Directors and officers liability insurance has become an essential risk management solution for corporations, private companies and non-profit organisations across the world.
Despite its global footprint, the evolution of D&O has largely been influenced by the highly litigious operating environment of the United States. From humble beginnings, coverage has expanded beyond basic executive protection to also include indirect, and sometimes direct coverage for organisations.
As the risk exposures of organisations and management teams expand, D&O coverage continues to evolve to meet their requirements.
1930’s: Personal financial protection insurance
In the wake of the Great Depression in the 1930’s, personal financial protection insurance, as it was called then, was developed in response to significant reforms in the U.S. financial system – namely, the U.S. Securities Act (1933 & 1934) and the Investment Company Act (1940).
At the time, organisations were not permitted to indemnify their directors and officers from claims, and as a result, Lloyds of London was the first market to introduce an insurance policy designed to protect them.
Despite the additional responsibility this new legislation imposed, the general consensus among executives was that their personal risk was negligible. Therefore, the uptake of this new insurance coverage was minimal.
1960’s: Corporate indemnification becomes commonplace
It wasn’t until the 1940’s and 1950’s that state laws in America were passed allowing directors and officers to be indemnified by organisations. This effectively transferred the cost of defending management onto the organisations which appointed them. According to surveys conducted at the time, by 1965 only 10 percent of public companies carried personal protection insurance for their executives.
However, significant M&A activity during this period, and the fact that executive claim costs were being bankrolled by organsations, induced further litigation against boards. Following this, the uptake of personal protection insurance increased throughout the late 1960’s, as executives realised that they remained exposed when indemnification from their organisation was not available.
1970’s: Increasing uptake of D&O insurance
The increasing demand for executive protection saw more insurers enter the market, with policies now being offered by insurers outside of Lloyds of London. As competition in this space increased, policies with broader coverage became available as insurers sought to differentiate their products from their competitors. A typical D&O policy structure now provided two distinct forms of insurance:
- Directors and officers coverage (Side-A), for protecting executives when corporate indemnification wasn’t available. By the end of the 1970’s, approximately 70 percent of public companies had some form of D&O insurance in place.
- Corporate reimbursement coverage (Side-B), to protect a company’s balance sheet from claim costs when indemnifying management
1980’s: Stock market crash & the insurance crisis
By the mid-1980’s, despite the majority of public companies having D&O coverage, the insurance market found itself in serious difficulty. A number of large company failures in the banking and oil industries, along with the stock market crash of 1987, resulted in the cost of D&O claims increasing by over 50 percent – placing significant strain on the profitability of insurers.
This, combined with a shortage of reinsurance capacity, saw eight of the top ten insurers leave the D&O market, leaving only Lloyds of London, AIG and Chubb remaining. Many organisations were faced with significant challenges when renewing their D&O coverage; including premium increases of over 200 percent, ultra-high self-insured retention levels, and limits of liability often reduced by half.
1990’s: Development of entity securities coverage
High premiums, restricted policy coverage, and improved economic conditions, attracted significant capacity back into the D&O insurance market, with the addition of several new insurers, including ACE and XL. The next few years witnessed two events that had a significant impact on the way D&O insurance responded to securities litigation:
- The Nordstrom decision
- The Private Securities Litigation Reform Act (PSLRA) 1995
During the landmark case of Nordstrom Inc. v Chubb & Son Inc. in 1995, the U.S. Court of Appeal rejected the insurers argument that the Nordstrom company entity (not insured by the policy) should be allocated part of the liability, because it was listed as a co-defendant in the claim. As a result, the insurer was responsible for paying the entire $7.5 million settlement. This judgment had enormous implications for insurers, as they realised that they potentially had far larger exposures than previously accounted for – and would either have to revise their policy pricing or coverage to accurately reflect the risk.
Later that year, insurers celebrated the introduction of PSLRA (1995) legislation, which was established to reduce the amount of frivolous securities litigation occurring at the time. This tort reform was successful in reducing securities claims by 45 percent over the next two years. Improved underwriting profits encouraged more insurers into the market, which bought about reduced premiums for policyholders and the development of entity securities coverage, or Side-C, which was designed not only to protect the organisation entity, but also solve liability allocation issues of the past.
2000’s and beyond: the modern market
The D&O industry as a whole has been susceptible to the peaks and troughs of the economic cycle, with securities litigation having a significant contribution to the difficult market conditions of 2001, following the collapse of Enron and the dot-com bubble, and then again in 2007 in the wake of the financial crisis. Insurance and reinsurance capacity generally remains strong, and due to sensible underwriting practices, the market is unlikely to see catastrophic changes in pricing and conditions – as experienced in the 1980’s.
Recent times have seen an increased uptake of D&O by private companies and non-profit organisations, with approximately 80 percent now carrying some form of management liability coverage. While the basic D&O policy structure remains unchanged, other coverage provisions have evolved to benefit executives, such as conditions surrounding financial adjudication and application severability.
The modern legal landscape has organisations facing increasing claim costs each year. Entity coverages, such as Side-C and employment practices liability, has created a range of challenges for executive protection, and continues to lead to the development of new products. Of these products, Side-A DIC, has become the most common additional coverage for publicly listed companies.