International D&O insurance: Evolving risks and coverage structures

Multinational companies are becoming more aware of these exposures and the need for D&O programs that adhere to the local regulations of foreign jurisdictions. These companies are questioning whether the traditional approach to insuring D&O risks exposes an insured, its broker and its carriers to potentially unfavorable local regulatory consequences.
In many countries, local financial responsibility laws and qualification regulations may require a locally admitted policy, which increases the potential exposure for multinationals that choose not to purchase admitted insurance. In some cases, local regulations might affect fundamental aspects of D&O coverage, such as the insured's ability to obtain funds from abroad to pay local claims. This is very important from a risk management perspective and makes it easier to recruit and retain qualified directors and officers.
One area of concern is countries that prohibit insurance of local risks by carriers not licensed to operate locally. For example, France requires that insurance risks be written by an insurer with its registered office in the EU or by a French-registered branch of a non-EU insurer. Intermediaries who place business with nonadmitted carriers could be fined as much as EUR15,000, or receive prison sentences of up to six months. Similarly, Japan requires insurers to establish a branch office in Japan and obtain a license from the prime minister to engage in insurance business. Violators can be fined up to 3 million Japanese yen or sentenced to a maximum of two years' imprisonment.
Brazil, China and Pakistan all prohibit both nonadmitted carriers and the "linking" of local policies to foreign policies in which policies share a single agreed-upon liability limit. This limitation indicates that individual policies may not all respond to pay the total extent of their otherwise stated limits.
Even in countries that allow a non-admitted carrier to provide D&O coverage, insureds using them may encounter significant difficulties. These often arise from local country laws and regulations that can pose unique perils to directors and officers working in foreign countries. There also may be currency restrictions and prohibitions on claim-related payments coming into the country from a nonadmitted carrier. For instance, in Brazil a policy payment originating from outside the country is subject to a 27.5 percent tax, as it is treated as income or a capital infusion rather than a claim payment.
These are all very strong incentives for an insured to find a more cost-effective way to purchase coverage from a locally admitted insurer, especially in light of what appears to be increasing risk of liability for operations and insureds of multinational companies abroad.
Pro-plantiff legislation and escalating private settlements
A primary example of globalized D&O exposures is the $352.6 million settlement in April 2007 by Royal Dutch Shell plc (Shell) with European and other non-U.S. investors stemming from claims related to Shell's 2004 restatement of oil and gas reserves. Both the Securities and Exchange Commission and the Financial Services Authority found Shell guilty of market abuse and collectively fined the Anglo-Dutch conglomerate ?84 million. Private plaintiffs also filed a class-action lawsuit in New Jersey, which is still pending with an agreement in principle to settle recently reported. If that settlement is approved, Shell will have to pay more than $80 million to those plaintiffs.
The Shell settlement comes against the backdrop of expanding class-action litigation in Europe. In particular, the European Union is encouraging private damages actions for violations of European Commission antitrust rules. In that regard, the European Commission may propose that all EU member states adopt some type of class-action litigation mechanism. As a result, many expect class-action litigation and accompanying exposures to spread across Europe.
One country that has already adopted such pro-plaintiff legislation is Germany. In 2005, Germany introduced new securities legislation that reduces the ownership requirement for bringing a securities action from 10 percent to 1 percent. Germany also recently enacted a law permitting shareholders to band together in groups of 10 or more to bring a "model case" to decide common legal and factual questions. After ruling on common issues, lower courts decide damages on an individual basis.
Shareholders and the plaintiffs' bar in Germany have taken notice of the new legislation. In 2006, Germany allowed its first-ever class-action lawsuit when approximately 100 shareholders sued Daimler Chrysler for monetary compensation due to company misinformation. In February 2007, a court in D?sseldorf, Germany, admitted an antitrust class action brought by a special purpose company, Cartel Damage Claims AG, which had purchased the assigned rights of 29 cement customers to sue certain cement manufacturers seeking approximately EUR150 million in damages.
The United Kingdom also recently allowed its first class-action lawsuit under the UK Enterprise Act of 2002. In March 2007, a consumer activist organization filed a class action against JJB Sports, alleging the company illegally fixed prices of England and Manchester United replica football shirts sold to fans. The lawsuit followed a regulatory action by the UK Office of Fair Trading, which resulted in a ?6.7 million fine against JJB Sports in 2003.
Securities and antitrust class actions have also increased in Australia, which can sometimes result in substantial exposure. In 2003, an Australian court approved a $97 million settlement plus legal costs in favor of investors in GIO Australia Holdings. GIO and its directors had made statements to shareholders in the course of defending a hostile takeover regarding the company's profits and had advised the shareholders to reject the takeover bid. GIO shortly thereafter reported a significant loss, and many shareholders concluded that they had been misled.
Increased regulation of cross-border corporate rate governance
There also has been a proliferation and toughening of corporate governance rules and Sarbanes-Oxley-type regulations in foreign jurisdictions. In late 2004, the EU adopted its Transparency Directive to improve information flow to investors in Europe's capital markets. The directive sets out key reporting requirements for listed companies, including quarterly financial or management reports, improved content in half-yearly reports and tighter deadlines for the release of year-end reports.
With the directive's heightened issuer disclosure obligations and requirements that penalties be imposed at a Member State level in the event of infringement, the need for D&O policies to cover risks arising in multiple jurisdictions is clear.
Several other developments have emerged from the European Commission's "Modernizing Company Law and Enhancing Corporate Governance" plan. This is aimed at raising the duty of care owed by executive officers and board members to shareholders and creditors. The plan led not only to recommendations on directors' remuneration disclosure and the appointment of independent directors, but also to a directive on matters such as related party transactions, off-balance sheet arrangements and corporate governance compliance statements.
Similar corporate governance developments are taking place outside of the EU. Japan implemented the Financial Instruments and Exchange Law on April 1, 2008. This legislation has been called "J-SOX" by observers because of its similarity to Sarbanes-Oxley. The new law requires listed companies to assess their internal financial reporting controls and initiate independent audits of their evaluation procedures.
Traditional method of insuring foreign subsidiaries
Insurance carriers traditionally provided D&O and errors and omissions coverage to a company's foreign subsidiaries by issuing a worldwide territory policy. Some traditional D&O policies include the issuance of separate foreign D&O policies (often referred to as "underlyers") in certain countries or import provisions that contain broader foreign standard terms. However, under the traditional approach, the issuance of foreign underlyer policies is rare. Further, the importation of standard terms without the issuance of actual foreign policies may create uncertainty as to coverage.
While it is legal under U.S. law for insurers to issue policies in the U.S. that provide coverage for worldwide risks, these may not effectively address other countries' laws and regulations. For example, France, Germany and certain other countries do not allow companies to indemnify their directors and officers. As such, traditional "Side B" type D&O coverage–under which insurers will reimburse organizations for indemnity paid to the benefit of directors and officers–does not apply in those countries.
Furthermore, the traditional method of covering D&O risks may leave the insured less informed about its legal rights in certain jurisdictions. For instance, some countries require carriers to provide mandatory run-off or "tail" coverage in certain circumstances, and an insured covered by a foreign-issued policy with worldwide coverage may not be aware of that requirement.
Current alternative methods of insuring foreign subsidiaries
This changing D&O landscape warrants new types of coverage. Alternative products currently available include the following methods of insuring D&O exposures:
o Issuing separate, stand-alone policies in foreign jurisdictions; o Issuing separate policies in foreign jurisdictions that share limits with each other and a related worldwide territory policy, through a tie-in of limits provision;
o The EU Freedom of Services policy (applies only to EU member states); and
o Issuing separate policies in foreign jurisdictions with an agreed-upon worldwide limit maintained by an indemnity or reimbursement agreement between the insured and insurer.
While these approaches solve some problems encountered under the traditional method, they can still present problems if not properly structured to meet the insured's particular needs and concerns.
One issue may be of paramount importance: choosing a carrier with the necessary international experience and resources. Regardless of the coverage, an insured may still face problems if it selects an inadequate carrier–including reputable carriers with inadequate resources in the foreign jurisdiction where an exposure arises.
Insureds–and their agents and brokers–must look beyond a carrier's marketing material and ask questions to determine its true international reach across the spectrum of underwriting, pricing, issuance, claims handling and loss payment. In general, insureds should confirm that the insurer has staffing with local knowledge and expertise, resources and developed relationships with defense counsels in all foreign jurisdictions where the insured could encounter potential exposure. In other words, when it comes to choosing a carrier to implement worldwide coverage structure, the scope and quality of the insurer's global resources matters greatly.
The company should evaluate whether the insurer can issue admitted policies in the foreign jurisdictions where it has operations. Many insurers who advertise an international reach to a large number of countries actually have limited global presence, service and underwriting abilities. These insurers commonly resort to setting up coverage through fronting arrangements with local insurers. The fronting insurer may have little experience or institutional knowledge about the nature of the insured's business, which can translate into poor underwriting, inadequate coverage and questionable service. Moreover, the fronting insurer may not be creditworthy, and the insured may ultimately bear the credit risk of the local insurer becoming insolvent.
The insurer's ability to respond to claims in foreign jurisdictions is also critical. This includes maintaining local claims staff and resources in all foreign jurisdictions to assist insureds in resolving claims. The insurer should have pre-established relationships with defense counsel in each foreign jurisdiction where the insured company does business. Similarly, an insurer should be able to demonstrate a true global reach in its ability to arrange payments in foreign jurisdictions. Without such capabilities, an insurer may resort to payment mechanisms that expose the insured to regulatory concerns. Even a structurally sound D&O coverage program can be undermined by an insurance carrier that is not experienced in each of the jurisdictions where the insured does business.
Finally, adequate insurer personnel, including claims staff, can prove critical when navigating foreign law and regulation. If a crisis arises regarding the chosen coverage structure, insureds will be better off with an insurer doing other business in the jurisdiction because the insurer will have a broader base of knowledge regarding the regulatory regime and the people enforcing it. As a result, the insurer is more likely to be able to leverage its resources and relationships to resolve any problems on terms most beneficial to the insured.
Conclusion
In today's global market, properly structured D&O coverage through a truly global carrier is a necessity for all multinational companies with operations outside their country. Local laws and customs present varying issues and require D&O coverage to respond in different ways. While each company's operations are unique and require individualized consideration when structuring D&O coverage programs, companies should understand the various types of coverage structures available and the advantages and disadvantages of each. The insured should review the carrier, ask pointed questions regarding its global presence, and challenge broad statements and commitments regarding coverage and service. The coverage will only be as effective as the carrier's experience, resources and ability to pay claims in applicable foreign jurisdictions. After all, the worst time for directors and officers to find out that their coverage is with a carrier that cannot meet its commitment is when they are the target of a claim.