Within most companies, boardroom discussion about D&O insurance still often revolves around the amount of coverage available. That is important, of course, but what should matter more to an individual sitting on a board is how that policy is structured, who it covers and its wording. In part, that is because even the largest policy may cover only $500 million in losses—and for multibillion-dollar companies, the combination of legal costs and settlements or judgments can dwarf even the biggest policies.

Scrutinizing D&O policies, however, is far from straightforward. “The policies used to be seven or eight pages long; now they are an inch thick,” warns William Passannante, cochairman of the insurance recovery group in the New York law office of Anderson Kill & Olick.

A policy can include coverage for many sources of liability. Some companies are discovering that they can save on insurance costs by bundling D&O coverage with, for example, insurance against employment claims such as sexual harassment lawsuits against staff members. Well-informed board members look to this kind of coverage and similar D&O tactics to protect themselves from a plethora of problems that, realistically, no director can monitor or guard against.

However, this type of overarching coverage seems to be more the exception than the rule, often because of its cost. “There is a fundamental conflict of interest that exists between the company and its executives, and the outside directors,” Galban says. This divergence is exacerbated by the fact that directors’ personal assets can serve as a magnet for attracting lawsuits—even though they may play only a minimal role in deciding what D&O insurance policy to buy to shield themselves from these risks.

In the wake of the accounting scandals, regulatory inquiries and court actions, insurers are trying to find new ways to circumvent fulfilling D&O policies when trouble strikes. Underwriters have been altering the language in their policies to give themselves more room to walk away or to strong-arm a company to settle. “There are all sorts of new trapdoors to get out of the obligation, where once they would just say they covered you for liability,” Passannante says. Prior to 2000, for example, underwriters might have been able to limit coverage or even withdraw or rescind a policy altogether in the wake of an act by directors or officers “arising out of, based upon or attributable to the committing in fact of any criminal, fraudulent or dishonest act, or any willful violation of any statute, rule or law.” Today the language reads something like this: “ arising out of or resulting directly or indirectly from any criminal or fraudulent act, error or omission.”

Even so, knowledgeable board members can lobby for expanded coverage. “Directors can still push to have the language changed to something more favorable, if they are aware of the importance of the words,” says Paul A. Ferrillo, a New York-based attorney in securities and corporate governance at Weil, Gotshal & Manges.

Addenda Value
One of the features that Downey and other independent directors seek is a Side A or Clause 1 policy. These addenda to blanket D&O policies cover directors and officers for any expenses or damages when they cannot be indemnified by the company and when a blanket policy is not in force or has been exhausted or rescinded by the carrier. Cash-rich companies that prefer to self-insure against balance-sheet risks are often buying Side A or Clause 1 policies instead of blanket policies. Two of the four boards on which Downey sits—Emulex and First Consulting Group—already have Side A coverage. “I think by the time we finish renewing our policies this year, we will have it in all four boards,” he says.

John Rafferty, New York-based vice president and national D&O product manager at Hartford Financial Products, explains that “Side A gives more cost-effective coverage for individuals and, in the event of a bankruptcy, it won’t get tied up in courts because it’s not considered a corporate asset.” Persuading a company to boost its coverage by adding a Side A policy may not be too difficult a task. These policies are typically less expensive, relatively speaking, than traditional policies. For example, Salter says that recently one of his clients—a regional bank—bought $100 million in traditional D&O coverage, at an annual cost of $1.5 million. It added a $10 million Side A policy covering the additional risk to directors and officers—which kicks in only when the basic policy is exhausted—for an additional $125,000. “The additional attraction of these policies is that they are often sold as nonrescindable,” Salter adds.

Some insurance underwriters are specializing even further, offering policies that cover only outside directors. “If I were asked to join a board today as an independent director, I would want a pool of insurance that is available just for us, that no one else can access and that won’t be eroded by anyone else’s wrongdoing,” says John Keogh, chief executive of National Union Fire Insurance of Pittsburgh. Independent directors, he says, often place substantial personal assets at risk—and are more likely to become innocents caught up in corporate scandals.

To enhance their risk management, some directors also buy a personal policy, a product that covers them for the risks associated with their own board positions. Galban says Chubb has started selling this to affluent individuals who sit on several boards and whose tolerance for exposing their personal assets to the risk of a class action suit is particularly low. He admits the process of underwriting the policy is labor intensive because every policy must be customized for each individual’s set of risks and be based on each policyholder’s specific board assignments. A $5 million policy may currently cost $10,000 to $30,000; costs, however, are expected to rise soon.

As more board members attempt to take an active role in the D&O policy process, calling in their own attorneys to scrutinize policy language and questioning details, some carriers are taking the customization process to yet another level. RLI Insurance of Peoria, Ill., recently sent letters to 7,000 independent directors designed to whet their appetite for new types of D&O insurance offered only to independent directors.

“There are products that didn’t exist a year or two ago that can protect just those outside directors today,” says Skip Orza, vice president of executive products at RLI. “That is the future.” 

Suzanne McGee, a former staff reporter for the Wall Street Journal, writes about corporate finance and governance. suzanne.mcgee@gmail.com