Strengthening Protection for Directors and Officers

Directors and officers liability premiums have risen by 30 percent—and sometimes by as much as 300 percent—in the past two years, following revelations of misdoings at corporations like Enron, Tyco and WorldCom. This rate increase reflects serious consideration by insurance carriers of the potentially ruinous costs of writing this business.

Following the wave of recent scandals, the federal government is likely to bring both civil and criminal actions that attempt to show that corporate managers breached their fiduciary duties in cases involving financial restatements, insider trading and the like. As litigation ensues, directors and officers will naturally turn to high-priced law firms to defend themselves. The result will be an increase in the sums that insurers may be obliged to pay, whether or not their insureds are guilty, (even though insurers may have the right to recover expenses). And this will, in turn, result in higher premiums to reflect the greater exposure.

Even if malfeasance is covered by insurance, the companies themselves, their employees and the overall economy can suffer greatly when executives and directors misuse their positions.

So the strategy has shifted—more and more CEOs, senior management and inside and outside Board members are increasingly susceptible—and sometimes liable—to all sorts of people including their employees, the media, the shareholders, the insurance companies, the government and the rating agencies.

And then there is the Sarbanes-Oxley Act.

Due to the requirements set forth by this more punishable Act, companies and their decision makers are focusing on implementing more effective compliance systems. These systems are intended to prevent violations of law as well as other forms of corporate malfeasance that can lead to D&O claims. Their aim is to bolster the knowledge of ethics and codes of conduct by means of training.

A meaningful component of a compliance system includes both management and workforce education to ensure that employees know and understand what constitutes proper behavior. One of the best learning systems for employees is online education, where students learn at their own pace, ask questions without embarrassment and cannot pass a class without first being tested. If they fail a test, they may retake it at their convenience, a process that ensures that the person has learned the material.

Studies confirm that 93 percent of employees expressed preference for the “e-learning” teaching environment over the classroom scenario. Traveling is not required, and the Internet is available 24 hours a day. Also, employers gain a “paper trail” showing who has completed the courses and how they progressed.

Effective compliance education programs educate employees in a minimum of subjects around ethics and the law, including: code of business conduct; conflicts of interest; accounting; financial integrity; and other forms of illegal business practices. Corporations have found training on such subjects in an online environment can be cost-effective, as well as influential in changing behavior and company culture. Another step to reduce possible risks is to implement an effective “whistle blowing” hotline for employees to report concerns and possible corporate misconduct on an anonymous basis. The Sarbanes-Oxley Act mandates such systems be put in place by Oct. 31, 2004.

In light of the reduced risks for all parties that can result from corporate education and an anonymous reporting system, carriers are beginning to take the lead in collaborating with insureds to this end. For example, insurers are offering insureds designated vendors that can offer proven and effectual educational programs. Offerings may include a free ethics curriculum, negotiating discounted rates on other compliance e-learning packages, and even insurance rate credits or improved terms for insureds that successfully implement such systems.

Although corporate ethics education is in its infancy, it heralds a new and appealing era of closer collaboration between carriers, brokers and insureds on educating workforces, which, it is hoped, may equate to “loss control” for D&O liability. However, an effective program must be engaging and its contents should be tailored to a company’s particular situation. Without applying this approach, a company may actually raise rather than lower its risk exposure, since an ethics program that fails to effectively teach employees could be worse than no program at all.

Intentions do matter. After all, heightened knowledge of, and adherence to, ethical corporate behavior matters; not only to the company’s reputation and self-regard, but to its bottom line, as well. In light of the current corporate climate, it is safe to say that in dollar amounts, ethics matter.

Ivan J. Dolowich is senior vice president and chief claims officer for Gulf Insurance Group. Contributors to this article include: John J. McElroy, senior vice president and manager of Gulf’s D&O Underwriting Unit, Alexander F. Brigham, president, Corpedia Education, and Beatrice de Montarlot, marketing assistant, Gulf Insurance Group.

Topics Carriers Training Development