Risk Management

D&O Insurance: The House Hangs on to Its Money

Carriers of directors and officers liability coverage slap buyers with coinsurance provisions.
Craig SchneiderJanuary 22, 2002

Just a glance at recent class-action settlements in securities fraud should be enough to convince any sane CFO that cutting back on corporate directors and officers liability coverage is a bad idea.

The payouts have been staggering. In late 1999, Cendant agreed to fork over a mind-bending $3.5 billion to settle a case brought by irate investors. More recently, Waste Management struck a deal with claimants for $220 million. The current recession — and the downturn in the equity market — won’t bring a decrease in securities-fraud lawsuits, that’s for sure.

For their part, underwriters of D&O policies are looking at recent settlements and coming to a slightly different conclusion: They should be charging a whole lot more for D&O policies. And they’ve begun to. Through the late summer, corporate clients were paying, on average, about 25 percent more for the same coverage limits. Following 9/11, however, D&O premiums simply skyrocketed — doubling or tripling for many buyers. While the attacks had little direct effect on actual D&O exposures, property/casualty carriers often tap the same reinsurance treaties for all their business lines. Hence, they’ve sought to recoup their losses via across-the-board increases.

“For the first time since the 1998, we’re seeing a majority of insureds and respondents say they have had an increase in premiums, while there’s been virtually no change in the limits being purchased,” says Mark Larsen, a risk management consultant at Tillinghast-Towers Perrin. “Typically, when you have an increase of premiums, you have an increase in limits. But that’s not happening.”

Co-Dependency

P. Jeffrey Hoke can speak to that point. The director of risk management at NCR Corp., Hoke emerged from his D&O negotiations in late December with a premium that’s twice as expensive as NCR’s prior rate — with the same coverage limits. What’s more, Hoke says he agreed to a deductible that’s more than two times the past retention — and considers himself lucky to get the deal. “Fortunately, we have good claims experience,” Hoke says, “or I think it would have been worse.”

Worse? Well, for one thing, Hoke could have agreed to a coinsurance provision — meaning NCR would wind up partnering with its insurer on every claim. Carriers, who are increasingly pushing such provisions, love coinsurance because it stiffens the resolve of insured defendants during the course of D&O claims negotiations. “It financially involves the insured throughout the duration of a claim or insurance limit,” explains Tony Galban, vice president and D&O project manager for Chubb Specialty. “In the case [of] a deductible, once you spend it, it’s the house’s money.”

Indeed, some insurers think offering deductibles in the absence of coinsurance breeds compliant defendants. “We are not looking for people looking for a financial instrument to just settle litigation quickly,” Galban notes. While he says it’s understandable for insureds to seek coinsurance-free coverage, he points out such policies may not be easy to find. Even when it is available, “it’s just going to be much more expensive than what they’ve been used to,” he notes.

NCR’s Hoke considered coinsurance during the company’s recent renewal process. He ended up declining the option. “There was not enough incentive created to go the coinsurance route,” he explains. “The math didn’t make sense. You ended up paying about the same and assuming more [risk].”

Tough Call

Other executives may have a tougher time saying no to coinsurance, higher deductibles, and higher premiums. That’s particularly true for management teams that are currently being sued by shareholders.

In addition, some larger companies can afford to do a fair amount of self-insuring. Bob McMullen, CFO at GlobespanVirata, believes taking on added D&O risk is just part of the cost of doing business at a fast-growing operation. “As the company grows over time, and the financial position gets stronger, the company may be willing to take a greater deductible,” he says. “To the extent they are larger by cash balance or shareholder position or larger in terms of revenues, those companies have the ability to absorb some of that cost.”

Globespan, a provider of digital-subscriber-line chips, recently changed its name to GlobespanVirata after a merger with — surprise — Virata. McMullen says the company “might take more risk in a higher deductible” in the D&O renewal the company commences later this year. Nevertheless, he expects GlobespanVerata’s premium to more than double.

Companies with greater budget constraints may not be able to shoulder increased financial risk, however. To keep policy costs down, risk managers at those corporations might simply have to buy less D&O coverage. Such parsimony, of course, puts directors — particularly those of public companies — at greater risk. “There’s a significant danger” in reducing limits, warns Randy Thurman, director of risk management for Gaylord Entertainment, a publicly traded company whose holdings include the Grand Ole Opry. “But there’s also a danger of spending more money for insurance than you have.”

The solution? Risk managers might consider blending D&O limits with other lines of coverage, including fidelity, fiduciary, employment practices liability insurance(EPLI), and kidnap and ransom. In that setup, corporate insurance buyers “might spend a total limit of $30 million dollars that applies to everything,” Thurman says. He concedes that a company could get hit with a big D&O suit and an EPLI suit in the same year — a big risk. “But that may be the better risk than cutting limits by 25 to 35 percent,” he says. “It’s a judgment call.”

Entity on the Table

Yet another judgment call: whether coverage for the entity — as opposed to that of individual directors and officers — should be included in the policy. “In recent years, it’s been a throw-in,” says Don Bailey, managing director of Aon risk management in Denver. “Now it’s negotiable.”

Those negotiations turn largely on treaty negotiations between reinsurers and primary insurers — not insurers and their clients. Some reinsurers are beginning to insist, for instance, that carriers take entity coverage out of D&O contracts or add a coinsurance provision for it.

Still, entity coverage is the least of a risk manager’s worries at the moment. “I would be surprised if entity was pulled out of the contract this year,” says Aon’s Bailey. But if losses continue to mount, he cautions, “it could be a possibility for next year.”

Something to look forward to.