Will Insureds Accept D&O Coverage Changes?

Chicago

Like other commercial insurers, those specializing in directors' and officers' liability insurance are starting to dust off their hard market strategies–and the biggest gun in their arsenal appears to be coinsurance, according to experts who spoke during a recent industry meeting.

But the question of whether D&O insurers will get such provisions past their clients–and whether they will be able to take back some of the coverage expansions they rolled out in recent years–was hotly debated at a session during the annual meeting of the Professional Liability Underwriting Society.

Squaring off at a session entitled, “D&O: Armageddon or the Dawn of a New Golden Age?” were defense attorney Tower Snow Jr., partner and chairman of Brobeck, Phleger & Harrison in San Francisco, and Donald Bailey, managing director of Aon Financial Services Group.

Suggesting that it was the sellers of insurance who drove a push toward expanded coverage at cheap prices and not buyers, Mr. Snow said: “If you go back to the mid-'80s and early '90s, insureds were very happy with the [D&O] product. There were no complaints in the business community that it wasn't a good product.”

In fact, he added, “if you surveyed the insureds, I think most people would be quite upfront and tell you that they have been amazed at what they've been able to buy and what has been offered, because everybody has understood that it's not reasonably priced.” In particular, he referred to the introduction of entity coverage and to multi-year policy terms among the expanded offerings.

Entity coverage was introduced in the mid-1990s as a way to deal with the issue of how to allocate judgments and settlements between insured directors and officers and the uninsured corporation under a D&O policy. Entity coverage solved the problem by adding the corporation as an insured for securities claimsproviding coverage whether or not individual directors and officers were named in a lawsuit.

“If you parse through what insureds are looking for, they are focused primarily not on entity coverage, but on the officers and directors side of the equation,” he said. Thats because “the reality is that you aren't going to get anyone to serve as an officer or a director of a public company unless they have insurance.”

“So for decades, there was no entity coverage,” he said.

“Whether you address that [now] by eliminating it or you address it with coinsurance–either way, you're going to be able to move back,” he predicted.

“A lot of the coverage expansions are very, very recent. People aren't used to it. People weren't looking for it or demanding it. You can even come back for higher retentions. I don't think you're going to get a push back on that,” he said.

“We must have very different clients,” the broker, Mr. Bailey, retorted.

“The idea that it wasn't the insureds that were pushing changes in the early '90s–my experience has been exactly the opposite,” Mr. Bailey said.

“The folks who never had a claim thought the policy was finethey had no problems with it,” he said. But it was a “completely different experience for those who had a claim. Those who had claims thought the structure of the program, the policy contract was absolutely dreadful. Claims [processes] were contentious–were long and drawn out–and they had an enemy for life, the D&O carrier,” he added.

“In 1995, I think the coverage initiatives,” such as the addition of entity coverage, “were critical” to the sale of D&O programs, Mr. Bailey said.

“I agreethat the pricing didn't catch up. Entity coverage was charged for, for about seven weeks and then thrown in for nothing,” he said. Still, “I think going back and taking entity coverage out is a big step backwards,” Mr. Bailey added.

Joseph Monteleone, vice president of Hartford Financial Products in New York, the sessions moderator, said that the talk in the industry right now is about “significant coinsurance.” He asked Mr. Bailey: “Is there absolutely no receptivity in your client base to accepting coinsurance–25-30 percent–as a means of avoiding contentious allocation disputes while still adhering to the concept of entity coverage?”

The broker representative responded: “My biggest push right now would be to do something we haven't done in a decade. Brokers need to broker and underwriters need to underwrite. Broad applications of exclusions and coinsurance do not do this.”

“We've got to identify good risks and we've got to identify bad risks. Twenty-five percent for everybody–I think that's a bad plan,” Mr. Bailey said.

Paul Lavelle, president of the claims division of National Union Fire Insurance Company in New York, and Kim Hogrefe, senior vice president of Chubb & Son in Warren, N.J., both pointed to the advantages of coinsurance and other methods of “partnering.”

“Im all for partnering,” Mr. Hogrefe said. “With settlement values up, the name of the game frankly has been that the plaintiffs attorney will make a demand within the combined insurance policy limits. The insured looks atthe insurance company, and says make this case go away and do it now.”

And “sometimes, to make matters worse, whether due to legitimate concerns about attorney-client privilege, reluctance to share information or other reasons, the insurance company does not have the minimum necessary information it needs to support a settlement at those limits.”

“So I think, in terms of injecting something structurally into the policy to insure a sense of cooperation and partnership, coinsurance is a great idea,” he said. “It brings us back to the point, without contention, where theres a true financial partnership through each level of the settlement.”

“One hundred percent coverage and significant insurance limits is a dynamic that puts no brakes on the ability of plaintiffs attorneys to push higher and higher settlements,” he said.

Mr. Lavelle agreed with Aons Mr. Bailey that “there was a lot of friction between carriers and insureds on the issue of allocation” in the 1990s “because it was an unknown.”

“I think coinsurance takes out the question” of what a company needs to reserve on the balance sheet for a particular event or lossat 25 percent of whatever they believe the case will eventually go for.

He also agreed that “there are accounts out there that shouldn't get allocation and there are other accounts that maybe should get more than 25-30 percent.” But, he asked Mr. Bailey, “How do you tell who they are?”

“Enron is going to be an asterisk to the statistics. Six months ago they looked like a good risk,” Mr. Lavelle said, referring to the highly-publicized problems at the Houston-based energy company, including a financial statement restatement resulting in a more than $1 billion reduction in shareholders equity.

“As an underwriter, with financial restatements at an all-time high level, how can I tell [which] is going to be the accounts that's really going to have problems,” Mr. Lavelle asked.

“I think you're right. Every account needs to be looked at differently,” he said, again addressing Mr. Bailey. “I don't think it does anybody any good to put an endorsement on a policy that says the magic number is 25. Some need 50 and I think some need 10. And I think it goes to how long the relationship is, have you ever had an experience with that carrier before? How did it work out?”

But, he added, “I do think coinsurance has to be out there. If you can tell me which account won't have a financial restatement, then I'm happy to take the coinsurance out.”

“Part of this is setting expectations,” Mr. Snow told the insurers and brokers. If “the mindset delivered to the client by the broker is: 'You are entitled to get unbelievable coverage with a low deductible for a dirt-cheap premium. This is your right, then you're going to get one reaction,” he said. He suggested that a different message might be: “'This is the loss reality of the industry. There is not going to be D&O insurance unless it's viable for the [insurance] industry.”

Returning to relationships between carriers and insureds, Mr. Monteleone asked Cathy Simon, a partner with Ross, Dixon & Bell, who specializes in insurance coverage issues, what types of coverage disputes might arise in the next few years. Ms. Simon responded that “dishonesty, fraud and personal profit exclusions could get greater play in the future.” She added that “rescission is an issue that will come more to the fore now, driven by the fact that a lot of [securities] cases allege accounting impropriety.”

If incorrect financial statements were “allegedly relied on by the shareholder/plaintiffs,” then they were “equally relied on by the insurance underwriters in the underwriting process for these policies,” she said. (See related story, page 27 for more on rescissions.)

Mr. Snow responded: “I think its very important to keep in mind that the enemiesare the plaintiffs; that it doesnt help anybody for the insured and the insurer to be shooting each other.”

“There are undoubtedly cases where exclusions should be invoked and rescission is appropriate, but it really is importantthat theres a true business partnership here,” he added.

Highlighting what he called, “a business reality,” he said that many parts of the business communitylike the technology sectorare incredibly networked. “If the carriers started to aggressively invoke exclusions or seek to rescind policies, theres a practical reality that entire business segments would stop directing business to that carrier,” he said.

Agreeing that exclusions should not be asserted across-the-board, but only when facts justify them, Ms. Simon went on to suggest that there is a “potent” partnering force in “defense counsel and insurers counsel” combining their efforts to pay closer attention to issues like striking down questionable plaintiffs damages models.

Mr. Snow agreed, calling attention to an article written for PLUS by Mr. Monteleone and John McCarrick, a coverage lawyer in the Pleasantville, N.Y., office of Duane, Morris & Heckscher, about the vulnerability of plaintiffs damage theories. “We really havent gone after [these theories] as often or as early as we should and that is something that has the potential to dramatically change the contours of the landscape,” Mr. Snow said. (See related article by Mr. Monteleone discussing an alternative for keeping down damages, page 23.)

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, December 3, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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