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D&O Liability Insurance: What Directors Need to Know

Today’s D&O market presents challenges related to pressure on pricing, increased retention and limiting capacity. Now more than ever it is important for organizations to evaluate their risk portfolio and truly define their risk appetite. In evaluating and managing your organization’s total cost of risk (TCOR), it is fundamental to understand your organization's risk exposures, appetite for retaining risk and available risk shifting mechanisms. In order to maximize D&O coverage, your organization should not only prepare for today’s risks but should also consider risk identification over the next few years and if your D&O program is sustainable with the pressures of the changing market.

The D&O market was already experiencing intense pressure on pricing, retention and capacity heading into 2020; the impact of COVID-19 has further destabilized the insurance market and materially impacted the D&O insurance market. Among other potential impacts, D&O insurers are focused on heightened liquidity/bankruptcy risk, disclosure risk to stakeholders, and employee exposure due to layoffs and wellbeing. Premiums are increasing monthly as the market firms. Public company D&O coverage is experiencing the highest rate increases in over fifteen years. Some industries are experiencing perhaps the highest ever increases, including sectors such as: IPOs, distressed companies, first-time buyers, pharma retail, travel/airlines, hospitality/leisure, gaming, Quebec domiciled, cannabis, oil and gas, mining, start-up organizations and healthcare[1].

While indemnification arrangements between a corporation and its executives may offer some liability protection for these executives – there are several situations where indemnification is either not permitted, not accessible or not available. Corporations purchase D&O insurance to “back stop” those indemnification obligations and even more importantly, purchase D&O insurance to fund those non-indemnifiable situations. In fact, most corporations purchase some level of D&O insurance for their executives and board of directors.

While actuarial loss models summarize a D&O claim as a one in 10+ year event, when the loss occurs it can be, and often is, significant. The frequency of shareholder class action litigation is on the rise, combined with increasing cost to defend a claim. D&O insurance offers balance sheet protection for corporate earnings and funds the defense and indemnity for directors and officers. Data and analytics are key to understanding a company’s true risk appetite. Few organizations decide to cease the purchase of D&O insurance all together. In this turbulent market, a structured and data driven approach to the purchase of D&O insurance is critical.

Trends in D&O Exposure:

The following are some top trends in liability for directors and officers:

  • Historic levels of securities class action filings
  • COVID-19 related litigation
  • Increased US derivative litigation
  • Anticipated increased bankruptcy filing
  • High severity US derivative settlement

Employment Issues:

  • Managing return to work
  • Mental health
  • Safeguarding employee and customer exposure to COVID-19

Complex US IPO Market:

  • Fewer public companies
  • Increased class action lawsuits
  • Duel forum litigation (federal and state)

Event Driven Litigation:

  • Cyber
  • #metoo
  • Lack of board diversity
  • Opioids
  • Cannabis

How do we decide the limits of insurance to purchase?

Litigation frequency and claim severity is rising in the US and severity is trending upwards for Canadian companies. In the current D&O market, many insurers are managing overall capacity deployment and some clients are facing capacity constraints at renewal. Other clients are facing material increases in premium for their current limit of liability, as well as, increased retention thresholds.

To determine appropriate policy limits, companies should seek benchmarking information that measures their exposure against similarly situated corporations and against current litigation and regulatory conditions. But beyond benchmarking and a historical view of class action settlements in specific jurisdictions, companies should look to data and analytics to assess risk. Determining an appropriate limit to purchase coupled with a policy structure that fits your risk appetite and ultimately will satisfy your board, is critical to managing the total cost of risk.

Market Management

The opportunity is now to customize your contract to address these trends and prepare for continued volatility. Contract customization would include but certainly not be limited to obtaining best in class terms relating to bankruptcy (i.e. priority of payments, pre-agreed runoff terms, bankruptcy centric carve-backs to the entity versus insured exclusion), particularly when a company is not in a state of distress. Also, a broad definition of claim and securities claim, including pre-claim inquiry, derivative demands and books and records coverage are fundamental to a broad-based D&O contract. Narrow exclusions and severability language are also trademarks of a best in class D&O contract.

D&O program structure has evolved with the changing market. A total cost of risk analysis will require an evaluation of your company’s D&O program structure to determine if it represents an efficient and effective approach to shifting your D&O risk exposures. Defining risk appetite and considering alternative structures will help companies and executives leverage the market. Companies may want to consider both conventional and innovative approaches to a D&O structure to fully evaluate the total cost of risk. Companies can consider, among a multitude of structures, alternatives such as: forgoing balance sheet protection and only insuring non-indemnifiable loss (side A only); ventilating retentions; utilizing a captive to spread risk and leverage market conditions; or creating an indemnification trust (where legally viable) to transfer certain risk.

The fundamental shift in considering the total cost of risk and loss will help organizations prepare for risk today and those unknown risks that will be identified over the next few years. Given the complexities of coverage and an insurance market that historically supported enhanced coverage at a lower cost, the D&O issues presented here should be discussed with an insurance professional skilled in management liability to achieve appropriate and adequate coverage for you and your organization.