Fears of Widespread D&O Carrier Rescissions Fail to Materialize

Underlying the lawsuits were actions by shareholders alleging fraud on the part of corporations and their directors and officers after a restatement was issued.

Attorney Carolyn H. Rosenberg also noted that new corporate-governance rules passed in late 1999 by the Securities and Exchange Commission and other bodies imposed "enhanced responsibilities" on audit committees composed of corporate directors. Ms. Rosenberg is a partner in the Chicago office of Sachnoff & Weaver, Ltd., where she heads the insurance coverage group that represents policyholders.

These additional duties led to a belief that audit committee members might "have more heightened potential exposure for D&O-related claims" in shareholder lawsuits, Ms. Rosenberg observed.

Steve Shappell, director of Aon Financial Services Group in Denver, believes not only that there has been no significant change in the number of rescissions, but that there actually may have been "a slight downtick." He based these views on his informal survey of D&O carriers and attorneys for policyholders.

Mr. Shappell suggested that fewer financial accounting claims this year are the result of the current "laddering phenomenon." He was referring to claims by purchasers of shares in initial public offerings that there was some form of wrongdoing in the allocation of shares by lead securities underwriters who handled an IPO. (See NU, Nov. 12, 2001, page 10.)

According to Mr. Shappell, of the approximately 360 securities class actions filed in 2001, more than 200 were laddering claims resulting from IPOs of the 1990s. He suggested that because Dec. 6 is the statutory deadline for the filing of laddering actions, plaintiffs attorneys are too preoccupied with those actions to be concerned with actions for accounting irregularities.

He also attributed the "downtick" to "better accounting principles," to audit committees "being in place and working well," and to "greater disclosures as a result of the committees."

"Without a doubt, our clients have taken the audit committee directives incredibly seriously," Mr. Shappell said.

"The ultimate underwriting intent was never to use this regulation as a vehicle to rescind [insurance] contracts," Mr. Galban emphasized. In fact, "no carrier pursues a course of rescission lightly," he stated, because the downside is that "courts can be quite punitive with carriers that take unreasonable positions."

Mr. Galban indicated that Chubb has always been "very satisfied" with the wording of its D&O policy because it provides "a nice, external finite standard."

"The bottom line is, audit committee or not, we're still not looking to pay for the crooks, but we're willing to go as far as we can to make sure that we pay for everybody else," he added.

Moreover, Mr. Galban believes that even before the passage of the SEC rules, the requirements for audit committees "should have been satisfied anyway, if there was a reasonable underwriting protocol taking place."

One trend that Ms. Rosenberg has spotted is that corporate directors and officers "are paying more attention to the coverage terms and conditions and are negotiating [them] harder."

She added that "policyholders are being told to expect a tightening market and higher premiums," although this may not apply universally.

In fact, Mr. Galban predicted "deep double-digit rate increases" for policy year 2001, as well as for next year.

Along with the expectation of paying higher premiums for a D&O policy, the policyholder now "more than ever" expects coverage that is "as good as it can be," Ms. Rosenberg pointed out.

It is important for policyholders to realize that D&O policies are not a "cookie cutter take-it or leave-it products," she said, declaring that the policies can and "should be negotiated and tailored to the particular needs of the insured."

Mr. Shappell concurred. "That's our bread and butter," he said, adding that the Aon Financial Service Group takes "a standard 11-page D&O policy and we add maybe 50 endorsements to tailor it to our clients needs."

To address what it perceived as the potential lack of proper coverage for audit committee members under traditional D&O policies, Marsh last year developed the stand-alone Audit Committee Management Liability Insurance policy. It provided primary limits and additional excess Side A limits of $25 million each, in the event of a rescission action by a D&O carrier. ("Side A" coverage protects directors who cannot be indemnified either as a matter of law or due to their companys lack of funds, Mr. Anderson explained.) However, because of corporate structural changes affecting the ACML underwriters book of business, Marshs freestanding policy no longer exists, Mr. Anderson reported.

Nevertheless, he stated that the SEC regulations caused other major D&O insurers "to expand the breadth of Side A coverage." He added that Marsh has seen "an increase in the number of companies that have purchased additional Side A limits over the last year."

Another reason for the increased interest in such coverage is the greater number of "corporate insolvencies that have taken place" due to the declining economy, Mr. Anderson suggested. "If you have a bankruptcy situation, Side A coverage can be invaluable." he said, because D&O policies can make monies available for the defense of an insolvent company facing shareholder actions.

Like the other experts, Mr. Anderson reported that in negotiating new policies and renewals, D&O carriers these days are pushing hard for coinsurance arrangements with policyholders.

This is because carriers "believe that unless the policyholder has a meaningful stake in the amount of a settlement," losses from a shareholder action will continue to mount if there is no incentive to "cut off the litigation," he noted.

This in turn "will continue to drive the need to increase premiums, and at the end of the day no one really wants that," he said.

But Mr. Shappell pointed out that, while D&O carriers claim to be offering price breaks in exchange for coinsurance, "most people who are doing the math just are not finding it attractive enough to take on the coinsurance."

Therefore, he believes that "for the coinsurance to work, the market has to get much harder or the discounts have to become mathematically more reasonable."

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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