Financial MANAGEMENT LIABILITY

Bugs, big deals, bad spills and a certain public official’s sexual high crimes and misdemeanors were all key factors driving the corporate insurance market throughout 1998.

And the same scary financial exposures will likely be very much in the minds of Canadian risk managers, their insurers and intermediaries for much of 1999, key industry players say. “Ask any underwriter on the street and Y2K was an issue in almost everything they did in 1998,” observes AIG’s Lynn Oldfield.

The millennium bug “added a layer to every insurer’s, broker’s and client’s due diligence,” she added. In mergers and acquisitions especially (in what Fortune magazine describes as yet another “record M&A year”), buyers were looking for coverage that would shield them from liability-minefields buried in an acquired company’s non-compliant systems. And that caution isn’t expected to let up as the clock ticks down to 2000.

The whole Y2K liability area is “pretty dynamic,” one observer notes. Chubb Insurance Company of Canada senior vice president Udo Nixdorf says he’s heard of a few doomsayers, like the kind who have predicted that next January 1 will kick off a claims snowball which will gain size and power threatening enough to send fleeing before it all of the market’s current excess capacity. However, he does not believe that Y2K will become the insurance crises predicted. “I believe the widely exposed corporations … especially the big, public companies here with U.S. operations for instance… will be prepared. There’s been an incredible amount of due diligence going on around this issue, it certainly will have an impact but it won’t be cataclysmic. And the biggest exposures are in the high tech world itself … the consultants, software manufacturers and so on.”

Chubb caused a stir last year when it announced that it wasn’t excluding Y2K. “We never believed there was really a valid reason,” Nixdorf explains. “Y2K comes down to due diligence and proper disclosure, the same as any other financial or operational oversight duty.” Instead, he says, the company embarked on a process of personal interviews with insureds beginning in 1995, to make clear its due diligence expectations.

D&O and E&O liabilities

Laura Bruneau, vice president of claims with Encon Insurance Services in Ottawa, agrees with industry experts who say that D&O and E&O policies will be obvious sources of coverage for Y2K related claims. And she says she won’t be suprised to see Y2K claims prompting “serious coverage disputes” between insurers and insureds.

“Many experts believe that the day you have a claim is the day you’ll find out what kind of Y2K coverage you really have.” She also suggests risk managers ensure they’ve factored expenses for these kinds of disputes into their organization’s potential Y2K litigation costs.

All of the M&A activity in 1998, in Canada as well as in the U.S. (here, think cable TV and newspapers, theatrical production companies, grocery chains, telecommunications, oil and gas, mining, insurance and banks … well, almost …), as well as some scandal-plagued stock offerings stirred up a swarm of new exposure angles, especially in the ever-more litigious environs to the south. However, with a few Canadian names hitting the headlines over the past few years — notably Bre-X, Hamilton-based Philip Services Corp. and Livent — some spark was added to both D&O and E&O markets here.

New players boost

rate competition

When it comes to Directors’ & Officers’ products especially, last year brought new players to new markets, expanded coverages and producing fiercely competitive pricing. On the latter, Greg Winterson of Royal & Sun Alliance offered one strong adjective to describe the market: “Horrendous. Absolutely horrendous.”

Winterson took particular note of the “blended” corporate covers that some companies are offering for everything from D&O/fiduciary, E&O, employment practices and at least some Y2K protection — single-limit, single-deductible and single-premium packages (which Chubb, for example, is offering to mid-sized companies via its Forefront package).

Winterson believes it won’t be long before someone introduces complete indemnity packages. “And I’ll wave as they go down the dumper,” he sniffs. Observing that there are now more than a dozen companies in Canada chasing D&O business (a pie that represents only about $120 million in premium according to most estimates, compared to about $3 billion in the U.S.), he suggests all of the competitive thrust-and-parrying going on will catch up to the D&O combatants.

Bargain days are over

Chubb’s Nixdorf, who might be seen as one of those fisting it out, insists prices can’t go any lower. And, although, insurers always say that, he offers some reasons why risk managers and their brokers shouldn’t expect to find many bargains in 1999.

He notes that frequency and severity trends are both still headed upwards. He sees the year as a “pivotal year for D&O and other specialty lines, and not just because of Y2K”. Most businesses being indemnified today, especially by insurers without sufficient D&O experience, have “a loss lurking somewhere,” he observes.

And, Nixdorf agrees with Winterson that the size of the Canadian market can only support “a handful of players”. As such, he believes there will be a market shakeout within the next 18 months.

Bleeding flows into

commercial fidelity

Another area that’s hurting is commercial fidelity, where again, claim trends are up while rates and deductibles are down, insurers note.

White-collar crime is on the rise and all of the M&A and new-stock-issue activity has ripened opportunity for less-than-honest players. According to RCMP alerts, Asian and Russian organized crime gangs are moving in on legitimate businesses as investors and jockeying those investments into seats on board of directors. And, Canadian companies venturing into foreign markets and projects are also vulnerable to ingrained local habits of bribery and corruption.

According to Bruneau, Canadian companies don’t have to venture all that far afield to get into trouble: just the other side of the 49th parallel is plenty far enough. For many growing, cash-hungry Canadian concerns, the deep pockets of American stock exchanges are too tempting. She urges them to proceed with caution.

Comparing the still relatively young civil Canadian securities law scene with the U.S., with all of its predatory plaintiffs lawyers, she says: “The differences are significant, namely U.S. SEC regulations, attorney contingency fees, trials by jury and the huge damage awards that U.S. juries often grant. Canadian Directors and officers often comment on their inexperience and their need to learn about it and their preference for getting this education before a claim and not during a lawsuit. You’re going from swimming with some smallish barracudas, who have a lot of sharp little teeth, to swimming with some big, hungry sharks.”

Bruneau adds that she’s “very concerned” over the lack of preparedness of many directors and officers of Canadian companies listing on U.S. exchanges. “There’s a huge need for education,” she adds.

Canadian twist

In light of the differences, Bruneau (who is also a lawyer) wonders if executives of Canadian companies with no U.S. exposure are being needlessly alarmed by some players trumpeting the dangers of increased Canadian based shareholder actions, as growth could be spurred by class-action legislation now in effect in B.C., Ontario and Quebec.

“An important distinction is that the allegation of ‘fraud-on-the-market’ is not available to Canadian shareholders when suing in Canada,” she explains. Normally, a U.S. shareholder class action will include allegations of fraud-on-the-market, as such conduct would be pivotal to the plantiffs’ case and the jury in assessing liability and damage awards. Without the right to claim damages for alleged fraud-on-the-market, it isn’t likely Canadian outcomes will match U.S. cases.

However, as Oldfield points out, the Bre-X case, which is now before a Te xas court, will decide whether Canadians may join U.S.-based class actions. And the more recent high-profile suits involving “accounting irregularities” (such as Philip Services and Livent), will keep this kind of exposure in front of risk managers for months to come.

Internet exposures

Oldfield warns that the Internet, especially the growing practice of posting prospectuses and other investor information on company Web sites, is also posing new exposure challenges for public corporations. For example, Internet service providers and their parent companies are under the gun after Philip Services won a dozen court orders in Canada forcing them to reveal the names of subscribers who had posted “defamatory” messages about the company on bulletin boards operated by America Online, PsiNet and others. (Philip Services, which restated up to three years of earnings last year after the discovery of what management insists were unauthorized copper trading, saw its stock drop from nearly $28 to $5. The company is now facing more than 20 shareholder lawsuits contending, among other things, that it artificially inflated earnings.)

Environmental exposures

Risk managers should have also taken note of two Canadian-managed companies at the center of toxic spills in other countries last year.

Damage and clean-up costs are still mounting from a toxic-waste spill from a burst reservoir on the site of the Los Frailes mine in southern Spain last April. The mine was owned by Toronto-based Boliden Ltd. The disaster, which occurred near Donana Park, the country’s largest nature preserve, has prompted demands from environmental and other groups for international monitoring of mining operations.

The second incident, which involved cyanide being spilled into a river in Kyrgystan in May, after a truck crashed while en route to the Kumtor mine operated and owned in part by Saskatoon-based Cameco Corp., turned out to have caused little lasting harm according to a report issued by a panel of international experts in September. Still, two such high-profile accidents in one year have further damaged the reputation of the Canadian mining industry, and are likely to increase risk management costs for domestic and foreign operations, experts suggest.

“Pollution is still a high-profile topic,” observes Bruneau. “Insurers walked away from it for a while but coverage for certain pollution exposures is now available. Still, we probably see more uncovered pollution claims than we see covered ones.” And there is a lack of understanding and clarity, she adds, partially caused by “some very tricky, specific wording”. She suggests risk managers review their pollution covers several times. “If it’s still not clear, call your insurer or broker and describe five or six examples of what could happen and ask if you’d be covered,” she suggests.

Her colleague, Encon’s vice president of professional indemnity Mark Reszel, notes that current dilemmas for risk managers around policy language and reliability of coverage in areas like pollution and Y2K “is probably a function of the current marketplace. If you remember there’s too much capacity right now, which has led to lower premiums, then competitively, you next have big pressure to expand coverage. There will be a natural tendency for insurers to want to appear as though they’re giving something more. But, more often than not, that won’t really be the case,” he comments.

Other exposures

When asked about other recent trends and developments likely to be shaping the Canadian corporate insurance market, such as several high-profile employment practices/sexual harassment suits and awards in the U.S. (President Clinton’s troubles chief among them), Laura Bruneau says: “In the strictly Canadian context, issues such as employment discrimination or sexual harassment are nowhere near as expensive as their U.S. equivalents. What can be frustrating is that a lot of these trends that originate in the U.S. aren’t all that significant for Canada while we have other, unique issues. Take bankruptcy claims for instance. They don’t even exist in the U.S. but they can be monsters in Canada.”

That’s because Canadian governments have generally adopted the view that directors can be held personally responsible for unpaid taxes, such as GST and PST, and employee wages, liabilities that can easily amount to millions, she points out. Recent cases have also seen creditors successfully sue for recovery of credit extended after they had been assured by a director or officer that the company’s balance sheet was a picture of health.