D&O and Underwriting

Directors & Officers Liability March 2015

Ram Garg CFA, MBA

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Disclaimer

This presentation is provided solely for generalinformation purposes and the information containedherein does not purport to be a complete descriptionof all terms, exclusions and conditions applicable tothe insurance agreement. It should not be relied uponto decide if a claim is payable under the policy or not.

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D&O Insurance

“A study sponsored by McKinsey shows that 36% of corporate directors polled

actually admitted that they did not fully understand the risks faced by their

company…others may have had their doubts but did not like to say so”

The Economist

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Legal liabilities of Directors & Officers

Directors of a company have several duties and liabilities imposed on them under various provisions of the law

Duties can be found under common law and statutes. Statutes such as the Companies Act impose on directors the duty to act with care and skill

If directors are held to be personally liable, they would have to defend and pay the damages on their own

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Who are the duties owed to?

Firstly to the shareholders

The Company itself and minority shareholders.

Creditors - allegations of wrongful trading can be made in the event of insolvency.

Employees including employment issues – unfair dismissal/discrimination etc.

Other companies - disposals and acquisitions.

Regulatory authorities e.g. health and safety issues

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Legal liabilities of Directors & Officers

Regulators in Asia are more active and focusing on;

– Transparency and disclosure– Financial reporting– Board practice

All above factors deriving greater expectationof best corporate governance practice

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What is D&O Insurance?

D&O Insurance provides indemnity for theIndividual Directors and Officers of acompany against their legal liability to paydamages to third party claimants as aconsequence of the third party havingsuffered financial loss through thenegligent act, error or omission of theDirector or Officer in his/her “managerialcapacity”.

In other words, it is a “ManagerialNegligence” cover

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D&O Insurance – Insured Persons

– All Past, Present and Future Directors and Officers (Ds&Os) of the Insured Organisation; and Its Subsidiaries

– In relation to Employment Practices Liability claims, all employees

– Spouses and legal representatives of Ds&Os for Wrongful Acts committed by said Ds&Os

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D&O Insurance – D&O Policy Trigger

Wrongful Act by an Insured Personwhilst acting in his Managerial

capacity

Claim against Insured Person

LOSS

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D&O Insurance – Loss

DAMAGES

DEFINITION OF LOSS

SETTLEMENTS DEFENSE COST PLAINTIFFS COST

Loss excludes fines or penalties imposed bylaw and punitive, aggravated or exemplarydamages.

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D&O Insurance – Insuring Clauses

Two Main Insuring Clauses

Insuring Clause 1 (Directors’ and Officers’ Liability Coverage) –pays on behalf of the Insured Person where he/she is unable toreceive indemnity from the Company

Insuring Clause 2 (Company Reimbursement Coverage) - payson behalf of the Company where it is legally permitted or requiredto provide indemnity to the Insured Person

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D&O Insurance – Structure

Claim or allegation made against Directors or Officers (D&O’s)

Claim or allegation notified to Underwriters

Q: Can and will the Company indemnify the D&O’s?

Insurers advance Costs andExpenses to the D&O’s under the

D&O Section of the PolicyThe Company advances Costs and

Expenses to the D&O’s

The Company recovers their outlay underthe Company Reimbursement Section

EXCESS OF THE DEDUCTIBLE

No Yes

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D&O Insurance - Structure

Liability of the D&O’s is finally determined through thecourts or settlement negotiations involving D&O’s,

The Company and Underwriters

Q: Is the Company legally able to indemnify theD&O’s for their liability?

Insurers indemnify the D&O’s underthe D&O Section of the Policy

Insurers indemnify the Company under the Company Reimbursement

Section EXCESS OF THE DEDUCTIBLE

No Yes

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D&O Insurance – Structure

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D&O Insurance – Side C (Entity Section)

Who is at risk?

What is at risk?

Cover?

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D&O Insurance – Claims Made basis

• D&O Policies are insured on a Claims Made basis.

• Responds only to Claims first made against Insuredduring the Policy Period.

• Policy allows circumstances which may lead tofuture Claims to be reported during the PolicyPeriod. Known as “locking in”.

• Known Claims or circumstances before policyincepted are excluded.

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D&O Insurance – Retroactive Cover

• The Policy will only respond to Claims made duringthe Policy Period arising from Wrongful Actscommitted on or after the Retroactive Date.

• For Full Retroactive Cover, the Policy will respond inrespect of Wrongful Acts committed sincecommencement of business.

• Subject to Known Claims, Circumstances and Prior &Pending Litigation exclusion.

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2010 2011 2012 2013 2015

Action starts / defense ongoing

Claim Made

Policy YearTriggered

ActionSettled

Wrongful Act

Committed

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2010 2011 2012 2013 2015


Circ.notified to &

accepted by Insurer

Policy YearTriggered

Claim Arises and

subsequentlysettled

Wrongful Act

Committed

20J B Boda

D&O Insurance Underwriting

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D&O – Information Requirement

The following is minimum requirement;

Completed Proposal Form (Must include Claim info)

Latest audited financials

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What you’re really underwriting when you underwrite D&O is

you’re underwriting the people. You’re underwriting the senior management, the quality of the

management team.

Underwriting Considerations

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Underwriting considerations include:-

a) Domicile and international activity (especially US exposure)

b) Claims record

c) Industry sector (for example: financial institutions are considered higher risk)

d) Stock exchange listing

e) Market capitalization

f) M&A activity

g) Professional CVs of the management

D&O Underwriting Considerations

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D&O Underwriting Considerations

Report and accounts - key documents:– chairman’s statement – insight into future strategy– directors report –statutory requirement– auditors report – ‘true and fair view’ – profit / loss account – what has been happening– balance sheet – snapshot of assets and liabilities– notes to the accounts / contingent liabilities e.g. in dispute with the

Inland Revenue. Provisions in the accounts for bad debts.

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D&O Underwriting - Understanding the Company & Management

What is the company all about?

Business - wide or specific?

Local, Regional or International player?

Is it a leader or a follower in the market?

What are the analysts saying about the company?

What is the Chairman saying?

Litigation environment?

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D&O Underwriting - Understanding the Financials

Are the revenues declining? How is the company performing relative to peers? Are the margins thin? Profitable? How long for? Have they ever been? Gearing Levels, Long Term Debt to Equity Ratios.

– is this in line with peers?– Some industry we know carry higher LTD/equity such as

Manufacturing company Cash Flow – operating cash flow Are they likely to go public soon / private offerings?

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D&O Underwriting – Premium Rating Process (Hypothetical)

Establish a basic rate for INR 10 mln limit – for example INR 250,000/-

ExampleBase RateAsset Size below Asset Size between INR 1 bln INR 1 bln to 10 blnLimit Premium Limit Premium

10,000,000 250,000 10,000,000 325,000100,000,000 500,000 100,000,000 650,000300,000,000 800,000 300,000,000 1,040,000650,000,000 1,000,000 650,000,000 1,300,000

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The following factors are examples of the issues that have a specific impact on the rating of D&O insurance premium by underwriters.

Financial Features Range– Credit rating and volatility -10% to +10%– Share price volatility and market capitalization -5% to +5%– Mutual or private company -25% to -15%– Bond or share issue planned +10% to +30%

Management Features– Rapid growth of the company +10% to +40%– Recent major merger or restructuring +30% to +55%– Divestments in hand +5% to +25%– Board reputation and profile -10% to +10%– Asset distribution -5% to +10%

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Reputational Features– Brand profile and quality -10% to +10%– D&O claims history -20% to +20%– Customer and supplier dependency 0% to +10%– Business diversity and diversification -10% to +15%

Marketplace Features– Trend, stability and types of the business -10% to +40%– Regulatory changes anticipated 0% to +10%– Specific exclusions imposed -40% to -10%– Specific extensions required +5% to +30%– Entity coverage +10% to +30%

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Claim Scenarios

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Claimant Ranking

1.Third party (30-50%)

2.Regulatory/Gov Body (10-30%)

3.Employees (20-30%)

4.Miscellaneous (10-20%)

5.Shareholder (Below 10%)

Source: various figures from different D&O insurers within Asia region

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Common types of claims

a) Shareholders: mismanagement, decline in investments, performance of the company, misrepresentation in offering documents, bad investment decisions

b) Employees: employment practices claims such as discrimination, harassment, libel and slander, improper working conditions

c) Investors: misrepresentation and misleading information

d) Competitors: unfair business practice, libel and slander

e) Regulators: breach of statutory provisions, market misconduct

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D&O Claim by Regulators

1. Market Misconduct: (a) Insider trading (b) Price rigging (c) False trading (d) Market manipulation (e) Disclosure of false and misleading information

2. Directors breaches of Statutory Duties

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Larger Sources of Claims

Trading Losses Accounting Irregularities Mergers, Acquisitions and Divestments Share Issues Change in Control or Shareholdings Employment Practices Liability (EPL) Issues

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Real Claim Examples

DESCRIPTION OF EVENTThe Financial Regulator ('The Regulator') issued notices to attend interviews to four directors and officers of the insured minerals processing company. The Regulator was investigating disclosures regarding the effect of falling commodity prices on the company’s balance sheet.

RESOLUTIONThe D&O insurer’s dedicated claims specialist met with the directors prior to the interviews to discuss the investigation and appointment of counsel. Counsel were appointed from Insurer’s panel at discounted rates. Counsel met with the insured persons prior to the interviews and attended the interviews with them. The insured persons were able to adequately answer all concerns and the investigation ceased after the interviews.D&O Insurer paid $30,000 in Investigation Costs in excess of the deductible.

Industry Public Company

Coverage Section Directors’ & Officers’ Liability

Cause of Action Investigation

Type of Organisation Minerals Processing

Number of Employees 112

Revenue $25 million

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Real Claim Examples

DESCRIPTION OF EVENTA large publically listed company based in Philippines, held a management meeting in Hawaii and flown key executives to attend same. After meeting was over, US Federal Communication Commission initiated investigation in relation to possible violation of anti-trust law.

RESOLUTIONKey executives of the company had to defend themselves in US district court in Hawaii. The company came out clean but incurred legal cost in excess of USD 4 million during the whole episode.

Industry Public listed Company


Cause of Action Investigation

Type of Organisation Telecom

Number of Employees More than a thousand

Revenue NA

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Real Claim Examples

Industry Private Company


Cause of Action Breach of Child Labour Laws

Type of Organisation Retailer

Number of Employees 11

Revenue $250,000

DESCRIPTION OF EVENTThe insured owned and operated a number of newsagencies. The insured employed a number of part-time staff, which included several teenage school students. The insured was investigated and subsequently charged with various breaches of child labour laws, including a failure to obtain the consent of the teenagers’ parents to their employment.

RESOLUTIONThe insured was fined $15,000 and incurred legal costs of $18,000. The fines and costs were covered by the policy.

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Thanks

Documents

D&O and Underwriting