VideoJust three years ago, directors' and officers' (D&O) insurance rates were so high that Ron Foster, then CFO for troubled fiber-optics giant JDS Uniphase, threatened to set up a self-insured facility with other companies rather than pay the prices insurance companies were demanding.
That approach would have tied up millions of dollars in escrow and led to potential legal complications, but Foster was willing to risk those headaches because the rates for D&O liability coverage "were verging on outrageous." Indeed, premiums rose an average 33 percent between 2002 and 2003 across all industries. Foster ultimately got a more reasonable bill from his insurers, but only after tough negotiations.
These days the market looks completely different. Foster, now CFO of semiconductor test-equipment maker FormFactor, says rates were down "substantially" when he renewed last May, and he's not alone. "It's a very good market for buyers of D&O insurance," says Mike Rice, managing director for Aon Financial Services. Rates have dropped about 46 percent from their 2003 high and are expected to fall another 5 to 7 percent this year, according to Aon. At the same time, many companies are finding it easier to get better terms, so much so that "you can probably buy as broad a contract today as at any time in the past 20 years," says Rice.
But how long can these good times last? Prices have fallen in large part because officers and directors have faced less fire: the number of annual securities class-action filings has decreased by more than 40 percent since early 2004. An absence of major scandals has helped, and the fact that law firm Milberg Weiss, renowned for its indefatigable efforts in securities class-action litigation, has been hamstrung by its own legal problems may not have hurt either. But cases that have reached settlement have become more expensive, up from an average of $28 million in 2004 to $71 million in 2005, according to PricewaterhouseCoopers's Securities Litigation study. Add to that the growing prevalence of claims related to the backdating of stock options, and the next renewal season could spell the end of the buyer's market. As Rice notes, "The combination of more-frequent and more-costly suits is what typically leads to problems," and half that equation already seems to be in evidence.
No company seems in imminent danger of surpassing the Enron and WorldCom settlements ($7.2 billion and $6.2 billion, respectively), but plenty of companies have been hit with outsized claims, according to the Stanford Law School Securities Class Action Clearinghouse. Nortel and AOL Time Warner each faced settlements totaling about $2.5 billion, for example, while Royal Ahold was on the hook for $1 billion. And those large claims may set the stage for others because, as Daren McNally, an attorney with Connell Foley LLP who specializes in insurance-coverage litigation, notes, "highly publicized and extraordinarily large cases threaten to redefine what's considered an appropriate settlement."
Covering Your "A" Side
Supersize settlements are leading many
companies to load up on so-called Side A
coverage, which covers officers and directors
personally (as when, for example,
bankruptcy or state law prohibits companies
from reimbursing them via Side B
coverage, which applies to the company
itself) and which has become critical as
standard indemnification gets harder to
come by. About 9 percent of directors and
officers received partial or no indemnification
from their companies when charged
in securities-litigation cases, according to
Tillinghast, a division of Towers Perrin,
and another 60 percent said their companies
were undecided. "Side A coverage is
definitely on the rise as individuals become
more concerned about decreasing indemnification
and competing claims for policy
limits," says Carol Zacharias, senior vice
president at insurance company ACE Ltd.
Concerns about protecting the personal assets of directors and officers are only likely to grow as suits related to backdating stock options play out. So far, most claims (about 80 percent) have been in the form of derivative lawsuits, in which shareholders sue officers or directors on behalf of the company. Since the company is effectively bringing the suit (and reaping any gains), it is prohibited from indemnifying officers and possibly from reimbursing them for legal-defense costs. Side A is the only type of insurance that covers officers and directors in such cases.
As demand for Side A coverage grows — in 2005, companies increased excess coverage lines, which include Side A only, by 10 to 11 percent on average, compared with 2 to 3 percent increases in primary-coverage limits, according to Tillinghast — there is concern that insurers will shift some of the burden back on the insured. To date, directors and officers have had to put up their own money in "only a handful of cases," says McNally, the best-known being WorldCom and possibly Enron. "But there is a real risk going forward that directors and officers will have to contribute their personal assets, primarily because the settlements are getting so large."
Some insurance companies are coming out with new products to help quell the fear that there won't be enough coverage to go around. One option is a new "enhanced" line of Side A coverage that offers separate additional limits for directors only or for officers only should a policy's standard limit of liability be exhausted. "This is in response to the increasing frequency of partial settlements we've seen," where directors are sued separately from officers and claims are settled separately, says ACE Bermuda executive vice president Patrick Tannock. Directors, he says, often seem to be able to settle sooner, "leaving officers holding the bag" when the policy is shared.
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