Directors and Officers Coverage in the Limelight

William Webster had enjoyed a long and distinguished career in public service, most notably as the only person ever to head both the FBI (under President Carter) and the CIA (under President Reagan). The onetime U.S. District Court judge retired from public office in 1991, at age sixty-seven, and devoted his time to practicing law in Washington, D.C., and sitting on the boards of several large corporations. One of them was U.S. Technologies, which develops and supports emerging Internet companies. But in July 2002, Webster was told the company could no longer provide adequate liability insurance to its directors and officers. He resigned.

All publicly traded companies must have a board of directors, a group of people elected by the stockholders to govern the company. Generally, the board is charged with selecting and supervising the executive officers, setting overall corporate policy, and overseeing the preparation of financial statements. This role leaves directors vulnerable to lawsuits from shareholders, creditors, customers, or employees on charges such as abuse of authority, libel or slander, and—the biggest concern these days—financial mismanagement. Board members at many corporations became concerned about their personal liability and started taking a closer look at the insurance known as directors and officers (D&O) coverage that is supposed to protect them.

Not surprisingly, the corporate scandals of 2001 and 2002–2004 had driven up the cost of D&O insurance. Following WorldCom’s June 2002 announcement that it had “inappropriately classified” nearly $4 billion in expenses, D&O insurers pulled back from covering not just WorldCom but also its banks, its suppliers, and its business customers. Another reason for the shrinking D&O insurance pool was the late 1990s trend toward astronomical settlements in class-action securities lawsuits. By 2002, high-risk companies—in the aircraft, financial, health care, technology, and telecommunications industries—were paying triple what they used to for D&O, if they could find coverage at all.

Directors and officers were made even more vulnerable with the passage of the Sarbanes-Oxley Act in July 2002. With this key piece of legislation, Congress hoped to restore the public’s confidence in U.S. financial markets by holding chief executives, directors, and outside auditors more responsible—even criminally liable—for the accuracy of financial reports. Sarbanes-Oxley was passed just one month after Enron’s outside auditor, the accounting firm Arthur Andersen, was convicted on obstruction of justice charges for its role in the financial fraud.

The days of shortage in D&O availability and affordability ended as the market softened. According to the 2005 Directors and Officers Liability Survey conducted by the Tillinghast business of Towers Perrin, the 2005 standardized premium index (that was created in 1974) decreased about 8 percent in the D&O coverage cost. The average index decreased from its highest level of 1,237 in 2003 to 1,010 in 2005. The only business classes that reported an increase from 2004 were durable goods, education, health services, and nonbanking financial services. The report also indicated that coverage limits and deductibles remained level.

The leading insurers for the line are: Chubb (21 percent) and AIG (35 percent). Interestingly, AIG, one of the major players in this line of insurance, saw its own 2005 D&O rates increasing in the midst of allegations of its improper accounting.