Directors and officers liability insurance premiums more than doubled between 2000 and 2003 because of accounting scandals at Enron Corp. and WorldCom Inc. and the fallout from the dot-com meltdown. Finally over the last couple of years, they have declined 30% from their peak in 2003–and insurance professionals predict that fees will fall another 10% in 2007. But after all the good news of the past year, there is one disturbing blip on the radar that may not be causing problems now, but could prove to be troublesome, particularly for individual executives and directors, in the future.
That blip is the surge in shareholder lawsuits over backdating options. To date, there have been 144 derivative lawsuits filed against about three-quarters of the companies that have announced government investigations or internal investigations into backdating options, according to insurance research firm Advisen Ltd.–and observers believe more are on the way. "The monetary awards associated with these suits are usually small to non-existent," says Dave Bradford, the editor-in-chief at Advisen. "But the legal expenses can be very high."
That's one area in which directors and officers could face a threat since in cases where fraud is uncovered D&O policies often won't pick up attorney fees for the individual if that person is somehow connected with the fraudulent behavior. To get around this, companies have so far chosen to settle so that no fraud is ever proven. But in many of these cases, shareholders are not seeking compensation anyway; rather they seek changes in a company's governance code to put in place better controls against it.
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The other problem associated with these shareholder derivative suits is the fact that they can tie up management and resources until they are settled or go away. In fact, as many of half of the suits get dismissed without any settlement associated. "The bigger issue here is the drain on management time, resources and energy that these suits cause," says Bradford. "Theoretically, there's no monetary damage to the company. The company should be the beneficiary of any monetary awards, but it does certainly cause a distraction."
None of this, however, should affect D&O costs. "While the options scandal is constantly expanding, it's not clear what the damage is," says Robert Hartwick, president and chief economist for the Insurance Information Institute. "In the case of Enron, we had the total collapse of one of the largest companies in America, with countless shareholders, employees [and] vendors left in the lurch. [The options backdating scandals] certainly smell bad, [but] the reality of it is that there do not appear to be significant economic losses suffered by shareholders."
Finally, D&O is currently flush with capacity from insurers, still smarting from the losses connected to Katrina and 2005′s tumultuous hurricane season, exiting the property coverage market. But more importantly, even after recent price cuts, D&O insurance remains very profitable, notes LouAnn Layton, managing director of Marsh. "In 2006, most [D&O] underwriters made a profit," says Layton. She adds: "As an underwriter, it's a good place to be–as a client, it's a very good place to be."
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