Are your officers covered?

Why has there been growing demand for directors’ and officers’ liability (D&O) insurance to be included in global programmes, and why has this become a problem?

The answers to those questions are quite simple, but finding a solution to the problem of global D&O coverage is anything but simple, according to Eugene ‘Trip’ Sheehan, D&O practice leader of Marsh’s FINPRO practice in Boston, who spoke at CRE’s Global Programmes seminar in London last month.

The basic reason for the growth in demand for D&O coverage is the relentless increase in D&O exposure. As Sheehan explained, following the big corporate accounting scandals in the early part of the last decade, and then most recently with many of the scandals arising out of the credit crisis, governance, compliance and enforcement have all increased.

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“Regulators, at the behest of shareholders, are demanding that directors and officers be held more accountable for the operation of their organisations. So you’re seeing much more focus on holding directors and officers accountable,” he told the seminar.

Not only that, but there has been a big increase in cross-border cooperation among regulators, said Mr Sheehan, who gave the example of the SEC which has memorandums of understanding with numerous regulatory bodies around the world.

D&O claims are typically regulatory or criminal in nature and they usually arise out of things like bankruptcy, worker health and safety, competition issues, environmental issues and bribery-related matters, as well as shareholder claims, said Mr Sheehan. He also pointed to pressure in a number of jurisdictions to give shareholders the right to litigate on a class basis as in the US, and the rise of litigation funding.

In terms of the jurisdictions with the most active D&O litigation activity, it was of course no surprise that the US is way out in front of the rest of the world.

But as Sheehan pointed out, Australia and Canada are following quickly behind, followed by Germany, the Netherlands, France, and then the UK. Hong Kong, Italy, South Korea, Israel, Spain and Sweden are also hot spots. “In terms of frequency and severity, nothing approaches the level of the US, which is instructive when you look at determining the appropriate limits you need in the local jurisdictions,” said Mr Sheehan.

Historically, the way companies dealt with D&O exposures was to buy a policy in the home country where the company was listed and traded, and the policy language stated that the directors and officers were covered worldwide.

As Mr Sheehan explained, this worked perfectly well and losses were paid all over the world under these policies with no apparent issues.

Then came the Kvaerner decision in 2001, which resulted in a heavy focus on property and casualty, but very little attention was paid to D&O insurance.

“For years everything was going along just fine,” said Mr Sheehan, “until insurers started to look at allocating premium tax for D&O insurance and other financial lines insurance and realised that they really didn’t have a way to administer the allocation of those insurance premium taxes in many jurisdictions, because the policies or the coverage in those jurisdictions was not admitted—that brought to light all of the issues and highlighted the problem.”

The ability to indemnify directors and officers around the world is not clear cut. As Mr Sheehan explained, in some jurisdictions it is very clear what you can, and cannot, indemnify. In other jurisdictions there is no guidance at all.

“I think it’s safe to say that in most jurisdictions that we’ve looked at around the world, and from lawyers that we’ve talked to in these jurisdictions, a company is able to advance defence costs most often with a requirement of an undertaking by the director and officer,” said Mr Sheehan.

“Often you can advance with an undertaking and then, depending on the outcome of the case, you may, or may not, be able to indemnify under the statutes of the local jurisdictions,” he added.

The most acute issue from an insurance standpoint arises in a situation where there is a claim that is non-indemnifiable and it occurs in a jurisdiction that does not allow non-admitted insurance.

In that situation, said Mr Sheehan, neither the parent company, nor the subsidiary company, can indemnify directors and officers. The insurance that is held at the parent company level cannot respond and pay the loss of the local subsidiary.

Mr Sheehan pointed to a survey of Marsh’s Fortune 250 clients in the US on the leading reasons that they decided to buy local D&O policies. The number one reason was to provide coverage certainty for the local directors and officers. The second reason was regulatory tax compliance in the local jurisdiction, the third was that it was requested by local directors. The fourth reason was because they were concerned about local exposure.

Mr Sheehan said that clients, particularly in the US, often demand the same endorsements and coverage that they have in the US for every other country around the world, because it is a global policy. But he asked whether this was really relevant.

“You really need to understand what the local practice is in the local country and make sure that if you’re providing cover from the master policy, and in a jurisdiction that allows non-admitted insurance, that you’re tailoring those master policies to provide that nuanced coverage or that specific coverage for the local jurisdiction,” he said.

So what is the answer to the problem of D&O and global programmes?

Generally, there is no perfect solution when it comes to global programmes, and Mr Sheehan said this is certainly true of D&O. However, there are a number of different structures that may be appropriate.

The most compliant solution would be a structure that includes a policy for the home country of the parent company and then also has local policies in place with specific limits, premiums, deductibles and terms and conditions for each of the subsidiaries around the world, he said.

Another option would be the controlled master programme approach where there is a master programme, with local policies in the local jurisdiction with the limits tied into the master programme where allowable.

A third structure is the dedicated global integrated programme, under which there is one policy for the parent company in the home country, and then a separate policy with one global limit for the rest of their subsidiaries around the world, said Mr Sheehan.