Customizing D&O insurance for corporate accounts

We encourage producers to initiate the relationship between their clients and representatives from our unit. Typically, we accompany producers to meetings with clients, where we begin to evaluate their exposures and determine appropriate avenues to pursue. After that, our unit becomes a client's primary point of contact, although we keep the producer informed of any developments.

Besides operating Chicago's largest independent insurance agency, Mesirow Financial is involved in real estate development, investment banking, investment services and investment management. We work with producers in these other divisions to provide management liability insurance to their clients.

While cross selling is one of our primary goals, we also pursue new business. Seminars are useful for this purpose, and sometimes existing clients sponsor them. For instance, we conducted one seminar for an association we work with. We held another for the clients of a large venture capital firm that is one of our insureds. At the seminars, we give attendees an overview of the market. We also explain how D&O insurance works, and point out coverage issues of particular concern.

I suppose you could say the venture capital firm and association functioned as centers of influence for us. We've also worked with clients of attorneys, accountants and other professionals. By turning to us, attorneys and other professionals can offer their clients expertise in an outside discipline, which enhances their status with their accounts.

Exposures and coverage

The primary exposure directors and officers of most privately held companies face is employment practices liability. Among the many allegations that managers and the entity itself could face are that they have established a culture that isn't favorable to minorities, or that has led to a hostile work environment. Fiduciary liability arising from the management of pensions, 401(k)s and similar plans also is a concern. Then there are the claims that arise against managers in their capacities as directors and officers of the business. As such, they can be sued by vendors, employees and regulators, among others. Although their companies may not be publicly owned, they also can be sued by shareholders. A difference of opinion concerning the wisdom of pursuing an acquisition or the competence with which it is carried out are only two of many issues that can prompt shareholders of a privately held business to sue the directors and officers.

We cannot stress enough that excellent communication practices can help minimize the chance for litigation. Shareholders should be kept fully informed about not only acquisitions but also possible conflicts of interest or any straying from customary business practices. Communication with employees is just as vital. Any misrepresentation about such matters as corporate objectives, employment guidelines, the company's financial condition or prospects for continued employment could come back to haunt directors and officers.

In addition to practicing prudent risk management, directors and officers should obtain appropriate coverage. We believe privately held businesses are often best served by a combined management liability product that provides EPLI, fiduciary liability and D&O. The individual coverages in such package products dovetail well, resulting in fewer gaps than could arise if three separate products were purchased. And rather than buy three policies, each with a separate limit, a privately held company often can save money and obtain better catastrophe coverage by buying a management liability policy with a single, higher limit applying to all exposures.

In regard to coverage particulars, we stress that a D&O policy written for a privately held business should provide entity coverage. Although most policies do include this provision, there are exceptions. We also recommend duty-to-defend coverage but can arrange indemnity coverage for those who want to provide their own counsel or otherwise take a role in the defense of a claim. When possible we also seek to avoid failure-to-maintain-insurance and major-shareholder exclusions.

In light of certain carriers bowing out of the marketplace-or even facing insolvency-we advise our clients that the strength and reputation of a carrier should be top priorities when choosing coverage. Of course, clients will always push for the best coverage value too. We place enough business with our partner markets to give us leverage in developing and delivering favorable programs and terms.

When evaluating publicly owned companies, shareholder litigation is definitely the exposure of greatest concern. In the wake of scandals at companies like Tyco and Enron, corporate governance issues have come front and center. Managers should strictly adhere to the rules and regulations established by the Sarbanes-Oxley Act of 2002 covering corporate disclosure of information bearing on a corporation's securities. The cultivation of outside, independent-minded directors also is highly advisable.

Because of the large shareholder exposure publicly owned companies face, we recommend that they purchase separate D&O and EPLI policies, rather than a single management liability policy. We also recommend the purchase of "entity" insurance to cover management liability suits brought against the business itself. Such coverage usually is automatically included in D&O insurance for privately held businesses, but there is a difference of opinion concerning whether it should be included in policies for publicly owned organizations. Some people believe D&O insurance should be reserved exclusively for a company's directors and officers, rather than be subject to diminution by claims against a corporate entity.

We feel that if an entity has an insurable risk, management should insure it, to safeguard the company's balance sheet. Of course, maintaining reasonable premium levels is also an important corporate objective. Removing or forgoing entity coverage may help meet this goal, but the client needs to be made aware of the ramifications. Establishing a pre-set allocation (determining in advance what amount the insurance carrier will pay on behalf of the entity for security claims) is a helpful compromise between the two extremes of no entity coverage or full entity coverage.

Meanwhile, individual directors and officers can be further protected by separate "Side A" coverage. (D&O policies historically have been written with two coverage parts. One part, "Side B," reimburses a company for indemnification its bylaws or charter require it to provide to directors and officers who have been sued in the course of carrying out their duties. The second part, "Side A," covers the directors' and officers' personal liability for losses that the company is not compelled to indemnify. As previously mentioned, a third coverage part, "Side C," for the entity itself, has become a subject of debate in recent years.)

Generally, separate Side A coverage is written as an excess layer to the D&O policy, thus providing additional coverage exclusively for the directors and officers. There also are some new products on the market, sometimes referred to as "broad form" or "difference in conditions" coverage (not to be confused with the property DIC policy) that function, as some put it, as "Side-A coverage on steroids." The coverage cannot be rescinded for negligence, fraud or perceived misstatements on the application. (Typically, violation of a warranty statement in a D&O application voids coverage). These products provide for severability of interests. Thus, if one director or officer does something to trigger an exclusion, it will not affect coverage for the other managers. Compared to Side A coverage, the broad form products also often have limited-or even no-exclusions dealing with such matters as pollution and ERISA violations.

As you can imagine, our publicly traded clients purchase widely varying D&O limits. We recommend that even the smallest companies buy at least $2 million limits. For the others, a loose "rule of thumb" is to purchase limits at least equal to about 10% of market capitalization (minus any part of the market cap that might be owned by insiders). However, this guideline is becoming obsolete as conditions in the economic and insurance market remain volatile (and as corporate governance claims continue to rise).

Submissions

Over the past few years, publicly traded companies have experienced a severe hard market for D&O liability insurance. Rate increases of 40% to 50%, or higher, have been common. Coverage also has been restricted. Now, however, the D&O market for publicly traded companies seems to be reaching a plateau. Rate hikes have dropped to 15% to 25%. Coverage, if not becoming broader, is at least being maintained at the present level.

The management liability market for privately held businesses, meanwhile, appears to be softening, with insurers competing aggressively for business. On renewals, carriers are offering rates close to (or within 15% of) those for the expiring coverage. EPLI is driving the pricing, producing attractive quotes for those with below-average exposures and better-than-average experience. Naturally, we emphasize such favorable factors in our submissions, if they are present.

We have an in-house indication worksheet that we use to gather information for submissions for privately held businesses. Among the information we require is a description of what the company does, its number of employees and a ballpark idea of its assets. With that information we can obtain a fairly accurate indication of what coverage will cost. To proceed further, we need to prepare a formal submission, which normally includes a completed application, a set of financials and an employee handbook.

More information is required for publicly owned companies, but we have to gather less of it ourselves than we do for privately owned businesses. That is because an abundance of data about publicly held organizations-including financials, annual reports and Securities and Exchange Commission filings-is available online. Underwriters know where to obtain this information and even can use online services like LexisNexis to conduct searches for articles and press releases pertaining to a company.

We feel that no one can tell a client's story as well as the client. So when preparing submissions for publicly owned companies, we often bring clients and underwriters together. Face-to-face meetings can help establish trust and rapport, and set the stage for a long-term relationship. Most of our partner markets have local underwriting offices, so arranging such meetings is not difficult.

Markets

When arranging coverage, we approach only those markets that are appropriate for our clients and interested in their business. By doing so, we better serve both our clients and the carriers we represent. For example, Travelers, Chubb and Hartford aggressively write privately held companies (particularly for businesses with fewer than 500 employees), while AIG or XL provide excellent terms on larger private or publicly traded entities. For hard-to-place risks, we may turn to E&S carriers, as well as Crum & Forster, an admitted market that will consider such accounts. We also use a number of other insurers, including Zurich, Fireman's Fund and Great American. When necessary we also talk to wholesalers, such as Heath Insurance Brokers or Arc Excess and Surplus Lines, to gain access to markets we don't represent or place only limited business with.

Mesirow Financial strives to foster a relationship of loyalty and longevity between our clients and carriers. When companies bounce from carrier to carrier, they end up getting bad reputations among underwriters. That said, our first responsibility is to maintain competitive, cost-effective programs for our clients, and it sometimes becomes necessary to move them to new carriers. When we do, continuity of coverage becomes an important issue.

The first question that arises when moving an account is whether the new D&O carrier will provide prior-acts coverage. If not, the best the client can do is get an extended reporting period ("tail" coverage) from the former insurer for whatever term the carrier will provide. Such coverage may be expensive. Fortunately, insurers often will provide prior-acts coverage for an account with a favorable claims history.

Another issue affecting continuity of coverage is the warranty statement. When a company first obtains D&O insurance, it must sign a statement warranting that none of the directors or officers knows of any incident that could give rise to a D&O claim. If the client does know of any such incident, coverage for it is excluded. On renew-als with the same insurer, no new warranty statement need be signed. But when coverage is moved, a new carrier could demand a new warranty statement. If so, there could be a gap for past incidents. So when moving a client, we ask the new insurer to waive the requirement for a new warranty statement. Many will, depending on the particulars of an account.

A final issue concerns coverage for pending and prior litigation, which a new insurer is often hesitant to provide. Of course, if coverage has been arranged properly in the past and claims have been reported in a timely manner, the prior carrier should take care of such claims. Still, P&P litigation can be a thorny issue. For instance, a malpractice claim against a professional working for a given company potentially could lead to a D&O claim against the board members. And if such a claim did not evolve until after the company moved its coverage to a new carrier, that insurer could deny it under a P&P exclusion. Consequently, we carefully explain the implications of P&P exclusions to clients who wish to change D&O carriers.

Arranging D&O and other forms of management liability insurance-either for publicly or privately held businesses-can be challenging, particularly in a hard market. But the rewards, in terms of greater revenue, increased client loyalty and professional satisfaction, are well worth the effort.

(Required disclosure: Insurance Services offered through Mesirow Insurance Services, Inc. Securities offered through Mesirow Financial, Inc. Member NYSE/SIPC.)

Craig E. Goesel is vice president of management liability at Mesirow Financial. He joined the firm last year after holding a similar position at Near North Insurance Brokerage. Mr. Goesel entered the insurance business about 10 years ago as an underwriter for Travelers Property Casualty, where he became branch manager for the Chicago region. He is a member of the Professional Liability Underwriting Society and is pursuing the Registered Professional Liability Underwriter and Associate in Fidelity and Surety Bonding designations.