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Protecting the board.

Here are 10 of the most frequently asked questions about D&O insurance -- what directors want to know, and should know, about their risk coverage.

Keeping your business life separate from your personal life is nearly impossible if you are a director of a corporation. Because of the fiduciary nature of your responsibilities, many decisions that you make as a corporate director fully expose your personal assets to the threat of litigation.

When directors are named in lawsuits they are held personally liable for the damages claimed. Obtaining directors and officers (D&O) insurance is an important step in protecting personal assets in the event of litigation. At Willis Corroon Financial Services Corp., we meet regularly with corporate directors to discuss D&O liability issues. Because of the complexity and personalized nature of this product, it is not surprising that directors raise a host of questions and concerns.

To help foster a clearer understanding of how D&O coverage works, we've put together a list of answers to the 10 most common questions that directors ask us.

1. How vulnerable am I as a director to the possibility of being named in a lawsuit?

According to the National Association of Corporate Directors, the number of lawsuits brought against directors has been rising steadily at an annual rate of 10%. This trend reflects increasing concern with management accountability on the part of shareholders, employees, and others with a stake in the affairs of a corporation. It also suggests that the court system has become the forum of choice for these parties in settling matters of corporate governance. Other key factors fueling the growth of D&O litigation include:

* Emergence of D&O litigation as a lucrative growth industry for plaintiff's lawyers who proactively pursue and initiate claims. Law firms representing shareholders, for example, which account for nearly one-half of the lawsuits brought against directors, typically receive up to one-third of the settlement in a class-action suit -- providing them with a strong financial incentive to become D&O specialists.

* Linking of corporate enterprise with a wide range of complex social issues, including the environment and sexual and racial discrimination. This has created a brooder spectrum of highly charged boardroom issues. Today's directors are more involved in making decisions on issues of concern to a larger audience of corporate constituents -- increasing the number of possible claimants.

* Severity of financial consequences for investors, employees, and other corporate constituents due to adverse economic conditions and market volatility in recent years.

2. What is the current regulatory environment for management liability?

Staying abreast of developments in government legislation regulating corporate management can pose a difficult challenge, as federal and state statutes are continually interpreted, amended, and applied to new and different forms of conduct, transactions, and conditions. And in some areas, federal agencies are intensifying efforts to enforce regulations.

It is not uncommon for directors to be caught unaware of the fact that some aspect of a corporate policy or practice is in direct or indirect violation of federal, state, and/or local laws. For example, many companies utilize employee handbooks, job application forms, and personnel manuals that may no longer be in compliance with current legislation. But in claims of alleged mismanagement, it doesn't matter whether or not the use of outdated employment materials was an oversight; the courts would probably find these companies in violation of employment laws. In fact, much of today's employment-related litigation arises out of deficiencies in, or absence of, proper employment practices documentation.

What About Indemnification?

3. Doesn't corporate indemnification provide me with enough protection?

Corporate indemnification, as provided by state statutes and corporate bylaws, does not provide directors with blanket protection. Corporate bylaws can also be changed by a company or successor company at the discretion of the board. In addition, directors should be aware that a company may be able to repudiate indemnification when requested at the time of a lawsuit.

Similarly, articles of incorporation, are restricted in the extent that they can limit or eliminate personal liability. And individual employment contracts between an employing organization and its directors are generally no brooder in the scope of protection they provide than corporate bylaws.

Moreover, state statutes, corporate bylaws, articles of incorporation, and individual contractual arrangements are ineffective in areas where they would be pre-empted by federal legislation. For example, directors charged with securities violations may not be able to receive protection under state or corporate provisions, as securities transactions are subject to federal law. As it is anticipated that the courts will continue to expand the scope of federal legislation to include more areas of corporate management and personal liability, the need for adequate D&O insurance becomes even more compelling.

Costs More Than It's Worth?

4. If D&O insurance is a critical part of providing me with protection to the fullest extent possible, why doesn't my company automatically purchase a policy for me and other directors?

Recent industry findings indicate that a primary reason why companies elect not to purchase D&O coverage is that they believe it costs more than it's worth. Unlike most corporate insurance programs, a D&O policy doesn't directly protect corporate assets. It protects the personal assets of a company's directors and officers. From a corporate perspective, the reasons for obtaining D&O coverage are not as evident as those associated with protecting a company's real property.

However, if a company requires its directors to routinely make decisions that expose their total net worth, it should take every reasonable step, including the purchase of D&O insurance, to minimize that exposure.

5. In a D&O policy, who is the insured? Elected or appointed directors and officers are covered by a D&O policy. Generally, coverage is extended to include directors and officers of subsidiaries in addition to those of the parent corporation. Corporate entities themselves are not covered by this type of policy.

Insured directors and officers, however, are not covered in every capacity in which they might act. Coverage is not provided when a director is sued while acting as a director of a business entity that does not qualify as a subsidiary of the employing organization or is not organized as a corporation.

In addition, coverage would most likely be denied if directors who are also major shareholders of their corporation are sued in their capacity as a shareholder.

6. What is the importance of allocation of loss in a D&O claim?

In the majority of lawsuits brought against directors, the employing organization is also named as a defendant. In such cases, allocation of loss between the organization and its directors must be determined once a claim is filed in order to calculate the amount in terms of defense costs and settlement or court awards that is provided for under the D&O policy.

In other words, the D&O insurer is not financially responsible for any portion of a settlement or court award corresponding to an allegation that is excluded by the D&O policy, or for any legal costs incurred in the defense of the corporation and other parties not insured through the policy.

Because there are no standard formulas to determine allocation, apportionment of loss is a highly controversial issue in D&O insurance today. As the industry looks to address this area in some fashion, we anticipate the emergence of D&O policies that feature some form of pre-agreed terms of allocation and/or entity coverage.

7. How is a D&O claim adjudicated?

A D&O policy is not a defense policy. Unlike an automobile or homeowner's policy, it pays for legal defense but doesn't provide it. Rather, it is up to the insured to select defense counsel who, once approved by the insurance carrier, keeps the insurer's attorneys apprised of claim issues. In this way, the insurer is able to monitor the litigation process.

Depending on the terms of the D&O policy, the insurer either pays for defense costs as they are incurred (advancement of defense costs) or reimburses these expenses once litigation has been completed. Reimbursement generally occurs after the corporation indemnifies its directors against such payments. Moreover, the insurer must approve any final settlement in advance whether or not it participated in the settlement negotiations.

International Exposure

8. Does my company's international operations create any exposure for me as a director?

Even though U.S. directors operate in a much more litigious environment than their European counterparts, personal liability exposure for directors does exist overseas. In fact, the number of management liability lawsuits filed in European countries is growing at a steady rate. A D&O program can be designed to protect U.S. directors from lawsuits initiated abroad.

9. Are all D&O policies alike?

D&O policies vary in types of coverage and exclusions, reflecting differences among insurance carriers in the way they approach D&O litigation. It is important to work closely with your insurance broker to select the coverage right for you and to ensure that your expectations are in line with those of your insurer.

10. Does D&O insurance provide me with all of the protection that I need?

Standard D&O coverage insures against some but not all of the management liability risks facing directors today. If personal assets are to be protected to the fullest extent possible, a management liability insurance program should include, at a minimum, both D&O and fiduciary liability coverages. Serious consideration should also be given to employment practice, kidnap and ransom, and crime insurance programs.

By and large, insurance carriers are quick to respond to changing market conditions and are continually introducing new products and services designed to meet specific insurance needs. It is part of a broker's responsibility to stay on top of market developments and keep clients informed of all pertinent issues.

Be Proactive

Neither company size nor professional competency can shelter directors and their personal assets in today's litigious business environment. Directors are increasingly becoming targets of lawsuits alleging such acts of mismanagement as breach of fiduciary duty, improper disposal of corporate assets, wrongful termination of employees, and violation of anti-trust laws. Prudent directors must be proactive in addressing their personal liability exposures and take all necessary steps -- namely, broadening indemnification through corporate bylaws and contractual agreements, limiting liability through articles of incorporation, and obtaining coverage through D&O and other management liability insurance -- to protect themselves in an era of greater exposure.

Jamie R. Anthony Jr. is President and Chief Executive Officer of Willis Corroon Financial Services Corp. in New York, which, as part of the Willis Corroon Group PLC, provides comprehensive insurance brokerage and risk management consulting services to companies in the U.S.
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Copyright 1993 Gale, Cengage Learning. All rights reserved.

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Title Annotation:corporate directors' risk coverage
Author:Anthony, Jamie R., Jr.
Publication:Directors & Boards
Date:Mar 22, 1993
Words:1784
Previous Article:The board, the proxy, and executive pay.
Next Article:Reform your governance from within.
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