An overview and history of D&O liability and insurance.

Background

Commenting on the hazards of serving in the capacity of a corporate director, Robert M. Estes, General Counsel of General Electric, offered this advice in his article Outside Directors: More Vulnerable Than Ever (Harvard Business Review, Jan.–Feb. 1973, p.114): "If Congress and the courts propose to hold directors hostage for corporate performance in a widening range of economic and social contexts…then the corporation should be alert to provide its directors with every reasonable protection against legislative, regulatory, and legal hazards. I have mentioned some primary steps: providing directors with improved access to the managerial information network, involving them more directly and intimately in the strategic planning and decision-making process, and accepting the need for a higher order of record keeping. Companies should supplement these with the best available insurance coverage and couple this coverage with optimum indemnity provisions in the company's by-laws." A principal reason for the purchase of any insurance policy is to reduce uncertainty. However, in the field of D&O insurance, the varied, tortuous, and sometimes confusing language of the available policies can create considerable uncertainty about the scope of coverage. In early 1990 a federal court, citing an earlier case, made this comment about the complex structure of D&O insurance policies: "This case presents another illustration of the dangers of the present complex structuring of insurance policies. Unfortunately, the insurance industry has become addicted to the practice of building into policies one condition or exception upon another in the shape of a linguistic Tower of Babel . . . We reiterate our plea for clarity and simplicity in policies that fulfill so important a public service. (Comments of J. Wilson in Keating v. National Union Fire Insurance Co., 754 F.Supp. 1431 [C.D. Cal. 1990.])" Although it is easy to blame insurers for confusing insureds with hard-to-understand policy language, the laws imposing liability on officers and directors and the courts' interpretations of these laws are continually changing, sometimes in whimsical, sudden, or surprising ways. Thus, our legal system should share the blame for confusing the people who are trying to reduce uncertainty through the purchase of a contract of insurance. To understand the full extent of the D&O coverage applicable to an insured, it is necessary to analyze and evaluate the application, the declarations page, the basic policy form, and the endorsements that the underwriter has attached. These elements of coverage then should be compared to the risks of the insured. To do this effectively, a basic knowledge of D&O liability exposures and insurance is needed.

Director and Officer Liability

Director and officer liability is created when directors or officers breach their fiduciary duties to the corporation and its shareholders or violate federal and/or state laws regulating corporate governance and related affairs. The consequences can be severe, encompassing a wide range of legal actions and penalties. Most common are when shareholders, regulatory bodies, and other stakeholders initiate lawsuits to hold corporate officials accountable. Civil litigation is common, and plaintiffs often seek monetary damages for losses attributed to the directors' or officers' misconduct. In addition, courts can impose substantial financial penalties to compensate for the harm caused by breaches of duty.

Regulatory bodies such as the Securities and Exchange Commission (SEC) in the United States or similar entities in other jurisdictions also have the authority to take enforcement actions. These agencies may levy fines, order disgorgement of ill-gotten gains, and impose bans preventing individuals from serving as directors or officers in public companies. In extreme cases involving fraud or gross negligence, criminal charges may be pursued, leading to potential imprisonment.

Directors and officers might also face reputational damage that can have long-lasting effects on their careers. The breach of trust erodes confidence among investors and peers alike, making it difficult for these individuals to secure future leadership roles. Consequently, maintaining rigorous compliance with fiduciary duties is essential not only for legal protection but also for preserving professional integrity and career viability.

The principle early antitrust and securities laws creating potential liability for directors and officers are described below.

The Antitrust Laws

The U.S. Congress passed the first antitrust law, the Sherman Act, in 1890 as a "comprehensive charter of economic liberty aimed at preserving free and unfettered competition as the rule of trade." In 1914, Congress passed two additional antitrust laws: the Federal Trade Commission Act, which created the FTC, and the Clayton Act which prohibited unfair methods of competition. With some revisions, these are the three cores of federal antitrust laws still in effect today and they became the basis for ensuing lawsuits against corporate directors and officers. The antitrust laws proscribe unlawful mergers and business practices in general terms, leaving courts to decide which ones are illegal based on the facts of each case. Courts have applied antitrust laws to changing markets, from the horse and buggy era to the present digital age. Yet for over 100 years, the antitrust laws have had the same basic objective: to protect the process of competition for the benefit of consumers, making sure there are strong incentives for businesses to operate efficiently and to keep prices down. Both the FTC and the U.S. Department of Justice (DOJ) Antitrust Division enforce the federal antitrust laws.

The Securities Laws

While the prosperous 1920s ushered in a feeling of euphoria among the middle-class and wealthy, people began to speculate on wilder and often fraudulent investments. This was exacerbated when following a brief postwar recession in 1920–1921, The Federal Reserve began setting interest rates artificially low, while easing reserve requirements on the nation's largest banks. The result was an increase of some 60% in the nation's money supply, which convinced even more Americans of the safety of investing in sometimes questionable schemes. Many people felt that prosperity was boundless and that extreme risks were likely tickets to wealth. Named for Charles Ponzi, the original "Ponzi schemes" emerged early in the 1920s encouraging novice investors to divert funds to unfounded ventures, which simply used new investors' funds to pay off older investors as the schemes grew. While there are many complex reasons for the ensuing Great Depression, an outgrowth of these events was the passage of new laws designed to prevent a repeat of the types of investor fraud that plunged the nation into one of the longest periods of economic dislocation.

Securities Act of 1933

Often referred to as the "truth in securities" law, the Securities Act of 1933 has two basic objectives (1) require that investors receive financial and other significant information concerning securities being offered for public sale; and (2) to prohibit deceit, misrepresentations, and other fraud in the sale of securities.

Securities Exchange Act of 1934

Congress created the Securities and Exchange Commission (SEC) which empowers the SEC with broad authority over all aspects of the securities industry. This includes the power to register, regulate, and oversee brokerage firms, transfer agents, and clearing agencies as well as the nation's securities self-regulatory organizations (SROs). The various securities exchanges, such as the New York Stock Exchange, the NASDAQ Stock Market, and the Chicago Board of Options are SROs. The Financial Industry Regulatory Authority (FINRA) is also an SRO. The Act also identifies and prohibits certain types of conduct in the markets and provides the Commission with disciplinary powers over regulated entities and persons associated with them. In addition, the Act also empowers the SEC to require periodic reporting of information by companies with publicly traded securities.

Trust Indenture Act of 1939

The Trust Indenture Act of 1939 (TIA) supplements the Securities Act of 1933 with regard to the distribution of debt securities in the United States. Generally, the TIA requires the appointment of a suitably independent and qualified trustee to act for the benefit of the holders of the securities and specifies various substantive provisions for the trust indenture that must be entered into by the issuer and the trustee.

Investment Company Act of 1940

The Investment Company Act of 1940 regulates the organization of companies, including mutual funds, which engage primarily in investing, reinvesting, and trading in securities, and whose securities are offered to the investing public. The regulation is designed to minimize conflicts of interest that may arise in complex transactions. The Act requires these companies to disclose their financial condition and investment policies to investors when stock is initially sold and, subsequently, on a regular basis. The focus of this Act is on disclosure to the investing public of information about the fund and its investment objectives, as well as on investment company structure and operations. It is important to remember that the Act does not permit the SEC to directly supervise the investment decisions or activities of these companies or judge the merits of their investments.

Investment Advisory Act of 1940

This law regulates investment advisers. With certain exceptions, the Act requires that firms or sole practitioners compensated for advising others about securities investments must register with the SEC and conform to regulations designed to protect investors. Since the Act was amended in 1996 and 2010, generally only advisers who have at least $100 million of assets under management or advise a registered investment company must register with the Commission. Other investment advisers typically register with the state in which the investment adviser maintains its principal place of business.

D&O Insurance Emerges

While a crude form of errors and omissions insurance for corporate directors and officers may have been available through underwriters at Lloyd's as early as the 1930s, serious interest in insuring directors and officers against personal liability did not occur until 1939. In New York Dock Co. v. McCollum, 16 NYS 2d 844 (1939), the court held that the corporation could not reimburse its directors when they had in fact successfully defended against a shareholder derivative action. This decision caused quite a stir. The idea that the corporation's directors would be out-of- pocket when they clearly prevailed in court sent shock waves through many board rooms. The outcome of McCollum was generally credited with the enactment in 1941 of the first corporate indemnification statute. While this was surely good news for directors and officers, it undoubtedly was also welcomed by underwriters in London, who had developed a D&O insurance product for which no real market had previously existed.

Despite the favorable decision in the McCollum case, corporate interest in D&O insurance was slow to develop. By 1960 only a small number of D&O liability policies had been written, all of which had been developed by a handful of brokers and wholesalers through placement into the London Market. Few insurance and business professionals understood D&O insurance or even knew that such coverage existed. In 1962 and 1963, two domestic insurers, the St. Paul and AIG, entered the D&O market for the first time. Several other domestic insurers also entered, and then left the market during the next few years. Most of the business, either through direct placements or as reinsurance, continued to be in London.

Although a lot of quoting was going on, there were still relatively few policies sold as corporate buyers grappled with the question of whether there was a real need for the coverage. Between 1967 and 1968, notable events unfolded that would solidify the demand side of the market.

Demand Soars

A major boost to demand for D&O insurance came in 1967 when Delaware passed new indemnification laws specifically authorizing the corporation to buy D&O liability insurance. By 1973, twenty-five other states had followed Delaware's lead, enacting similar statutes. Prior to this time, it was not clear whether the corporation could legally pay the cost of the individual liability coverage part. It was common prior to 1967 for the premium to be allocated between the corporation for the reimbursement coverage, and the directors and officers for the individual liability coverage part. In 1968 two landmark cases brought to the forefront the potential personal liability faced by directors and officers. In Escott v. Bar Chris Const. Corp., 283 Supp. 683 (SD NY 1968), all but one inside director were held personally liable under Section 11 of the Securities Exchange Act of 1933 for issuing a prospectus and other SEC registration documents having omissions and misrepresentations. There was no evidence of fraud, but these directors were found to have had reason to believe the documents were incorrect. An outside director also was found liable when he did not detect the misrepresentations (he did not read the documents). Because the corporation was insolvent, the directors were forced to pay defense expenses and liability out of their own pockets without the benefit of corporate indemnification.

D&O liability became the topic of increasingly more articles in business, legal, and insurance publications. When it became well known that a sizable number of Fortune 500 firms had been buying D&O insurance for some time, many directors and officers were quick to give notice that they would not serve without the benefit of D&O insurance.

By 1968 two elements for a burgeoning D&O market were in place: potential buyers with a desire for coverage and multiple insurers competing for a piece of the pie. The primary London Market facility was underwritten by the Sturge Syndicate, using an open market form called the ALS, or Sturge Syndicate Form. Another London facility, the Minnis Syndicate, was used by Stewart Smith (formerly Stewart, Smith, Haidinger, Inc.), for the underwriting of its SS Form. This policy was sometimes referred to as the Pacific Indemnity Form or the Leslie Dew Form (named after the lead underwriter). The other two major domestic insurers continued to be the American Home, which was considered quite aggressive, and the St. Paul, which was declining as a competitor. Other domestic insurers offering D&O liability coverage around this time included Liberty Mutual, Employers Mutual of Wausau, Lumberman's Mutual, and The Travelers. These markets, however, were little more than fronting arrangements with most of the risk passed to London underwriters. By 1975 the market for D&O insurance had significantly expanded to include the following principal underwriters and insurance companies:

American Home Assurance Lloyds of London CNA Home Insurance Company of New York Sequoia MGIC—Banks only St. Paul Fire and Marine Unigard Ins. Company GATX Insurance Company—newly formed subsidiary of General American Transportation Bellefonte Insurance Company—subsidiary of Armco Steel International Surplus Lines Harbor Insurance Company Seaboard Surety Today, the specific number of insurance companies, underwriting facilities, and alternative risk-financing mechanisms offering D&O protection is likely not known with precision.

Policy Forms

Most of the original D&O policy forms had as their basis the old London wording. Policies following this format consisted of two separate policy documents, one covering the individual liability coverage part and the other the corporate reimbursement coverage part. The overall coverage grant was difficult to understand because it was in two separate policy documents with references back and forth between the two forms. These required readers to flip back and forth between forms when evaluating coverage.

In 1976 Lloyd's introduced what it called Lydando No. 1, which was supposed to clarify some of the difficult language of the earlier policies. This form combined the separate policy format into a single contract having two insuring agreements, much in the same way some domestic insurers had been doing with their forms for some time. While this streamlined the format, the policy still had opaque language and was not very well received. By the early 1980s there were numerous new policy forms introduced that are the basis of many modern forms in existence today. By the 1990s underwriters at Lloyd's had for some time relinquished their position as market leader, with AIG, the Chubb Group, and others continuing to dominate the market.

Variations in Coverage

The expansion of the D&O market since its early beginnings has done little, however, to consolidate or standardize policy forms. Although many policies appear to be similarly based on one another, they each have their own mix of unique characteristics and provide varying levels of protection. This underscores the need of agents, brokers, and insureds to firmly establish an understanding of D&O liability and insurance before attempting an evaluation of coverage. In addition, many D&O policies are now designed to provide additional optional coverage parts such as employment practices liability, fiduciary liability, and other related coverage such as extended Side-A coverage through endorsement or attachment of separate insuring agreements, or separate policy forms. Such package policies, endorsements, and separate policy forms require an even higher level of examination and can complicate already tedious comparison of policy forms to one another.

The D&O Insurance Market – Historic

As in the infancy of the D&O marketplace, a relatively small handful of insurers still underwrite the lion's share of all D&O business. Today it is estimated that as few as ten insurers underwrite up to 70 percent or more of the entire D&O market premium worldwide. The demand for D&O insurance has been sufficient, however, to support numerous competitors. These include both small- and large-size insurers—some writing a broad range of industry risks while others concentrate on specific focused segments or niches of the market such as not-for-profit, private company, and financial services. In addition, numerous captive insurance companies and risk retention groups have made advancements in offering alternatives to the more traditional forms of D&O insurance.

The D&O insurance market has experienced much competition for more than a decade, and because loss experience was generally favorable in the D&O market during this period, underwriters aggressively pursued new business by offering an ever-expanding array of new coverage enhancements. Many brokers and insureds alike reported that coverage enhancements in addition to favorable pricing were there for the asking. This phenomenon allowed many insureds to improve the quality of their coverage and to increase limits instead of concentrating solely on price and availability. Even after nearly three years of a highly competitive and buyer-friendly market, this condition is likely to continue. Coverage terms and conditions are still flexible and negotiable and minimum premiums for excess and Side-A coverage remain soft, at least for the most desirable risks.

Between about 2010 and 2012, there was a slow but significant hardening of the primary D&O market for domestic risks, however this phenomenon was offset by widespread competition for excess layers of coverage. In 2014 and 2015, primary layer coverage renewals were experiencing premium increases in the 2-5% range but with overall program cost decreasing by 5 % or more. Average rates fluctuated between +5 %to -5 %. Although many insurance professionals had been expecting the market to reach a state of equilibrium (at least temporarily), a rather soft market continued despite numerous insurer consolidations, including the nearly $30 billion acquisition of Chubb by ACE in 2016. Although such consolidations should have had a stabilizing effect on premium decreases, the addition of new significant markets such as Allianz and Berkshire Hathaway increased supply and kept overall premiums down until the end of 2018.

Many insurance brokers we surveyed at the time reported that favorable market conditions continued in part due to a history of easing of securities class action lawsuits and a high rate of dismissals. In 2015 and 2016 however, we saw increasing settlement values, higher levels of SEC enforcement, and an increasing number of cyber-related claims. During 2016 the SEC filed over 800 enforcement actions. In 2017 the D&O market continued to be competitive even though class action lawsuits were filed at historically high levels. This phenomenon is partially attributable to a significant uptick in the number of federal court merger objection lawsuits (93), well above the 2016 number of 80. The frequency of D&O claims in several key areas, and the potential for significant D&O exposure in other areas, increased with few signs of relief on the horizon. In addition, some recent case law, claims developments, a changing regulatory climate, evolving business challenges and new dynamics within the plaintiffs' bar have created a potentially troubling future for directors, officers, and their insurers.

Around Q2 2019 the D&O insurance market began to enter a hardening period for some segments of public and private companies as well as healthcare. Such hardening, at least in the short-term, was limited to specific areas such as California high-risk exposures, for-profit education, crypto currency, cannabis-related companies and companies with merger and acquisition exposures. In the short-term overall renewal rates remained flat for the most desirable classes with modest increases of up to 10% or higher for other sectors. The latter part of 2019 and continuing throughout Q1-Q2 of 2021 marked a continuing and widespread hardening of D&O rate escalation across the board as evidenced by the following: The Council of insurance Agents and Brokers' Commercial/Casualty Market Survey found that in Q2 of 2020, the average D&O rate increased 17% over the prior quarter with 93% of respondents reporting an increase.

Aon reported Q2 2020 D&O rate increases up over 70%, and in Q3 2020 Marsh & McLennan Companies reported an astonishing 50% increase with over 90% of clients experiencing some form of rate increase.

2021, many insurers aggressively forced companies to accept higher retentions by either not offering expiring terms and conditions or through premium incentives to accept higher retention amounts. Many insurers scaled back on primary limits capacity and breadth of coverage offered. These changes were particularly acute for high-risk and hard-to-place risks.

The D&O Insurance Market-Current Market Snapshot

According to a recent Fitch Underwriting Performance in U.S. Directors and Officers Liability Insurance Sectors improved significantly in 2023, the third straight year of positive results. The loss and defense cost containment (DCC) ratio for the property and casualty (P/C) industry segment saw an impressive 8 percentage point reduction in 2023, reaching 60%. Such result signifies a strong underwriting profit, marking the sector's best performance since 2014. However, sustaining these favorable results may prove challenging in 2024 due to decreasing premium revenues, falling premium rates, and inherent D&O insurance underwriting volatility stemming from ongoing changes in litigation activity, defense costs, and settlement trends. Following a period of poor market performance from 2017 to 2020, the D&O insurance industry experienced significant growth in direct written premiums (DWP), increasing by 134% between 2018 and 2021. Yet, a shift in pricing dynamics because of improved operating performance has led to a notable 23% decline in DWP from 2021 to 2023 of over $11 billion. In addition, a recent Aon 2024 Q-1 D&O Quarterly Pricing Index survey reported the following findings:

  •  The average price per million of D&O coverage decreased nearly 30 percent compared to Q-1 2023,
  •  The price per million of D&O coverage for Aon clients renewing in both 2023 and 2024 decreased by 15 percent,
  •  There was a 5.5% premium decrease for primary policies renewing at the same limit and deductible,
  •  76 percent of primary policies renewing with the same limit and deductible experienced a premium decrease with only 4% experiencing a premium increase.

Based on projected short-term positive financial performance and increased competition we anticipate that premium volume will continue to decrease in 2024 and for the domestic D&O market to remain soft for the remainder of 2024. However, many insurers and insurance brokers we talk to believe the current soft market conditions may be short lived and unsustainable. Because of an oversupply in D&O market capacity, expect more insurers to be competitive on scope of coverage, coverage enhancements, pricing and retentions. Don't be afraid to ask for concession in these areas. Overall domestic premium rates to remain stable, expect 0 to -5 percent change in price.