Ripped from the Headlines: Law & Order in Today’s D&O

News from Worldcom, Enron and Spitzer invades PLUS Symposium.

Settlements that reach beyond insurance and into the pockets of firms’ former directors draw attention to the limits of insurance, according to professional liability experts.

Recent Worldcom and Enron events have liability insurance professionals musing about the adequacy of corporate directors and officers policies, how best to protect outside directors, and the future of the D&O market.

Early last month, a judge in Texas approved a $168 million shareholder lawsuit settlement with 18 former Enron directors who sat on the firm’s board before it succumbed to its own accounting tricks in 2001. The agreement with plaintiffs led by the University of California involves $155 million in insurance payments and $13 million from the personal assets of 10 of the former directors. The judge is to consider final approval in April.

Soon after the Enron announcement, a creative World-com deal was in the news for a few days before eventually falling apart. This overall $54 million proposal included a provision requiring the directors to pay $18 million of their own money. But U.S. District Judge Denise Cote nixed that part of the agreement as unfair to other defendants who might end up paying more in any jury award as a result of the deal with directors. When that happened, the plaintiffs, led by New York State Comptroller Alan Hevesi, withdrew from the $54 million settlement and proceeded to trial.

While these cases were making headlines, the Professional Liability Underwriting Society (PLUS) met in New York for its 2005 D&O Symposium. PLUS experts on two different panels on consecutive afternoons put the deals affecting directors’ personal wealth and other real world developments in timely perspective.

One panel, Key Issues Facing Brokers and Underwriters in an Evolving Market, featured moderator Michael Cavallaro, broker, ARC Excess and Surplus, L.L.C./Professional Risk Facilities Inc.; Jeffrey P. Klenk, senior VP, St. Paul Travelers Bond; Kevin M. LaCroix, president, Genesis Professional Liability Managers; Susanne Murray, executive VP and D&O practice leader, HRH Executive Risk Solutions; John A. Rafferty, VP, The Hartford Financial Products; and Jeffrey R. Lattman, Beecher Carlson Holdings, executive liability practice.

The second panel, Industry Foresight: The Surprises of 2004 and Their Effects on 2005, included James Bron-ner, VP, Chubb & Son; Greg Flood, COO, National Union Fire Insurance; Anthony G. Giacco, senior VP, XL Profes-sional Insurance; Bruce D. Hayes, executive VP, Zurich North America Specialties; Laurie B. Lopes, senior VP, AXIS Financial Insurance Solutions; and moderator, Donald Bailey, leader of Willis Risk Solutions North America and Global Executive Risks.

Comfort level with D&O
“Will directors and officers no longer feel comfortable about their coverage?” asked Cavallaro, referring to reports of directors reaching into their own pockets to settle.

“They probably weren’t comfortable before this and this won’t help,” noted Klenk.

Brokers and underwriters on both panels tended to agree that the Enron and World-com examples are atypical.

“Enron and Worldcom are extreme examples and I don’t expect this is a trend,” commented Rafferty.

Bronner offered that the punishment of personal payment by directors might represent a trend but only within the “most egregious situations” and not in typical D&O situations.

Among the factors making these cases unusual is that the plaintiffs are institutional players, not individuals. This factor is disturbing, noted Flood, suggesting that this development has altered the tone. “I don’t think the institutional investors are prepared to sit still any longer on this. The taking of personal assets is a huge step. I think they are saying it’s time to make an example,” Flood maintained.

Giacco agreed that it is significant that the plaintiffs are not the typical parties but are instead “institutional investors who are trying to change behaviors of directors.”

Cavallaro suggested that despite the high-profile cases, a “normal” D&O policy is still a good product in most situations.

If, however, the purpose of settlements becomes to punish bad behavior, buyers need to be told that their “insurance may not keep up,” Bronner advised.

PLUS Spitzer
Those corporate scandals were not the only ones causing a stir at PLUS. The various charges and investigations into brokerage compensation spearheaded by New York Attorney General Eliot Spitzer divided PLUS experts into two camps: those who believe it is a “watershed” event and those who aren’t so sure.

Flood views the Spitzer charges and the coming changes as significant. “It isn’t a matter of a few brokers’ mistakes,” he said. “Things are going to change. There are huge disclosures still to come.”

He also believes the light focused on insurance compensation, along with available technology, could pave the way for low cost insurance brokers along the lines of securities discounter Charles Schwab. He envisions an online system offering, for example, excess D&O coverage.

Hayes agreed that this is an historic time. “It is a watershed event and it’s just beginning,” he said. In his view, the effects could move beyond brokerage compensation to where insurance companies will reconsider their rating models so that they can offer D&O prices that clients can understand.

Bronner appeared less convinced that a revolution is underway. “Carrier behavior won’t change much,” he predicted. However, a more level playing field and improved transparency on broker compensation will evolve over time. Bronner acknowledged that brokers would have to find ways to recover fees lost due to the controversy over contingencies. They can do this by convincing buyers they deserve higher commissions or by creating new business models, he added.

Others agreed that brokers would eventually recapture any lost revenues.

Whatever changes occur, Flood suggested they should lead in one direction. “We can’t get fatter and dumber about this. Rather we must get leaner and smarter.”