Strategies to Protect Directors and Officers and Manage D&O Insurance Costs

By Thomas, Keith | Risk Management, April 2003 | Go to article overview
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Strategies to Protect Directors and Officers and Manage D&O Insurance Costs

Thomas, Keith, Risk Management

D&O exposure continues upward: A recent study conducted by the Stamford Law School Securities Class Action Clearinghouse in cooperation with Cornerstone Research reports 327 federal securities class action lawsuits filed in 2001, 60 percent more than were initiated in 2000. The median dollar loss in securities claims jumped to $1.2 billion in 2001 from $500 million in 2000, the study found.

Keith Thomas,
senior vice president
Zurich North America
Solutions Group

In 1995, with securities claim costs escalating exponentially, Congress passed the Private Securities Litigation Reform Act (PSLRA). An objective of the Act was to rein in D&O exposure. D&O insurers began underwriting to the expected reduction in exposure, decreasing the cost and broadening terms and conditions over a period of years. In the latter part of that decade, however, it became evident that PSLRA had not achieved its intended mission. Securities class action litigation continued to rise in both frequency and severity, fueled in part by market capitalization growth. By early 2001, the D&O industry understood the reality of the risk--and knew that its D&O contracts had been drastically underpriced for years. Correction began.

Risk managers saw average rate increases of approximately 25 percent in 2001 and 150-200 percent in 2002; similar rate increases are expected through the end of the year but they are likely to temper. At the same time, underwriters have been tightening terms and conditions significantly. Responsible underwriters are now meticulously writing to the reality of today's D&O exposure,

This market hardening comes at a difficult time for board members. The Sarbanes-Oxley Act has left corporate directors and officers shouldering new responsibilities and potential personal liability. In addition, board actions are now under unprecedented scrutiny from shareholders. For risk managers, this creates a formidable challenge: How can you manage D&O insurance costs, while giving anxious board members the broad D&O liability coverage they need to continue serving in the face of significant personal risk? Underwriters will reserve the most favorable terms and conditions for companies that demonstrate a commitment to partnering with their brokers and underwriters during the underwriting process--and on the risk itself.

Share risk

In order to most efficiently secure optimal limits in a severely contracted market, a company can restructure its insurance program to share a greater portion of the risk. This increased risk sharing could realign the customers' vested interest with carriers and possibly reduce claims severity trends over time.

Many companies are increasing retentions. At Zurich North America, one large-cap company recently increased its retention from a few million dollars to $50 million. By assuming more risk at the lowest layer, the company was able to manage insurance costs up front and obtain the higher level of protection needed to fund today's exorbitant losses.

Adopting a predetermined allocation and forgoing entity coverage is another way organizations are sharing risk and making insurance costs more predictable. Such an allocation preestablishes the division of losses between the corporation and the insurer in a securities claim. It allows a company to streamline its insurance program, reducing frictional costs. When a company requires entity coverage, coinsurance and higher retentions can be used to share risk and achieve similar benefits.

Purchasing Side A D&O coverage alone can give directors and officers needed protection in an economical fashion. Side A coverage assures protection for the personal assets of board members if the company is bankrupt or otherwise unable to indemnify them.

Utilize forensic accountants

Zurich is developing another powerful addition to the risk manager's insurance-cost-management arsenal, forensic accounting.

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