Take Out Entity Coverage: InsurersInternational Editor

The directors and officers marketplace has seen a tremendousupheaval as insurers have pulled out of the marketplace orsignificantly reduced their writings, while rates have risen andterms have tightened. But there are some signs that new capacity isreturning to the market.

Rates and retentions, which had gone belowprofitable benchmarks, are now starting to approach profitablebenchmarks indicating a substantial correction in the marketplace,said Brian Houghlin, vice president of the D&O underwritinggroup Allianz Insurance Company in Chicago. Allianz has moved intothe U.S. D&O market for large public companies.

“Weve seen a tremendous correction in terms of rates andretentions and thats very, very good,” he said. “Weve also seen ameaningful amount of contraction in the policy form right now,which makes this a very compelling opportunity,” he said.

“Insurance companies are trying to incorporate coinsurance intothe policies, which requires the corporate entity to participate inthe claim,” he added.

According to Michael Cavallaro, director with ARC Excess andSurplus in Garden City, N.Y., premiums increases vary. “Ive hadsome good accounts in public companies that have gotten a 35-40percent increase, and Ive had some public companies that hadpricing go up three to four times, depending on the circumstances,”he said.

“The accounts that have been affected the most are obviously thebig market capitalization companies, the Fortune 500s,” he said.But “it doesnt have to be a Fortune 500. It could be a companythats trading at a very high multiple, where the stock marketvalues it at a high figure.”

Underwriters in the directors and officers liability businessincreasingly want to get back to D&O basics and are pushing toprovide coverage for the personal liability of the directors andofficers, which they say was the markets original intent.Nevertheless, there is still a demand for entities coverage, whichunderwriters are still providing, but following strict underwritingcriteria.

Paul Brodeur, directors and officers liability product managerfor Travelers Bond in Hartford, Conn., said there is still a lot ofcapacity out there thats willing to provide securities entitycoverage. “Weve seen some withdrawal but not to the point where Iveseen people having problems putting together the program theywanted,” he said.

However, on an isolated basis, individual companies may behaving trouble getting securities entity coverage in the amountsthey would like, especially if they have had problems or are intougher industries that have been sued, such as software companies,Mr. Brodeur said.

He said that a lot of the newer D&O products are going backto the traditional “A-Side” coverage that responds only to thedirectors and officers for derivative claims and claims that ariseout of an insolvency. The Side A coverage is pure Side A. So theresno coverage for the entity securities claims or for the indemnifiedclaims for the directors and officers (otherwise known as side Bcoverage).

“The decision to purchase entity coverage does, withoutquestion, come at the expense to some extent of the board,” saidTony Galban, vice president, D&O underwriting manager for ChubbInsurance in Warren, N.J.

After a bankruptcy, the entity coverage creates an argument asto whether the policy belongs to the company or the board, he said,explaining that the courts have held in some cases that thecoverage may very well belong to the company. “That has put boardsin precarious situations.”

Bill Cotter, chief underwriting officer for National Union, theNew York City-based subsidiary of American International Group,said the fundamental intent of a D&O policy is to buy coverageto protect the personal assets of individuals.

“If a risk manager wants to go beyond that, to provide coveragefor the balance sheet, thats why we continue to provide protectionfor the indemnification responsibility of the organization onbehalf of individuals. Were not taking that away,” he said,referring to what is traditionally known as Side B coverage. “Ifthe risk manager wants to provide further balance sheet protectionfor the liabilities of the corporation itself, that productnull may also be available,but there will be a coinsurance provision added.”

The real answer for a board of directors is that the policyshould not have entity coverage. It should be devoted strictly tothe board members as individuals or to the companys obligation ontheir behalf, Mr. Galban stated.

“I love all this debate about entity coverage. The simple answeris take it out. Take out the entity and the board can breathe asigh of relief. It has never served the individual board memberspurpose. It has always served the company,” he said.

Nevertheless, Chubb still provides entity coverage butseparately charges for it, he said. “We build it into the policyand then offer programs that have it with or without it,” he said.“Its not a separate policy. I want to be clear about that. Itsstill in the basic policy.”

Mr. Brodeur thought that entity coverage would still be offered,but insurance carriers would be more careful about the companiestheyre willing to offer it to. “It will become more limited and theprice will continue to go up,” he added.

“Weve always taken the approach that well provide fullsecurities entity coverage to accounts that meet our strictunderwriting guidelines,” he said.

“We dont provide it to a broad range of companies. We looked atthe larger companies and we feel we cannot provide their balancesheet protection for a securities lawsuit,” he said. “We cantunderwrite which ones will have a claim and which ones wont. Itsgotten that bad. So we just dont provide it in some cases.”

For other companies, Travelers will offer “A Side” coverage inits broad form policy, which only provides coverage fornon-indemnifiable claims to the directors and officers. “Theres noentity coverage whatsoever, securities entity or directors andofficers coverage for the indemnified claims,” he said.

The industry as a whole has tried to mitigate losses through theuse of larger retentions and coinsurance, but that doesnt seem tobe helping, he said.

“Basically its gotten to the point where, when you have asecurities loss, pretty much the whole tower of insurance is goingtoward the settlement value, and no matter where you are on thatprogram, if youre providing securities entity coverage, youre goingto be paying,” he emphasized.

Over the last 20 years, the value of individual directors andofficers policies have been eroded to the point where more coverageis being provided for the company than to the directors andofficers, Mr. Brodeur said.

“If you pay out for the company, then the directors and officersdont have the coverage,” he said.

When a claim comes in, if the corporation is sued and thedirectors and officers are sued, if youre only providing A-sideD&O coverage, then you run into the issue of allocation, whichentails trying to parcel out how much of that claim against thedirectors and officers would be covered by the insurance policy, henoted.

“There would no coverage for claims against the corporation andno coverage for claims against the directors and officers where thecorporation is permitted to indemnify them,” he said. “So the onlycoverage that would be provided is for claims where the corporateis either not permitted to indemnify or is unable to by reason ofinsolvency.”

Describing Travelers Broad Form PLUS+ policy, Mr. Brodeurexplained that its for directors and officers who wish to make surethat no matter what happens, they have a policy out there thatsgoing to respond to their situation and not provide any coveragefor the corporation, he said.

(The Broad Form PLUS+ policy is a stand-alone policy that is inexcess of any other directors and officers policy.)

“The expectations that have been placed on their roles asdirectors and officers were always serious, but obviously its beenbrought to the forefront now,” he said. “Their individual liabilityhas been brought to their attention because of whats happened” withthe various corporate scandals.

He noted that in Travelers standard D&O policy, securitiesentity coverage is still being provided in some cases. “In othercases, were only providing A-Side,” he said.

Mr. Galban at Chubb noted there are products surfacing for thebenefit of individual directors.

“Weve just released one ourselves called a personal directorsliability policy, which is built for individuals, for that outsidedirector to buy themselves, to cover the situation where they mayfind themselves hung out to dry because theyre in the midst of ascandal of which they were unaware,” he said.

“They want to buy an individual protection that would cover themfor their individual liability in that circumstance,” he said,noting that this policy is getting a lot of interest” because itsvery hard as an outside director to get to know the other directorsand officers well.

Certainly the bar has been raised with the new audit committeerules and the Sarbanes-Oxley requirements, but if somebody wants tocommit fraud internally, its often hard for an outside director tosee it, he said.

Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, May 26, 2003.Copyright 2003 by The National Underwriter Company in the serialpublication. All rights reserved. Copyright in this article as anindependent work may be held by the author.