Directors and officers insurance is a coverage sort after by some of the biggest institutions in the world. However, as regulatory systems have become more litigious, smaller private companies have begun to realise the benefits of having a competent D&O insurer. Insurers have refined their underwriting practices over time, to ensure that they remain profitable, building rating systems which reward proactive risk management by the organisations they cover. Below we outline nine rating indicators used by underwriters to prepare D&O insurance policy pricing and conditions:
1. Financial condition
An insurance underwriter will typically require a copy of a company’s audited financial statements in order to determine it’s financial health. They will use this information to calculate a range of financial ratios, which can used to benchmark similar companies within industry. A company with stronger financials, operating within an industry with positive economic outlook, will be looked upon favourably.
2. Business activities
Often the industry of a company will contribute significantly to an insurers perception of D&O risk. For example, companies that operate within speculative markets, such as mining and technology, will present a higher risk than a more traditional industry such as, manufacturing or consumer retail. When forming an opinion of a potential new client, insurers will often take into consideration any recent litigation reported in the media, along with their own underwriting experience of companies in that sector.
3. Quality of management
Insurers will analyse the formal qualifications and professional experience of a company’s board of directors. Directors with high public profiles or a history associated with troubled organisations will be carefully considered, as this can be seen to increase the risk inherited with an executive position. Smaller private businesses may not be required to provide a comprehensive profile on the experience of its directors, particularly if they have been with involved with a organisation since its inception, the company is of solid financial condition, and has been operating for many years.
4. Diversity of business activities
Generally, executive risk is lower for organisations that concentrate their efforts on one core business activity. Underwriters may look unfavourably on companies who are involved in too many unrelated areas, where the directors don’t have expertise in them. For example, the management of a furniture manufacturer is unlikely to have the experience required to successfully develop software for the pharmaceutical industry.
5. Length of time in business
As far as insurance companies are concerned, the longer an organisation has been operating within industry, the better the risk. While proof of a successful track record is ideal, underwriters will make inquiries into any recent significant changes affecting the business; i.e. mergers or acquisitions, alterations to shareholdings, and changes to the company’s financial position. Companies seeking insolvency coverage for their executives will typically be required to produce two years of audited financials, or budgeted financials at the very least.
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Alright, let’s take a look.6. Mergers and acquisitions
If a company has been involved in any significant takeovers, mergers or acquisitions, insurers will treat this with caution. An underwriter will investigate the reasons for these transactions to gain an understanding of its associated risk. For example, a hostile takeover may carry a higher exposure to executives than a friendly one. Depending on these specific details, an underwriter may impose certain restrictions (i.e. charging a higher premium or removing retroactive/insolvency protection), or choose to decline the risk altogether.
7. Organisation structure
Of all companies, those listed on the stock market present the highest risk to insurers. Publicly listed entities have greater obligations and responsibilities than their private counterparts, and are subject to a range of compliance and regulatory monitoring. Additionally, they are exposed to many external factors that can impact the operations of the business, for which management cannot control. In comparison, non-profit charitable organisations generally present a much lower risk, due to their community and social system based objectives.
8. International operating exposures
Companies that operate in international markets face a high degree of risk, primarily due to the onerous management compliance requirements that exist in each jurisdiction. Underwriters are also careful to review any business’ which operate in and around trade sanction restricted regions. For companies based outside North America, insurers will be wary of any business conducted within the USA/Canada, as litigation in this area has been proven to be very expensive. In situations where North American exposures exist, underwriters may offer coverage with certain limitations, i.e. protection from claims bought in US jurisdiction sub-limited, excluded, or included for additional premium.
9. Claims history
Insurers, by their nature, look to acquire profitable business. Therefore, any past claims or circumstances previously notified by a company will be reviewed and carefully considered by an underwriter. They will generally request a full description of the event, and the amount that is expected to be paid, also referred to as the ‘quantum’ of a claim. Insurers view a history of frequent claims as undesirable, and may decline to offer cover to a company if they have frequency issues, or any other severe claim pending, for that matter.
