In this segment of Inside Scoop, Kathy Jaffari is joined by Sarah Downey, Managing Director, Financial Services Claims Leader and Blockchain Advisory Leader at Lockton Companies, for a timely conversation regarding D&O insurance. Sarah shares her thoughts and practical guidance, covering the fundamentals of the protections that A-B-C D&O insurance coverage provides and three topics that D&O insurers are focused on right now — event-driven litigation such as cyber breaches, board diversity, and shareholder activism around ESG. She explains that if companies are aware of and prepared to discuss the topics that are top of mind of insurers, they will be better equipped to negotiate their insurance coverage, especially during the renewal process.
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Transcript
Katayun Jaffari:
Hello, everyone. Thank you so much for joining us today on Inside Scoop, a series brought to you by Cozen O'Connor. Welcome to your next 20 to 30 minutes of getting the inside scoop regarding some topics in corporate governance and securities that we believe are top of mind of board members, executives, general councils, as well as compliance officers.
I'm very happy to be here today with Sarah Downey of Lockton Companies. Sarah is a Lockton Financial Services claims leader, as well as the blockchain advisory leader. I've had the pleasure of meeting Sarah, who works with a longtime friend and colleague, Deana Calvelli, a partner and consultant of Lockton's Northeast leadership team. As chair of the Corporate Governance & Securities Group at Cozen O'Connor, I have the privilege of advising clients with respect to directors and officers insurance. It's always helpful when advising clients with respect to D&O insurance, to actually learn about the trends and those challenges, opportunities, and pitfalls that might arise around D&O insurance.
Katayun Jaffari:
Some of you actually may be looking at D&O insurance as we speak because I think this might be the time with respect to some renewal. As a result, we have Sarah here who may be able to provide us with some tips to consider. Sarah is one of the leading D&O and executive risk claims and coverage experts. An industry pioneer in creating risk transfer solutions for clients, Sarah is also bolstering Lockton's expertise in the blockchain risk advisory space. Lockton is the world's largest privately held insurance broker with nearly $2 billion in revenue. Lockton's business is focused on helping employers in all areas of risk management, workplace benefits, and retirement plans.
Sarah, thank you so much for joining us today on Inside Scoop here at Cozen O'Connor. I wanted to actually start, because I'm hoping that you could provide us with some really tips, insight, guidance, practical guidance, when we're talking about D&O insurance and trends, especially since we are in the renewal time for some of our clients.
Katayun Jaffari:
I really enjoyed speaking to you previously when we were planning this event. And I know there's a lot we can talk about regarding D&O insurance in general, but I actually, Sarah, want to start at the basics. So would you mind just reminding us all what we mean when we're talking about the—and I'm going to call it the alphabet soup, right—the side A, B, and C—when we're talking about D&O insurance. Let's start there.
Sarah D. Downey:
Sure. First of all, thank you so much for having me, Kathy. I'm so glad to be here. So to break down D&O insurance to the basics. We do refer to it as A-B-C coverage. Just big picture wise, directors and officers liability insurance, or D&O insurance, protects the individuals—the directors and officers—that run a company. And many times it also protects the company itself.
Sarah D. Downey:
So when we talk about A-B-C insurance, we'll start with Side C insurance first. We call that balance sheet protection. That is the part of the coverage that protects the entity or the company if the company is alleged to have done something wrong. Side B coverage we call reimbursement coverage and that coverage is where the individuals are alleged to have done something wrong, but the company is able to indemnify the directors and officers for defense costs or settlement and judgment. So it's reimbursement coverage. And then last but certainly not least, is Side A coverage, which we refer to as personal asset protection. And that is the part of the coverage that most view and consider to be the most important because that protects the individual directors and officers for non-indemnifiable loss of where the company, for whatever reason, cannot pay the directors or officers defense costs, settlement, or judgment.
Katayun Jaffari:
And we're going to talk a fair amount about that side, right? Because that's one of the most important sides when we're talking about D&O insurance. And that's what directors and officers—they're focused on all of it, but we want to provide some guidance and tips regarding the Side A. Is that right, Sarah?
Sarah D. Downey:
That is right. Absolutely. Side A is definitely the most important piece of the coverage. It is referred to as personal asset protection for a reason. It is often the last line of defense protecting an individual and their personal assets. So think derivative actions where settlements in many jurisdictions are not indemnifiable, or insolvency situations where a company is unable to advance or pay the defense costs on behalf of an individual. And then just sometimes indemnification is actually prohibited by law or a company, for whatever reason, refuses to indemnify an individual. And that's where Side A coverage kicks in and that's why it's so important.
Katayun Jaffari:
And I'm glad you touched on that. I want to talk about the derivative litigation piece of it. Okay. Share your thoughts on that piece of it. Are we seeing more derivative suits?
Sarah D. Downey:
Yes. It's not even the number of derivative suits per se that's relevant in this discussion. It's more the way that the derivative lawsuits are playing out. So just to step back again, derivative suits, it's not where there's a stock drop necessarily, but instead it's where a shareholder steps into the shoes of the company itself and sues the board for things like breaches of fiduciary duty. And traditionally derivative actions would settle for corporate governance changes or corporate therapeutics. But over the last, I would say, 10 or so years we've started to see more and more derivative actions settle, not just for corporate governance changes, but for compensatory monetary damage piece as well. And in most jurisdictions, that settlement is non-indemnifiable, and the amount of that settlement can be significant. So that's the trend the D&O insurers are really watching—there's been an uptick in the amount of derivative action settlements and, therefore, how much Side A insurance has been paying out.
Katayun Jaffari:
Got it. And you also mentioned to me that there's been an uptick on the damages themselves, right? The size of damages has grown as well.
So now let's actually talk a little bit about trends. I want to have a sense, or share with our audience, what are the hot topics that D&O insurers are discussing because they're trying to actually figure out how to underwrite certain areas. You really shared a number of really interesting hot topics.
Sarah D. Downey:
Yes. So the three I want to highlight, because there are more than three, but the three I want to highlight—the first is event-driven litigation, and that's kind of a big bucket. But that's non-accounting-based litigation arising out of adverse news or an event that causes financial or reputational loss to a company. So think of cyber breaches or wildfires, COVID-related claims, product recalls. Those are just examples of event-driven litigation. And because there have been fewer financial restatements over the last number of years, the plaintiff firms are now focusing on event-driven litigation. And those are so hard to predict.
Sarah D. Downey:
Think about cyber breaches, for example. So of course this happens very often these days. D&O insurance doesn't insure the actual cyber breach, but it could insure the directors and officers if they're named in some type of management suit arising out of a cyber incident. And how can D&O underwriters really underwrite this exposure? Other than focusing on a company and their cyber protection, they try to ask as many questions as they can about those cyber protections—the board involvement. But it's really, really challenging to underwrite something that just isn't predictable.
Katayun Jaffari:
Well, and I think the next one that you and I talked about is diversity. And let's talk about that one a bit because I can't imagine how you underwrite that. So share your thoughts on that.
Sarah D. Downey:
Yes. Board diversity is another really, really hot topic. It's both from a litigation perspective and a regulatory perspective. So from the litigation perspective, there are a number of suits that we know have been filed against directors arising out of board diversity or lack of board diversity issues. And tying this back into the derivative action discussion, all or most of those diversity suits that have been filed are actually derivative actions with regard to allegedly false assertions about a company's commitment to diversity and inclusion. From the regulatory perspective, we've seen California, for example, pass a law that requires greater diversity on boards. That law is similar to a law that was passed shortly before that addressing the need for women on boards, and other jurisdictions are following. And so, of course diversity suits are very challenging to predict as well, and underwriters are trying to figure out how to underwrite this exposure. But again, short of asking questions about a board's composition or some other board-focused questions, it's a struggle to underwrite board diversity exposure because it is so unpredictable.
Katayun Jaffari:
And the next one, same difficulty, hot topic of—
Sarah D. Downey:
The shareholder activism and ESG, or environmental, social, and governance issues. Board diversity fits into ESG, but board diversity, I think, warranted its own specific discussion.
Katayun Jaffari:
I agree. I'm glad you distinguish that a little bit, but go ahead.
Sarah D. Downey:
Good. Awesome. So for shareholder activism, it's a real concern, especially for public companies and their boards. And it's not just limited to public companies, but activist demands can come in many forms. They come can come in as a proxy contest, a demand around adding a specific director to a board, or a demand that a company be sold or broken up. And increasingly activists are focused on ESG issues, which really just highlights how important this is. We already touched on board diversity, but not just board diversity issues, but there are also demands for diversity in the workforce as well. So it's important not to lose sight of that. Climate change is the other really hot ESG issue right now. There has been, and there will continue to be, an increase in demand for greater climate-related disclosures and financial statements, and that companies enact environmentally-friendly policies.
Sarah D. Downey:
And if that's handled incorrectly or in a way that is perceived to be incorrect, there could be exposure to the company and the individual directors and officers. It's worth noting that coverage for activism activity has traditionally been limited and really varied by insurer. And what I mean by that is that coverage for activist claims is often based on the nature of the specific activity, that issue, how the claim is brought, and the specific policy wording. So this is something that may ultimately not be covered under a policy, depending on how an activist demand comes in. It's just something to pay attention to. And unfortunately like event-driven litigation and board diversity issues, climate change-related issues and activism overall is incredibly hard to underwrite and predict. And of course, again, like event-driven litigation and board diversity, climate change claims can also come in in the form of non-indemnifiable exposure. So it just kind of ties neatly back in with the importance of Side A coverage.
Katayun Jaffari:
Exactly. And that's going to be my next question. And you took the words right out of my mouth, which was perfect because it does really highlight the importance of Side A. So how do carriers actually look at these issues and what should directors and officers and companies think about as they are trying to get renewals of their D&O insurance?
Sarah D. Downey:
Yes. So it's worth noting that, of course, and I said it before, these are not the only issues D&O underwriters are thinking about. So if you put yourself in their shoes, renewals are very challenging for the D&O underwriters themselves. These buckets of issues and others are very challenging to predict, so the underwriters are rightfully pretty concerned about them. And right now the best way for them to really underwrite these unpredictable exposures is by asking a lot of questions.
Sarah D. Downey:
So again, going back to board diversity, some examples of questions you might get at your renewal are what does your board composition look like? How often do you do a board refresh? When it comes to cyber related issues, which is a very, very hot topic, you might get questions about your cyber protections. What do they look like? Have you ever run a cyber tabletop exercise? What do the internal communication and reporting channels look like? Should there be a cyber issue, how involved is the board? Things like that. So while underwriters can't really underwrite for these issues, per se, they try their best to do their research and homework before actually offering a renewal term.
Katayun Jaffari:
So a couple of tips and things that I want to tease out so far of this excellent conversation. Thank you for sharing your thoughts on all of this, Sarah. Is, number one. I'm glad you highlighted it a second time. Make it clear. These are just three topics we're sharing. This is not all of them that are a focus right now of carriers. But we thought that it would be important to make sure that companies, officers, and directors really understand that there are topics out there that five, 10 years ago, even two years ago, for example, the diversity one, might not have been brought up as much as it will be, does today, and will continue to be.
Katayun Jaffari:
I also want to highlight even the SEC is, we all know, looking at ESG this fall and rules and regulations around ESG disclosure. So this is not going away. So the tip and guidance is—be prepared. We want clients and companies to know that the questions will be coming, and don't be surprised, and be prepared to answer these types of questions. So I just want to highlight that piece, Sarah. I thought it would be important to highlight that piece. Let's actually move the conversation to a little bit about the D&O market. Could you give us some insight as to what the market looks like right now?
Sarah D. Downey:
Yes, absolutely. And it's a very, very important discussion. So after about 15 or so years of a soft market, now a soft market is a buyer-friendly market when pricing is low, the terms are very, very broad, the underwriters were very open to negotiating policy terms to the benefit of the insured or the policy holder. So after about 15 or so years of a very soft, buyer-friendly market, the D&O market started to harden about two years ago and it progressively got worse and more challenging. And I'm going to get to it, there is a light at the end of the tunnel, but right now the market is very challenging. Some call it a hard market and a hard market really means the opposite of the soft market—pricing is high, the policy terms, the coverage terms are pretty narrow. If there had been certain endorsements or enhancements on a D&O policy, there's a chance that the carriers might have pulled those back in the last year or so.
Katayun Jaffari:
Oh. Okay.
Sarah D. Downey:
Yes, it's challenging, and it's not just limited to that. So when carriers are adjusting claims, they have become much more challenging. Where they used to be open to potentially negotiating and compromising, they're taking a much harder line with respect to claims. And then going back to just underwriting, they're cutting capacity. What I mean by that is previously you might have seen a large carrier put maybe a $10 million limit on a program for a specific policy holder, or even a $15 or $20 million policy limit. Now you could see policy limits from one specific carrier, as low as, let's say, $2.5 million dollars or $5 million. So if you have a client or if you're a company and you're used to buying, let's say, $100 million worth of D&O insurance—$100 million in limits, previously, maybe, you could have had five to 10 insurers on your program make up that a $100 million. Now you could see 15 or 20 insurers making that same $100 million tower. It's different.
Katayun Jaffari:
That's very different, Sarah. So again, another tip or piece of guidance, don't be surprised. Companies should not be surprised if that spreadsheet comes in front of them with 15 versus what it used to look like, five.
Sarah D. Downey:
Exactly. But the good news is that there is a light at the end of the tunnel. We are all very optimistic about it. There are a number of new entrants in the D&O space, meaning there are some new D&O insurance markets that have entered the space. And of course the more competition you have, the cheaper pricing becomes and the more carriers are willing to negotiate, and the more manageable the whole placement process becomes. So we are cautiously optimistic that we're moving in the right direction.
Sarah D. Downey:
You know, it's also worth just pointing out, in addition to these new insurance entrants into the D&O market, the harder to place classes of business. So if let's say you look at a life sciences company or potentially a cryptocurrency company, or cannabis, things that are harder to place. Those companies, many of them have explored, during this hard market, some creative alternative risk-transfer solutions, things like captives or trusts, or just different creative program structures. And so those are things that all these companies will carry forward even as the market becomes softer. So it's just worth noting that there are some alternative options out there as well.
Katayun Jaffari:
Okay. So what's a company, or what should companies, do to prepare for the current D&O market?
Sarah D. Downey:
I think there are a few important things that you can do to prepare. First of all, spend time building relationships with the insurance market. Really, you need to distinguish yourself from the pool of other companies out there looking for insurance. And while that can be done during the underwriting meeting and at the time of renewal, it's more meaningful to try to do that off cycle. So when you're not actually asking for something from the insurers, you can focus on building your relationship. So at the time of renewal, it's a little harder for your underwriting contacts to take a hard stance. In addition to building relationships, establish your coverage priorities. So think about, is keeping pricing down your priority? Is it adding more limits? Is it the breadth of coverage that's important to you? Maybe you only need Side A insurance. Maybe B, C insurance is not that important.
Sarah D. Downey:
And these are all things to think about and be prepared to talk about with your insurance broker at the time of renewal. You could also discuss creative options with your broker. I already mentioned captives and trusts, but you could consider taking a very large self-insured retention, which is akin to a deductible. Co-insurance options is something else we have a lot of clients talking about, where the company itself pays a portion of its limits. So they have some skin in the game too. So, again, just understanding and establishing your coverage priorities. Definitely prepare for your underwriting meetings in advance and start the underwriting process early. Now that doesn't really mean, we like to say, try to start planning this 90 days out. That's not a hard and fast rule, but the earlier you start it, the more time you have to market your program to newer insurers, maybe who aren't already on your program, the more time you have to respond to underwriting questions and things like that.
Sarah D. Downey:
And then the last tip, review your policy wording, understand its limitations, understand the coverage triggers, know what your obligations are as far as when to report a claim, and just be sure that you are getting the coverage in your policy that you think you need. And these are all things that if you decide there's something that is not currently in your program, the earlier you start to do that, and the better understanding you have, the more you can try to work through some of that stuff with your broker and the carriers.
Katayun Jaffari:
Those are a lot of great tips. I don't need to repeat any of them. And I actually think what I heard from those is the last tip, which is really, make sure that you have the type of Side A coverage in place that you want. Sufficient Side A coverage, I think. Sarah, anything else to add?
Sarah D. Downey:
No. Really, just make sure you have the appropriate Side A coverage in place to protect the individuals serving your company and start your underwriting process early.
Katayun Jaffari:
That's perfect. Thank you so much, Sarah, for giving us some helpful insights, guidance, and what I would say is a lot of tips—a lot of things to keep your eyes out on when you are looking at D&O insurance. And you also shared with us some trends and hot topics that help us keep in mind as we look at D&O insurance. So thank you so much for joining us for this conversation. I also want to thank the audience for joining us for this conversation. If you have any questions, to the audience, you can contact me directly at kjaffari@cozen.com. And I'm sure if we need to, we can get you in touch with Sarah, right, Sarah?
Sarah D. Downey:
Absolutely.
Katayun Jaffari:
So please keep your eyes out for future programs brought to you by the experts, and brought to you by Cozen O'Connor's Inside Scoop. Thank you everyone and have a great day.