Don Bailey and Ann Longmore look at the current D&O climate

Until fairly recently, it was fairly safe to assume that D&O claims were exclusive to the US. However, beginning in the late 1990s and increasingly ever since, there has been a growing global who's who list of directors and officers facing liability claims. All of this has caused global risk managers to question how their D&O liability policies will respond to the mounting threat.

In response to this spate of high-profile, financial debacles, there have been both national and international initiatives to systematically address corporate governance concerns. In this process, close scrutiny is being paid to the duties and responsibilities of corporate executives, and the resulting penalties for their failure to act appropriately.

Breadth of coverage

Global risk managers want to know, and are often prodded by their local country managers to determine, if the unique exposures to which they may be exposed are being covered under their executive risks program. While most directors' and officers' personal liability may be covered under a basic, broadly written D&O contract, local differences in risks may need to be specifically addressed in even the most state-of-the-art D&O policies.

Experienced insurance carriers will tell you that this is an evolutionary process that highlights an ongoing need to survey the relevant jurisdictions to ensure that newly created exposures are being covered. A recent example of this would be certain Italian penalties (under Article 2, subparagraph 1 of the Italian Legislative Decree No. 472/97).

Another approach used by at least one of the major global insurers is to build in a certain amount of additional assurance that its master global program will pick up unique local exposures. Roughly, the policy states that for claims made under the global D&O policy in a foreign jurisdiction against a local insured company and/or its executives, the broader terms and conditions that may exist in the carrier's local policy will apply to this claim (sometimes referred to as a 'liberalisation' clause).

This could be especially valuable when it comes to terms such as the insured versus insured ('one v one' or '1v1') exclusion. Many local policies do not include this standard US policy exclusion (or apply the exclusion only to US claims). The liberalisation provision might effectively knock the exclusion out for many if not most non-US claims. Additionally or alternatively, a specific D&O policy modification removing the 1v1 exclusion for claims brought in and against German insureds may be added to the global program. Germany is singled out here because the technical process for bringing D&O claims in this country may require an internal committee or board to advance the claim, coverage for which would otherwise have been eliminated through the 1v1 exclusion.

Similarly, a number of countries do not permit claims-made or claims-made and reported insurance contracts. Since this claims-made feature can be responsible for totally eliminating coverage for otherwise covered claims, the fail-safe mentioned above could prove invaluable.

Locally issued policies

Another unfortunate fact of life today for global companies is the growing number of countries that either require locally issued insurance policies or, perhaps more common, do not permit the use of non-admitted policies, thus possibly precluding use of policies written outside the local jurisdiction.

While it may be true that the vast majority of countries that take this position penalise the insurer rather than the insureds for non-compliance, this is not always true.

Where it is true, it is still possible that the insured company will face additional tax penalties as a result of using a non-admitted insurance program. Savvy risk managers will be familiar with a possible solution to this problem from their global casualty programs - transferring this exposure back to the carrier as part of covered loss. Similar solutions (although potentially eroding the existing limits of coverage) are also possible for D&O.

It may also be possible to partially address the concern of global versus local coverage by asking a carrier to issue a local policy or policies where there is a requirement for local policies, as long as the carrier has a policy filed in the relevant jurisdiction(s). Such wording could actually be added to the global program.

It is also important to recognise that there may be legally viable shortcuts in some instances. For example, while a given European country may have a problem with a non-admitted policy, the issue can be addressed by having a locally issued policy that is issued in any European Economic Community country.

Program structures

The hard insurance market of the last three years has driven up the cost of D&O insurance and with the size of D&O claims payments still soaring, there is a great deal of discussion as to whether there is still such a thing as a 'traditional' D&O policy. Carriers have attempted to drop entity coverage or coverage for the company itself, a staple for Securities Claims in US D&O policies for the past 15-20 years, and insureds have questioned their need for any coverage beyond 'A-Side' where they are unable to indemnify their directors and officers.

In this regard, it may be important to consider the comment from the underwriting manager of a major global D&O carrier that underwriters work on the assumption that "most claims against executives in foreign jurisdictions are A-Side until proven otherwise." This may be the natural consequence of the fact that historically, non-US executives on the whole had less personal liability than they have been subject to in the US. Generally, when executive liability increases, the relevant local indemnification statutes are adjusted or expanded accordingly.

The program structure implications are that there may be more need for an A-Side program in foreign jurisdictions, where possible indemnification may be narrower. This analysis may also help explain why the pricing for A-Side coverage, typically set at 75-85% of the cost of a traditional D&O policy, is as expensive as it is.

Lost in translation

There continues to be some potentially widespread confusion for global companies as to whose indemnification provisions will apply when their foreign subsidiaries and their executives are involved in D&O claims: those of the parent company or those of the subsidiary? Compounding this lack of clarity, most D&O policies today contain what are referred to as 'presumptive indemnification' provisions: that if you are legally permitted to indemnify the executive, the carrier will assume that you have done so when determining coverage. This might read as follows: "Indemnifiable loss" means loss for which an organisation has indemnified or is permitted, or required to indemnify an insured person pursuant to law or contract or the charter, bylaws, operating agreement or similar documents of an organisation.

While knowledgeable, international legal scholars should be consulted in this regard, as a general matter, indemnification provisions flow from the place that the company is incorporated because, when incorporating, a company agrees to be subject to the laws of that jurisdiction. A jurisdiction is empowered to establish laws for its citizens, including its corporate citizens, but not generally for the citizens of other jurisdictions (corporate or otherwise).

This line of reasoning suggests that executives of foreign subsidiaries may have the benefit or right solely to that subsidiary's indemnification, and not that of its parent organisation. From a coverage perspective, the narrower local or foreign indemnification provisions may lead to more A-side or non-indemnifiable claims, which can, in turn, impact both program structure and limits adequacy.

It is also possible for executives at both the global parent and the foreign subsidiary to be part of the same D&O claim. In this case, there might be different indemnification rights for different insureds. This would, in turn, impact the application of the D&O policy's retention, which only applies to indemnifiable claims and claims against the company itself.

Table 1: standard global wording in most broad D&O policies

1. Covers all Subsidiaries.

2. Covers foreign equivalents of US directors and officers.

3. Worldwide territory.

Source: Authors' own.

Table 2: traditional D&O insuring agreements

1. "A-Side" coverage for claims against the executives where their company is not legally or financially able to indemnify them.

2. "B-Side" coverage that reimburses the company for indemnifiable claims against the executives.

3. "C-Side" coverage for the company itself (limited to Securities Claims for publicly-traded companies).

Note: there is no self-insured retention or deductible that applies to the A-Side of the policy.

Source: Authors' own.

- Don Bailey is National Practice Leader of Willis' Executive Risks Practice, and Ann Longmore is Senior Vice President of Willis' Executive Risks Practice.