D&O liability: The private side

Private companies often overlook the need for D&O coverage until it is too late

By Michael J. Moody, MBA, ARM

There have been many casualties of the recent financial meltdown. No business sector has been spared from the adverse results of the crisis. Many of the publicly owned corporations are just now coming to realize the long-term effects from increased regulations that have been enacted over the past few years. Additionally, they are also now beginning to feel the pain of "shareholder backlash" as more and more lawsuits are being instituted by unhappy stockholders. And while there has been a growing number of such suits, most experts believe that this is just the tip of the iceberg.

Of course, much of the mainstream business press has been reporting on these types of D&O claims and subsequent litigation that involves public companies. As a result, private companies frequently don't think that they have a similar problem. "Even privately owned companies have a minor exposure to federal and state securities laws," says Lisa Jones, vice president and private commercial product manager for Chubb Specialty Insurance. She points out: "Statistics show that about 29% of public company respondents report having a D&O claim in the past 10 years, compared to 26% of private company respondents reporting having a D&O claim over the same time period," according to the 2010 Towers Watson Directors and Officer Liability Survey of Insurance Purchasing.

Jones points out, based on Chubb's own 2010 Private Company Risk Survey, which includes responses from more than 450 U.S. private for-profit companies, "Customers were the largest source of D&O suits" at 29%. This is followed closely by governmental agencies with 28% and vendors at 20%. She also said, "One emerging trend we are seeing is that suits are beginning to come from competitors, and they currently account for 17% of the litigation activity." Another interesting fact to come out of Chubb's 2010 survey is that the average D&O claim is $225,000—with some claims reaching several million dollars. These are significant amounts that would cause financial ruin for many small businesses if the exposures were uninsured, Jones says.

"While we are all cycling through this difficult economic climate," she says, "some issues are becoming clearer." Breach of contract claims is a good case in point: "Recently they have been on the rise as well. Some of these involve employee piracy claims, where key employees leave to either go to a competitor or start their own firms." Many times, she says, these types of D&O claims result in counter suits as well. Many of these suits involve issues such as violation of non-compete agreements, confidentiality issues and/or unfair competition. A hallmark of these types of claims is that, says Jones, "the suits are frequently protracted and long and unlike similar public D&O cases, are intensely personal." All of these points usually result in significant amounts of legal expenses for both parties.

Coverage differences

For all the similarities in exposure between D&O risks for publicly owned companies and those for private companies, there are some significant differences in coverage. Obviously, concern about security litigation is a huge exposure for public firms, but not as much for private companies. D&O coverage for private companies is written on a claims-made form, as are those of public firms; however, "there are meaningful differences here," says Jones. The most obvious deals with the "prior acts" aspects of the coverage. Traditional professional liability coverages, such as medical professional or agents and brokers professional liability policies, have a specific prior acts date that determines the beginning of the policy period. This prior acts feature is much more restrictive than the private D&O coverage that has a "pending and prior litigation exclusion." Jones notes, "This may limit claims from prior policy periods."

Jones points out that Chubb pioneered the use of the "duty to defend" feature in D&O for private companies. This is an extremely important aspect of Chubb's policy "since many private companies would typically not have access to these specialized legal services without this aspect of the policy." Additionally, she states, coverage for private firms includes protection for the organization/entity. Similar D&O coverage for public companies is provided "only with regard to security litigation," she says. Defense costs are "included within the limits of liability under the private company D&O policy." Thus, Jones says, it is important that adequate limits are purchased to cover the defense costs.

Lessons learned

"There continues to be a real disconnect with regard to how prospects see the need for private company D&O liability," Jones says. "Despite all the work that the insurance community (agents, brokers, and carriers) has done, many private companies still don't truly understand the need." At the end of the day, "Many still think it is something that is only needed for shareholder suits." Further, "Some may feel the majority of claims will be covered by their general liability policy." Thus, she says, "it is our collective challenge to make certain that the private company buyers know where the gaps in their coverage are."

Based on Chubb's past experience, Jones states, "We know that agents who are very successful at marketing these types of coverages are the ones who fully explain the need for the coverage, via the coverage gaps created by commercial business insurance policies." And, she says, "We have found the most effective way to do this is take the prospect through a 'gap analysis' to help the prospect understand where they are exposed."

Additionally, Jones notes that taking a "hands-on" approach can be very beneficial to the agent. "But with regard to private D&O claims, the agent is frequently not as involved to the extent as they are in traditional business insurance claims such as general liability or workers compensation." However, this is a time that the agent can really provide some value-added service. This is also especially true during the underwriting phase of the work.

Jones says, "They can really act as a good facilitator by providing current information and making sure that the underwriter has all needed data." The biggest issue here is obtaining financials, which is a key to determining the acceptability of the risk as well as the premium. Historically, this has been one of the sticking points for underwriting this business, says Jones, "since some private firms do not want to release their financials. While this was a big issue 10 years ago, it is less so today." She points out that Chubb has developed methods for a "workaround" so the underwriter can usually find some method of obtaining the information needed. However, she indicates that this can affect the timing of the quote that frequently must be issued subject to receipt of the financials. Bottom line, "Agents can help when this process gets stuck."

More focus 

Recently, Chubb introduced a new approach to offering management liability insurance for privately owned companies, known as Forefront Portfolio 3.0. This new product includes an integrated suite of nine flexible insurance coverages that are designed to work as stand-alone policies or seamlessly together. This program, which has D&O liability coverage as one of its cornerstones, is designed to minimize coverage gaps, reduce overlaps in coverage and evolve with the private company as it grows. In addition to specific coverages tailored to the needs of smaller, privately owned companies, the product provides "state-of-the-art" risk management resources, ongoing research and education on private companies, as well as superior claims handling.

Many agents and brokers wonder why they should spend so much time and effort trying to appeal to smaller, privately owned companies. They would be wise to take a similar approach as Chubb has to this business. First and foremost, Chubb has developed a deep understanding of private company business risks, and they are frequently considered as "thought leaders" in this area. According to Jones, they consider small, privately owned companies as an "untapped frontier." In its simplest terms, this means, "There are still a lot of non-buyers in this sector." So, rather than trying to find a low premium for traditional coverages, the agent can concentrate on educating the prospect and then providing a superior product to solve the problem. Jones says, "This creates a great opportunity for both the agent and the carrier."

As Jones has noted previously, "The challenge for the industry is to make certain that the customer or prospect understands the D&O exposure and coverage available." They must also be able to answer: "How are we dealing with these exposures?" Part of the problem, according to Jones, is that information is not readily available in the public domain. In addition, since these are typically low frequency/high severity exposures, many smaller firms don't think they will be sued. However, the recent Chubb study quickly disproves this.

Most businesses believe that the recent financial meltdown has raised the possibility of getting sued. That is certainly true for publicly traded companies, but it is also true for private companies as well. It is important that the insurance industry continue to educate the consumer about private company D&O exposures. Not only will agents be doing the insurance buyer a great service, they may be able to capitalize on a good business opportunity to acquire a long-term customer.