watson finds that more than 80 percent of public companies bought Side A-only coverage – a significant increase over 2008, when the survey was last conducted.

Experts believe Side A-only policies have proven more popular than IDL because it’s usually officers who are doing the buying. ‘When officers are spending corporate money on buying insurance, they are naturally inclined to buy coverage that protects them as well as the outside directors,’ says Bailey. Racioppo agrees: ‘There really are two different factions here.’ LaCroix has found that CFOs and general counsel don’t get particularly excited about IDL, but when he speaks at annual conferences for outside directors, IDL ‘is the most interesting topic in the universe as far as they’re concerned. If board members were more informed about the insurance-buying process, I truly believe you’d find more companies buying IDL.’

While larger companies with deep pockets tend to buy IDL, as do financial services firms, IDL buyers don’t always fit neatly into any particular category. One of the best forms of protection IDL provides is psychological. ‘If you get board members who are antsy and worried about their personal assets and exposure, this product goes a long way toward giving them comfort,’ says Bailey. And Racioppo emphasizes that this kind of mental protection matters. ‘IDL can be a good recruiting tool when you’re courting directors,’ he notes.