Evaluating Your D&O Protection

In a recent interview, Gary DuBois,
president and CEO of Valiant Insurance Group, offered some advice and tips on the questions boards should ask when evaluating the coverage and track record of their D&O policy underwriter.

We want to talk today about the process of choosing the right D&O underwriter. Could you go through some of the questions that boards of directors should ask their brokers and agents as they work through their due diligence to determine their credentials?

Interestingly, I currently sit on four different boards of directors and I act as a senior officer within an organization at the CEO level, which has given me a variety of perspectives on the decision-making process at the board level, including the very important decisions surrounding the review of the directors and officers liability insurance policy. While there are a lot of articles that provide a good tactical perspective on D&O coverage, and on directors and officers liability issues from a legal and insurance perspective, in my opinion, most board members don’t have the background, the expertise, nor the time to be educated on some of the finer points of what they need to know about these policies. Therefore, most boards rely on advisers to deal with those points at the level below the presentation to the full board. At that point, the critical issue for the board is whether the adviser who will be providing the recommendations has the requisite expertise, knowledge, and timely perspective to be able to make appropriate and considerate recommendations.

Very often, boards rely on the agent and brokerage community for guidance in this regard, but when doing so, they should be sure that agents and brokers have an appropriate degree of expertise in the D&O specialty line within the broader mainstream insurance community. Furthermore, while many of the larger regional, national, and international brokers have significant resources in the specialty line arena, including D&O, that doesn’t necessarily mean that individual brokers have that same background. So a board should ensure that its individual broker is bringing an appropriate degree of experience about the product line to the table.

At some point a legal review is warranted, as well, correct?

Yes, in addition to the insurance agent or broker involved on the account, there should be some degree of legal review and, depending on the size of the organization and its structure and how it approaches D&O insurance, this could come either through the internal general counsel’s office, from an external law firm, or it could involve a combination of both. With regard to this type of review, it’s important to remember that there are a number of commercial law firms out there that don’t necessarily have specific expertise in D&O liability insurance. This coverage is very important to the individuals on the board, and therefore, the legal advice that they should be receiving regarding the coverage should be coming from individuals that have a track record and background of credibility within the D&O liability insurance field specifically.

Who generally takes the lead on this review process?

Normally, an insurance buyer will spearhead the D&O purchasing review process. In larger corporations that’s normally going to be a risk manager; at a smaller organization it may be a CFO or treasurer or someone under those officers’ supervision. But again, the board should be directing those individuals to ensure that they have done their background work on the current state of the marketplace and on some of the relevant issues that are being presented that will evolve year after year. This entails examining the background, at the individual level, of the advisers on whom they’re going to be relying in order to arrive at an informed decision.

Can you describe how boards can learn to discern the subtle differences among various carriers?

Once the board has developed a comfort level with the credibility of its advisory group, the directors will be well served to take it to yet another level, which is to look closely at the individual carriers that will be involved in providing the coverage. This is especially true of the primary carrier that will be setting the lead terms and conditions, but also if there are excess carriers involved in a larger program. The lead carrier is the most important because normally D&O is written on what’s known as a follow-form basis, such that the excess carriers will generally adhere to the primary carrier’s terms, conditions, and positions.

What are some of the practical questions the board should be asking of the carrier at this point?

The board should be honing in, first and foremost, on establishing the credibility of the carrier. At one point, there used to be a perception that the credibility of the carrier was synonymous with its financial strength rating; however, events that have transpired over the last year and half or so have made it clear that a financial strength rating, in and of itself, may or may not have value when looking at an insurance carrier, especially looking at one who could ultimately be responsible for protecting the individual liability of a board member. So today, hearing that a carrier has an S&P rating of AA or an AM Best rating of A- isn’t really enough in terms of establishing a minimum threshold of comfort for the board respecting to the carrier’s credibility.

I would suggest the board ask more specifically about the individual management of an organization. What is the track record of the company in this particular line of business? Again, because D&O is a specialized line of business, it can be more volatile than many traditional standard market commercial coverages, and what that has meant, historically, is a greater degree of movement into or out of the line of business among carriers. And as a director, what you really don’t want to do is put yourself in a position of buying a policy from a carrier that may be here today and gone tomorrow-either as a result of financial issues or as a result of lack of appetite for a specialty class of business.

So the only way to get to a true comfort level is to ask some questions about the individual management of the organization. Ask about the experience level of the underwriting management of the organization. How long have the principals been involved in D&O liability insurance? Has this been their primary area of expertise for a number of years? Do they have a good track record to which the advisory group can point?

So really you are trying to find out if this company has exhibited a commitment to the specialty classes, and D&O specifically, and to ask whether there have been any changes within the organization that would suggest that their appetite may change in the near to intermediate term.

Is there anything else the board should investigate?

One of the areas that I think really gets overlooked in the D&O purchasing process and is consistently underweighted in terms of its importance is to look at the claims side of the equation. All insurance carriers have developed a track record and a reputation relative to their willingness to pay appropriate claims in a timely manner. But it’s not enough to look at the general reputation of a carrier, because that can vary by product line within a given organization. The board should ask its primary carrier about the degree of experience and credibility that exists within the claims side of the operation. D&O is a very critical coverage for both the organization and for the most senior individuals at the board level. They pay a significant amount of money for an insurance policy and, down the road, when they need it most, having filed a claim, they don’t want to find themselves in the middle of litigation. That’s the wrong time to find out that your carrier doesn’t have the necessary experience in D&O insurance, or that they’ve got the experience, but they just don’t like to pay D&O claims.

D&O claims generally have a profile of having large limit losses, regardless of the size of the company providing the insurance. Even within larger organizations, D&O limits tend to be large net losses for these organizations, which can cause some carriers to be reluctant to pay claims in a timely and appropriate manner.

There should be a comfort level that the individuals that will be making the decisions relative to the claims that could be filed on a D&O policy have the necessary expertise and the appropriate philosophy of having a fair, reasonable, and rational approach to paying appropriate claims when and if those claims arise.

You mentioned that directors ought to be aware of managerial changes within the D&O group. What do such changes signal to you, and why should directors be leery of those situations?

Well, it’s not necessarily a red flag, but it should certainly be a yellow flag that causes them to ask further questions. Again, D&O is reliant on management expertise on the underwriting and the claims side, and if the individuals involved at that level are no longer there or there’s been changes of personnel at that level, that means that the company’s appetite, philosophy, direction, and strategy within the D&O line of business may well be evolving. Now, that may be a good thing, a bad thing or it may be a relatively neutral thing, but it certainly portends the possibility of change and it makes it tougher to rely on the track record of the organization as it has appeared historically up to that point.

How should companies evaluate their carriers with regard to their own industry sectors, say, for financial institutions or energy or technology, that have very specific types of risks and liabilities?

Most carriers have appetites that are broken down along industry segments. Certain carriers have a greater comfort level within financial institution or financial services industries. Others may have a particular expertise in retail or manufacturing. But most carriers define, to some degree, their appetite by industry segments.

Certain industry segments like financial services, or in many cases the technology industry, because of the volatility that’s frequently associated with technology-related stocks, have specialized underwriters or underwriting units that focus specifically on those areas and those segments. So that’s a good thing to know as a director if you’re operating within a specialized industry segment yourself.

Financial services are particularly relevant in today’s environment, and there are carriers who have historically moved in and out of the financial services segment.

They will, for a period of time, usually during a more benign economic environment, express an appetite for financial services, but then when things turn into more of a negative environment for the financial services industry, they will pull back or pull out of that segment, frequently leaving a lot of their insureds to have to try and replace their coverage at what could be for them a difficult period of time as an insurance prospect. Therefore, establishing the individual carrier’s appetite for individual industry segments can have some value.

While it makes sense that the board needs to understand all these points, it seems like a pretty detailed task to put to a group of individuals who have so much on their plate already. Do you have any advice as to the best way for boards to manage the D&O evaluation process?

I don’t view it as being an especially time-consuming or onerous task for the board to put some of these basic questions before their advisers. Make sure that the risk manager is running through these issues. And ultimately, when it comes to the buying decision, if the directors have developed a certain sense of comfort that these questions have been looked at, and that the appropriate answers have been provided and can be conveyed with a degree of confidence by the group that will be responsible for the day-to-day mechanics of soliciting, reviewing, and putting forth a recommendation for a D&O insurance policy, I think that the board will ultimately have a much greater comfort level in making a final purchasing decision. At the very least, they will be assured that the purchase that was made will ultimately provide a policy that will respond in an appropriate manner and will be there when they need it over the long run. |BD|

This article also appears in “Boardroom Liabilities: Keeping Your Board Bulletproof in a Challenging Coporate World,” a thought leadership report published by Corporate Board Member magazine.