Protecting your assets requires prudent questioning. J. Thomas Presby has done your homework for you. The former chairman of Deloitte & Touche USA compiled this list based on his multi-board experience.
- Do I belong on this board?
- Do I really want to be associated with this company/management?
- Is the company’s indemnification clause as good as it can be?
- Am I doing everything that a good, diligent director should do?
- How much D&O is the right amount for this company?
- Will asking questions about D&O be considered hostile?
- Under what circumstances are personal assets exposed?
- Are there other “bundled” covers that could drain the D&O coverage away from the directors?
- Do I lose coverage when accused of a bad act or only when convicted of a bad act?
- Does the Side A coverage include a DIC provision?
- When does my D&O policy get triggered?
- Will a financial restatement impact the coverage in any way?
- What is the quality of the underwriting carriers?
- Will the coverage be available to the directors in the event of bankruptcy?
- What is my exposure if another director or an officer of the company is accused or convicted of fraud? Is there a severability provision?
- What changes in coverage take place when a company does an IPO? Is new coverage required at that time?
- Is there coverage for foreign operations?
- What is the right deductible?
- Does the cover include the right to buy a “tail” if the policy is not renewed?
The Response to Presby’s Questions
Should a director consider board service for a company that does not provide insurance coverage? Most would not consider it for fear that their personal assets would be put at risk. Some believe that the existence of insurance attracts litigation—a subject for a different story—but most directors of public companies today are simply not willing to accept that chance.
To take some of the guesswork out of how the questions developed by J. Thomas Presby should be answered, NACD Directorship sat down with Louis Lucullo, an executive vice president in the Executive Liability division at Chartis, for a fast-paced game akin to “Twenty Questions.”
ADDITIONAL STORIES IN THE DIRECTOR’S GUIDE TO LIABILITY:
Litigation 101: You’ve Been Sued. Now What?
Avoiding the “F” Word: How Your External Auditor Can Help You Avoid Fraud
The D&O Glossary: Litigation Terminology Every Director Should Know
Lucullo recommends that before an executive considers joining a board she review the company’s bylaws and that an insurance provider be analyzed for its ability to pay claims.
To assess the quality of the insurance carrier, the best measurable for directors is the policyholder surplus, which for an insurance company, is its assets minus liabilities. What needs to be determined is whether the insurer has the wherewithal to sustain future catastrophic losses.
“Too often that’s a forgotten analysis by directors,” Lucullo says. One way to make such an assessment is to check with ratings agencies such as A.M. Best.
Also find out if the insurer has an effective claims process and a favorable approach to claims resolutions by asking other directors.
How much D&O insurance is the right amount? Typically either third-party consultants or the insurance broker should detail for the board what their peers typically buy.
The peer group can be based on a company’s direct competitors, size of its employee base or market cap. This allows the board to assess its own purchase decision.
Under what circumstances would a director’s personal assets be exposed? This is why so-called Side A coverage has become so popular. A feature built into a new insurance product recently launched by Chartis called Executive Edge goes a step further by advancing defense costs for covered loss when the the company fails or refuses to indemnify the executive for any reason. It’s important that directors review the order-of-payment clause in a policy to ensure that the corporation is paid after the officer and directors in the event of loss.
Will coverage be available if the company is insolvent? “The filing of bankruptcy does not in itself trigger an end to coverage. In fact, the policy should contain as part of the definition of an insured ‘the debtor in possession of the named corporation,’ which is what the company becomes when bankruptcy protection is filed for,” Lucullo explains.
Upon an emergence from bankruptcy, typically there’s a change in control that typically ceases coverage and converts the policy into what is called “runoff” or “tail” and claims have to allege a wrongful act before that date to be considered for coverage.
What is my exposure in the event another officer is convicted of fraud? This question introduces the concept of severability and whether the actions of one adversely affect the actions of another. The conduct exclusions in a D&O policy should be fully severable and should not have an impact on any executive who did not commit any fraud. Directors all share the limit, but new policies have gone out of the way to ensure that individuals are not adversely affecting other directors as much as they used to.
Another feature in Chartis’ Executive Edge policy is a claim cooperation clause that also is fully severable.
“Part of the requirement when there is a claim against you is that you cooperate,” Lucullo says, “and if you didn’t cooperate, we would have the right to deny the claim. Now, under this new policy, one’s action in not cooperating with the claims investigation does not affect the coverage of others under that policy.”
Does Excess Side A coverage include a DIC provision? Excess Side A coverage should always include a Difference in Conditions (DIC) provision, Lucullo says. If the underlying primary policy does not pay the Side A loss, the Excess Side A policy with a DIC feature would, under certain circumstances, drop down and pay the loss.
Will a financial restatement affect coverage? If fraud or criminal conduct is an element of the financial restatement, coverage could be at issue.
“Directors should look for Side A non-rescindable coverage—the insurance company cannot rescind A-side coverage, Lucullo explains. It should be obtained on both the A, B, C tower as well as the A-side DIC tower. Directors should also review conduct exclusions, which prevent the insurer from providing coverage in the event of fraud or a criminal act. Those exclusions, he points out, should be fully severable.
For example, if there is a financial restatement based on fraud there’s potential that a conduct exclusion is applied and insurance is knocked out for those individuals involved in the fraudulent activity. The corporation could also lose coverage based on the actions of certain individuals.
The bottom line is that it’s “important for directors to understand how their D&O policy works when the actions of another executive are at issue.”