Risk Management

Wrestling for Dollars: It’s Managers vs. Owners

If company is included in D&O coverage, directors and officers could take a big hit.
David KatzAugust 30, 2001

A CFO whose company is hit with one of the growing number of shareholder class-action suits could well come down with a case of divided loyalties. On one hand, it’s a senior financial executive’s job to protect corporate assets. CFOs, for instance, need to make sure their companies’ lawyers mount sane legal defenses. They also need to make sure that risk managers institute sound loss control strategies. Moreover, they must be certain that management buys enough directors and officers (D&O )liability insurance to cover a whopping jury award.

But those same directors and officers may be sued personally when their company gets hit with a lawsuit. This presents a real dilemma. Should CFOs worry more about protecting management — or the company?

On the surface, the answer seems simple: Protect the company and you protect yourself. But conflicts may arise if d’s and o’s must divvy up insurance payments with the corporate entity if the corporation has been named in a suit.

Of course, that wouldn’t be a problem in a traditional D&O policy, which covers directors and officers — and not the corporation — for legal costs and liability in connection with suits by shareholders. Like an old 45 record, such policies consist of two sides.

The “A side” of the coverage pays d’s and o’s directly for claims involving third parties. The “B side” reimburses the corporation if the company itself pays the legal costs of the d’s and o’s, as it’s sometimes required to do under state law.

Problems crop up, however, when the policy also includes the corporate entity as a potential recipient of the coverage.

“D’s and O’s might get shortchanged if the corporation takes the bulk of the [coverage],” says Gary Lockwood, a lawyer with Lord, Bissell & Brook in Chicago who represents insurance companies. “It will eat up the availability of funds.”

If the policy includes coverage for employment practices liability, that could complicate matters even more. A big sexual- harassment or race-bias settlement could blow through the company’s coverage, leaving directors and officers bare of personal coverage.

That potential for coverage erosion should make CFOs skeptical when a “fresh-faced risk manager” touts added policy features, Lockwood thinks. “At the very least, the board should pass off on [a new D&O insurance policy],” he says.

If a company must have entity coverage, its risk manager can help avoid conflicts by buying a policy in which the claims-payment proportions are clearly spelled out, advises Lockwood.

With jury awards mounting sharply, however, even fairly allocated coverage may seem flimsy. D&O carriers and brokers interested in striking fear into insureds’ hearts most often cite the Cendant case. In March 2000, Cendant Corporation agreed to pay out $2.85 billion in cash to settle more than 70 lawsuits filed in connection with its accounting irregularities.

Take It to Court

With the economic downturn, shareholders are suing much more often. According to an ongoing PricewaterhouseCoopers study, 263 federal class-action lawsuits alleging securities fraud have been filed so far this year. That’s the largest single-year total since 1995, the year the Private Securities Litigation Reform Act (PSLRA) went into effect. And 2001 isn’t over yet.

Things may get even uglier, too. Jack Flug, a managing director with Marsh, the big insurance brokerage, thinks the number of federal securities-related class-action suits could break 400 by the end of the year. Further, he says, the PSLRA, intended to curb frivolous lawsuits (by, for instance, protecting a corporation’s “forward-looking statements”), has strengthened plaintiffs’ cases.

The act, says Flug, has made each suit that passes muster “more valuable” than it might have been before 1995 by forcing plaintiffs’ lawyers to “plead cases with a lot more specificity.”

The heightened legal threat has not been lost on insurers. Fearing big claims payouts, they’ve hiked D&O premiums, added coinsurance, and tightened coverage. While few industries are immune from such moves, carriers are particularly wary of health care and high-technology risks, says Steven White, first vice president of claims for Hartford Financial Products.

Underwriters regard health care as particularly risky, White says, because of the industry’s abundant mergers and the chance of new lawsuits if a patients’ bill of rights is enacted. In the high-tech sector, some companies are facing a 300 percent increase in premiums, says Marsh’s Jack Flug, adding that even in less risky industries, companies with infrequent claims are being asked for increases of 15 percent to 25 percent.

In such a market, Randolph Thurman, director of risk management for Gaylord Entertainment Company in Nashville, thinks he has himself a good deal. In September 2000, just as the market was starting to harden, he negotiated a three-year, pre-paid, non-cancelable contract with the Chubb Insurance Group and CNA, thus capping his company’s total D&O premiums until 2003.

Refusing to give further details on the coverage, he says Gaylord paid more than $1 million to get $30 million worth of D&O insurance above a $500,000 deductible. “I would think that for the same program I would be paying more than 20 percent in excess of what I paid last year, and would have less favorable coverage terms,” he says.

Thurman notes that CFOs tend to focus on D&O insurance only before a board meeting, or when they’re putting a budget together. But in these litigious times, they might want to revisit the issue more frequently.

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