Heightened regulatory scrutiny increases need for D&O auditsPosted On: Mar. 4, 2007 12:00 AM CST
With more than 150 different directors and officers coverage forms in the marketplace and increased scrutiny by the U.S. Securities and Exchange Commission, it is now more important than ever to ensure that any policy adequately meets the needs of your officers and directors.
The post-Sarbanes-Oxley Act world has resulted in a new corporate environment that makes D&O coverage more important for directors and officers. Indeed, a 2004 study by a leading D&O insurer found that many corporate executives expect that their directors and officers will be sued by a combination of customers, vendors and shareholders. As you contemplate renewal of your policy, a complete analysis of its provisions will go a long way toward heading off potential costly and harmful problems down the road. Whether you work with outside counsel, a broker, risk manager or chief financial officer in evaluating your current policy and in negotiating changes, there are some important considerations that should be addressed.
- The policy should match the business needs of the directors and officers. To do that, one must understand what specific policy terms and conditions are necessary, how they have been interpreted by various courts and, in the event of D&O litigation, what duties and obligations exist under the policy. Because of recent high visibility cases such as WorldCom Inc. and Enron Corp., courts are issuing decisions that have major impacts on the scope of D&O coverage, decisions that must be borne in mind for any D&O policy renewal.
- When negotiating a policy term and/or condition, one must be able to answer the question "Does it matter?" in connection with certain language. Knowing the importance (or lack of importance) of certain language allows the parties to focus on what is material to both the policyholder and the insurer. Clarity early in the process can help avoid disputes down the road when and if a claim is filed.
- Given the ability to negotiate many of the terms, conditions and exclusions in a D&O policy and despite the best intentions of the insurance underwriter, mistakes or clerical errors can be made when issuing the actual insurance contract. In the event such mistakes are made, they typically can be resolved during the underwriting or insurance audit process. Once a claim has been made, however, it becomes more difficult to correct any mistakes.
How much coverage?
One of the most fundamental issues to be determined is how much and what kind of coverage is needed. The annual limit of D&O coverage that is being purchased by corporations is widely divergent, ranging from $1 million to $500 million. Considerations include:
- While the market has loosened considerably recently, the cost of D&O coverage can be high. Many boards want to know not only what type of coverage has been purchased for the cost, but also what type of coverage is available to be purchased. Moreover, as a result of the soft market, many insurers began to offer "entity coverage" for the company itself. This coverage can either be broad, insuring the company against a wide-range of claims, or more narrow, providing coverage for the company solely against securities litigation. While many agents and brokers view entity coverage as a must, such coverage can create serious issues and, ultimately, may significantly reduce the amount of D&O coverage that is available to directors and officers. As a result, the inclusion of entity coverage may actually defeat the main purpose of D&O insurance--namely to allow a company to obtain (and retain) top-notch directors and officers.
- Also, as insurers continue to compete for new and returning business, many insurers are introducing new D&O products that are aimed solely at protecting the personal assets of directors and officers. These products, such as Side A difference-in-conditions policies, are also a means to address the issues raised by the inclusion of entity coverage in a traditional D&O policy. It is important that boards understand the availability of these products, as well as the advantages and disadvantages of purchasing such additional D&O coverage.
Corporate directors and officers continue to face heightened scrutiny by regulators and other stakeholders, making it imperative for organizations to carefully review their insurance policies to make sure they are protected in the event of litigation. More than ever, plaintiffs are going to target directors and officers, whose potential liability and legal costs can be significant. Steps to avoid or eliminate that exposure, in addition to sound corporate governance, include a sound D&O policy.
Kim Marrkand is chair of law firm Mintz Levin Cohn Ferris Glovsky & Popeo P.C.'s insurance/reinsurance practice group. She is also a member of the firm's insurance bankruptcy group and is based in the Boston office.