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.

The real 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 liability market.

Early last month, a judge in Texas approved a $168 million shareholder lawsuit settlement with 18 former Enron Corp. 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 Worldcom deal was also 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 this 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 was meeting 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 vice president, St. Paul Travelers Bond; Kevin M. LaCroix, president, Genesis Professional Liability Managers; Susanne Murray, executive vice president and D&O practice leader, HRH Executive Risk Solutions; John A. Rafferty, vice president, 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 Bronner, vice president, Chubb & Son; Greg Flood; COO, National Union Fire Insurance; Anthony Giacco, senior vice president, XL Professional Insurance; Bruce D. Hayes, executive vice president, Zurich North America Specialties; Laurie B. Lopes, senior vice president, 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 of ARC Excess and Surplus, referring to reports of directors reaching into their own pockets to settle.

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

“It does beg the question of, ‘why am I buying D&O coverage?” said Murray of HRH.

Brokers and underwriters on both panels tended to agree that the Enron and Worldcom examples are atypical. “Enron and Worldcom are extreme examples and I don’t expect this is a trend,” added Hartford’s Rafferty.

“To their extreme this type of case raises questions about our product…but it’s not going to get that far,” said LaCroix, Genesis Professional Liability.

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 in them are institutional players, not individuals. This factor is disturbing and perhaps representative of a trend, noted Flood, who suggested 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 of them,” Flood added.

Giacco of XL 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.”

The message to insureds has to be that “they can’t have drive-through board meetings,” said Rafferty.

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,” added Bronner.

LUS 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.

Among those most outspoken in urging the industry to view the Spitzer charges and the changes coming as significant was Flood.

“It isn’t a matter of a few brokers’ mistakes,” Flood said. “Things are going to change. There are huge disclosures still to come.” He predicted that the disclosure agreed to by Marsh in its settlement with Spitzer will eventually permeate the entire industry.

Flood 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.

“New technology and bid processing will open up. Now that clients know all the compensation of a broker, it will change the dynamics. It’s like United Airlines versus Southwest Airlines,” he said. He envisions an online system offering, for example, excess D&O coverage. “Somebody’s going to make that move. Disclosure will put pressure on expenses,” he added.

Hayes tended to agree, at least that this is an historic time. 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.

XL’s Giacco said he thinks “there will be some fundamental changes in operations” as the industry tries to remove the “black stain” off the industry.

Chubb’s Bonner appeared less convinced that a revolution is underway. “Carrier behavior won’t change much,” he said. However, a more level playing field and improved transparency on broker compensation will evolve over time.

Bonner 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.

Others agreed that the brokers would eventually recapture any lost revenues. “I see commission rates going up. I think brokers’ true value will be appreciated,” said Lopes. She also warned against contingencies, whether based on profit or other criteria, because they “may not be in the client’s best interest.”

Panelists suggested that discussions of compensation alternatives, including having insurers quote net prices only or establishing standard broker commissions that fluctuate with losses, are underway in the industry.

Topics New York Agencies Flood Professional Liability