Directors’ & Officers’ Liability Training presentation Zurich UK Commercial Jim Gaskin, Financial Lines Manager Zurich UK Commercial August 2005

Directors’ & Officers’ LiabilityTraining presentation

Zurich UK Commercial

Jim Gaskin, Financial Lines ManagerZurich UK CommercialAugust 2005

2© Zurich - Zurich UK Commercial / Jim Gaskin, Speciality Lines Manager / August 2005

Topics to be looked at

• Current market

• Background and history

• The cover

• How liability arises

• Statutory duties / the law

• Sources of claims

• Underwriting / financial analysis

• Conclusion


D&O - current market place

• 2005 market situation:- Last 24 months moved from soft to hard to soft market.- Rates increased – small private companies 20-30%.- Larger organisations – 200-300%.- 2005 rates now flat with some pressure to discount.

• AIG and Chubb early dominance diluted by newer entrants RSA, ACE, Markel, St Paul, Zurich and others.

• 2004 saw severe US losses plus some significant UK losses which drove price increases, capacity shrinkage and cover withdrawal but 2005 has seen some return to a softer environment.

• Loss experience increasing but capacity also increasing, targeting SMEs via online facilities.


D&O - the UK market

• Size of the UK marketplace:

- 2004: £385 million (20% growth over 2003)

- 2009: £749 million


Market changes

• Premium rate increases now flattening.

• Variation in wordings by sector such as tailored cover for charities.

• Withdrawal of additional covers (Insured vs Insured by some).

• New capacity has entered the market place in the last 18 months targeting SME business.

• A cautious approach to risk selection still exists.

• SME is the new battleground.

• Online quote tools allowing brokers to quote and bind online, thereby simplifying the process.


D&O - recent SME survey findings

• Zurich 2004 SME survey - findings:- Only 50% of companies are aware of D&O cover.- 20-30% expected growth for 2005.

• Drivers are:- claims inflation- increased risk exposure- an increase in take up of D&O first time buyers- publicity generated by Higgs* report in 2004. (* see next slide)


Higgs report 2004

• Report that looked at the role and duties of non-executive directors.

• Feeling that in the past they did not show enough independent thought and failed to provide sufficient challenge to the executive directors.

• The report put forward a number of recommendations including the minimum number of non-executives on a board and the availability of D&O insurance to protect their liabilities and so encourage a larger pool to draw from.


History and background to D&O cover

• Initially purchased by USA companies.

• UK companies first bought in early 70s driven by their USA exposure.

• Demand has grown from FT 100 companies down to PLCs, then to private companies, now non-profit entities.

• Exposure increasingly driven by:- legislation- increasingly litigious society- greater number of shareholders who are much more aware of

their rights to challenge directors, and more willing to use the courts.


The cover

• Extensions:- Outside positions – covers directors and officers when sitting on

the board of Associated Companies.

- Pollution - defence costs and shareholder actions for any loss e.g. loss in value of shares.

- Company cover for shareholder costs – order of court to cover shareholders costs in pursuing a claim against an insured person in the company.

- Employment claims – covers past, current and prospective employees (deals with discrimination in the interview process)


How the cover operates

• Claims made policy i.e. claims made in the policy period regardless of occurrence date.

• Aggregate limits - costs inclusive (as opposed to costs in addition).

• Advancement of defence costs by the Insurer so the directors are not out of pocket.


The cover - who is covered?

• Directors of the company including non-executive directors and shadow directors.

• Officers of the company including Company Secretary, Chief Accountant, Personnel Manager.

• Managerial and supervisory positions.

• Employees when joined as co-defendant.

• Persons appointed by the company as liquidator administrator.


The cover - what is covered?

• Civil awards, judgements and legal defence costs arising out of wrongful acts committed, or alleged to have been committed.

• Allegations of a criminal nature are covered but only for legal defence costs incurred - if proven then any fines or penalties imposed are not covered.


The cover - what is not covered

• Proven fraud and illegal profit.

• Pension trustee exposure.

• Insured versus insured. Cover will vary in response to directors suing fellow directors.

• Professional indemnity. A director who also acts as an engineer is not covered for their advice as an engineer under a D&O policy.

• Prior circumstances and litigation e.g. situations aware of in advance purchasing the policy.


How does liability arise?

• Duty of skill and care:- Common law duty.- Test of reasonableness which is subjective.

• City Equitable (1925) - “a director need not exhibit in the performance of his duties a

greater degree of skill than can reasonably be expected from a person of his knowledge and experience. A director of a life insurance company does not guarantee that he has the skill of an actuary or a physician”


How does liability arise?

• Fiduciary duties:- Common law duty and embedded in corporate governance.

- Directors are in a position of trust, act honestly, in good faith and act in the best interests of the company with their first duty towards shareholders.

- Conflicts of interest must be managed in the best interests of the company – e.g. non-executives who serve on two companies trading together.

- Enron in the USA was good example of a breakdown in these duties.


Statutory duties

• Continually evolving- Companies Act 1985 & 1989 – Patricia Hewitt, misleading

auditors 2 years, unlimited fines.

- Insolvency Act 1986 – fraudulent/wrongful trading.

- Health & Safety at Work Act 1974 – unsafe working practices.

- Environmental Protection Act 1990 & 1995 - pollution.

- Employment legislation e.g. ageism.

- European legislation – who knows? What’s next?


Who are the duties owed to?

• Firstly to the shareholders – example Claims Direct faced a £200m claim from its shareholders.

• The Company itself and minority shareholders. Future legislation may enable minority shareholders to hold directors accountable.

• 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


Consequences of directors failing in their duties

• Criminal prosecution - fines and/or prison.

• Civil proceedings leading to fines.

• Civil proceedings leading to an award for damages or other remedy e.g. injunction.

• Official enquiry, investigations etc - costly.

• Disqualification of directors.


U.S.A. Company law

• Securities legislation:- Securities Act 1933- Securities Exchange Act 1934- Racketeer Influenced & Corrupt Organisations Act 1970.

• Recently the Sarbanes-Oxley Act - executive certification of financial statements plus other governance rules and increased penalties. This may have an impact on UK directors.


Company indemnification

• The Companies Act states that the company cannot indemnify its directors unless the director is found to be innocent of the allegations - but it also allows the company to purchase insurance to offset that risk.

• Therefore directors are on their own in terms of:- funding their defence- payment of civil awards- damages and settlements (all covered)- payment of fines- penalties- jail sentence (not covered).

• This was the position up to April 2005.


Update on indemnification

• Companies (Audit, Investigations and Community Enterprise) Act 2004 - effective 1st April 2005.

• Allows the Company to now indemnify directors only, (not other insured’s as covered in a D&O policy) when there is permitted indemnity.

• In other words it allows Companies to indemnify directors in respect of actions brought by 3rd parties for legal costs and the financial cost of any adverse judgement.

• Except for:- criminal penalties- penalties imposed by regulatory bodies- legal costs of unsuccessful defence of criminal proceedings- legal costs in any civil proceedings brought by the Company or any

Associated company when judgement is against the director.


Update on indemnification

• So, in conclusion:- Directors are only protected by the Company in certain

situations.

- The Company is only able to indemnify and is not required to.

- Only directors are protected not officers or other insured persons.

- Directors and officers are still at risk for which both the Company and its D&O’s would seek to transfer that risk to a D&O policy.


Where do claims come from?

• Shareholders - when they feel the company has been mis-managed to the detriment of their share value.

• Share issues and listing on stock exchanges.

• Creditors e.g. wrongful trading.

• Employees e.g. discrimination, wrongful dismissal.

• Libel and slander.


Where do claims come from

• Regulatory and Government bodies e.g. Corporate manslaughter.

• Competitors e.g. unfair competition as dealt with under the Enterprise Act.

• Customers e.g. Holidays abroad and customers left stranded.

• Mergers, acquisitions and disposals e.g. hostile takeovers.


What do underwriters look at to assess the risk

• 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.


Underwriting factors

• Financial performance and strength – the better it is the less likely a claim.

• Share price performance if applicable – is it out of line with the industry sector.

• Overseas exposures especially USA and Australia – amount of assets is the key measure.

• Industry sector.

• Length of establishment – longer in existence the less risk.

• Acquisitive – Nature of business, aggressive acquisition strategy.

• Future strategy – credibility of strategy.


Underwriting factors

• Experience of Board of Directors e.g. some directors attract greater profile.

• Recent changes at senior management or board level – churn rate of directors.

• Changes in auditors – too cosy, challenging, poor relations/why?

• Representation at proceedings – how often does this happen?

• Previous claims / circumstances – number of previous claims, history.

• Employment issues / layoffs / closures, e.g. failing strategy?


Rating

• Traditionally assets have driven the rate - US assets carry a far higher rate.

• U/W factors then load or discount premium but financials are the most important factor.

• Other sources of info would include press coverage, credit rating services etc.

• Turnover is an alternative but only suitable for small companies with low risk.


Conclusion

• Directors’ & Officers’ Liability is an ever changing product responding to an ever more threatening legal landscape and driven by an expanding market place.

• Cover needs to be examined carefully.

• Please log in to the sales section of www.zurich.co.uk/commercial for more information on D&O cover including case studies.

• Please contact your local Speciality Lines Underwriter with any questions.

Documents

Directors’ & Officers’ Liability Training presentation Zurich UK Commercial Jim Gaskin, Financial Lines Manager Zurich UK Commercial August 2005