The Unique Importance of Insurer Financial Stability For D&O Insurance

But while marketplace observers are appropriately concerned with insurer financial stability, little attention has been paid to the unique importance of insurer financial stability when it comes to directors and officers liability insurance.

The possibility of insurer insolvency is of course a concern with respect to any insured exposure. But unlike most other kinds of insurance losses, if a D&O insurer fails before a D&O loss is paid, individual directors and officers might have to forfeit the financial fruits of their lifetime of work to pay a settlement or judgment in the litigation.

Moreover, even in a successfully defended securities claim, the defense cost expense can reach millions of dollars. Such a victory would be bittersweet indeed for the director or officer who had to pay for that expense out of his or her own pocket.

D&O liability exposure is personal to individual directors and officers. In particular, their potential liability under the federal securities laws is theirs individually. Their individual liability exposure remains whether or not there is a company or an insurer to indemnify them. Moreover, many of the new fines and penalties for which directors and officers may become liable under the Sarbanes-Oxley Act are not dischargeable in bankruptcy.

At the day of reckoning, when a directors or officers liability obligation must be funded, the corporation with which they had been affiliated often no longer exists because it has failed or gone bankrupt. In that event, the only thing standing between the plaintiffs lawyers and the individual director or officers personal assets is the balance sheet of the D&O insurer.

For the individual facing direct personal liability (which may not be dischargeable in bankruptcy), it would be a cruel development indeed to learn that his or her D&O insurer has gone belly-up.

A recent case suggests just how this might unfold.

Mattel Corporation recently settled a securities class action lawsuit against itself and several of its directors and officers. According to Mattels Form 8-K dated December 6, 2002, the settlement involved a payment to the plaintiffs of $122 million.

This should have been an event that mostly involved Mattels D&O insurers, since Mattels D&O coverage should have covered almost the entire settlement amount.

Unfortunately for Mattel, a $20 million layer in its D&O program had been placed with Reliance. In order to settle the case, Mattel had to pay $20 million out of its own pocket to cover the Reliance layer. While this was a highly unwelcome development for Mattel, it at least had the cash to cover the shortfall. Many companies in this position would not have sufficient cash to plug the gap, which could be ruinous for any individual defendants involved.

Anyone who questions whether individuals really would be exposed in these circumstances need look no further than the failed bank cases in the mid-to-late 1980s. The governmental regulators were relentless in pursuing recoveries from former bank directors and officers, regardless of whether or not there was insurance available. I personally witnessed an uninsured former bank director burst into tears when it became apparent that he would have to liquidate most of his assets to extract himself from the regulators lawsuit.

In choosing a D&O carrier, the insurance buyer is essentially selecting the balance sheet he or she might have to depend upon to protect him or herself from the possibility of personal financial ruin.

In making this assessment, however, it is not enough merely to assess the D&O insurers present financial condition. The insurance that is purchased today will provide defense and indemnity for a possible claim that would not be settled until years from now. That is, the insurance promise that is made today will only be redeemed years down the road, in 2006, 2007 or even later.

For all of these reasons, the well-informed consumers of D&O insurance and their insurance advisors must realistically assess their insurers financial durability, not merely at the present moment, but at an unknown time far in the future and at all points in between.

The current generalized marketplace concerns about insurer financial stability do have one predictable effect, which is that insurers regarded as more financially vulnerable must cut their prices to attract business. This not only puts these companies in a downward spiral that may hasten their demise, the financially shaky carriers cut-rate prices also mean that insurance from the most financially solid carriers will appear relatively more costly.

But in the end, cheap insurance from financially weak carriers is no bargain. Insurance isnt worth very much if there is no insurance company left when the time comes to pay the losses. The assurance that an insurer will still be there at the day of reckoning is by far the most valuable attribute available for any insurance policy, and that is particularly so with regard to D&O insurance.

Kevin LaCroix is president of Genesis Professional Liability Managers in Beachwood, Ohio. Genesis Insurance Company is a Berkshire Hathaway company. Mr. LaCroix is also currently serving as president of the Minneapolis-based Professional Liability Underwriting Society. Mr. LaCroix can be reached at klacroix@genesismanagers.com.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, November 26, 2003. Copyright 2003 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.