Private Protection in Turbulent Times

Directors and Officers (D&O) liability insurance is purhased by companies to shield the personal assets of the directors and officers against claims. In some cases, the coverage also shields the corporation itself from claims. It is a much better known coverage for publicly traded companies to protect them from claims such as securities violations, insider trading, shareholder and investor suits, corporate fraud, etc. But brokers and insureds would do well to realize that private companies might benefit just as much as public companies do from D&O liability coverage.

Private companies include a broad range of businesses and business structures. Examples of large private companies include insurance brokerages, investment advisors and many other professional, service and manufacturing enterprises. Small private companies are also prevalent, including firms such as computer consultancies or local clothing manufacturers.

The size of the D&O liability insurance market for private companies is smaller than that for public companies. It is, however, worthy of attention by brokers and insurers alike. As it stands, only a minority of private companies purchase D&O coverage. Statistics from the United States indicate that 50,000 to 70,000 private companies purchase D&O, generating premium volume of approximately US$2 billion. Given that there are more than 1.6 billion private companies in the U. S. market place, it would appear that only approximately 4.4% of private companies actually purchase this coverage.

Private companies and brokers often under-appreciate D&O liability exposures. By providing this liability coverage to their clients, brokers can use the product not only to increase their premium volume, but also increase client retention by showing the client a true appreciation for their risk exposures and a desire to help address them.

Private companies and their directors and officers are no more insulated from liability exposures than are public companies. The Professional Liability Underwriters Society (PLUS) notes the typical claims situations faced by private company directors and officers include those launched by employees (more than 50% of all claims made against D&Os); government actions (based, for example, on claims due to tax irregularities and misrepresentations, or claims that directors and officers have violated pollution laws); competitors claiming encroachment on their business; creditors claiming misrepresentation of financial information and bad faith negotiation; liability from mergers and acquisitions; customer claims such as discrimination and harassment. Statutory liability is also a particularly important risk for Canadian private companies. Governance issues related to income tax deductions from employee wages, corporate remittances for GST and CPP and employment insurance1 are all important exposures that can be addressed with properly constructed D&O policies.

The D&O policy can represent a large component of the total insurance handled by the broker. Premiums usually start as low as Cdn$2,500 for a Cdn$1-million liability policy and can reach into the six figures for the largest private companies. But no matter what the size of the premium is, the D&O policy helps solidify the broker’s relationship with that insured. It shows the insured that the broker appreciates his or her client’s risks; it also adds to the policies and bonds the client has already placed with that broker.

For the director or officer of a private company, the decision to purchase this coverage is both made easier and more difficult in the current economic environment. Making it an easier decision is the potential impact of an uncovered claim against the directors and officers and the desire to be shielded from that exposure. Making it more difficult is the need for cash preservation and fiscal prudence in this unprecedented economic downturn.

According to Deloitte & Touche’s financial advisory practice, “Canada’s economy generally mirrors major U. S. trends with a 12-18 month lag in areas like housing. However, our valleys tend not to dip as low. That means Canadian businesses will continue to be affected by the U. S. meltdown, just not as drastically.”

But, the outlook is not all rosy. As the market continues to de-leverage, global loan rates continue to decline. Lending will, as a result, become more expensive for both borrowers and lenders. Some credit-worthy borrowers may benefit, but average businesses face a period of belt-tightening.

Private companies are not immune to the impact of market turbulence. Publicly traded companies enjoy a fairly clear process when valuing their equity and debt as a result of market transparency and regulatory guidelines. For private companies, the picture is much less clear. If private companies do not clearly valuate their assets, their debt-to-equity ratios may be compromised.

The current financial crisis has both increased the cost of credit and constrained its availability. Private companies must therefore be particularly focused on managing and preserving cash flow. Even if the company itself is well positioned financially, its customers may not be. For instance, the inability of U. S. and foreign customers to pay their bills can put pressure on a company’s bottom line. So although the domestic situation in Canada may be relatively positive, global customers facing their own challenges can be detrimental to Canadian corporations.

The life-blood of many private companies is sufficient cash flow. In times like these, when credit is at a premium and hard to obtain at affordable rates, many private companies could experience a financial crisis if cash is burned faster than it is generated. Even if not directly affected by poor access to credit itself, the private company could very well see its suppliers or customers affected by the paucity of credit and therefore suffer an indirect impact. The strain on the bottom line could provide the trigger for a D&O claim. It could also, as mentioned above, cause a company to delay or suspend the purchase of D& O insurance.

CONCLUSION

For an insurance broker, helping clients help themselves means aiding in the identification and mitigation of all of the potential risks the client faces. Liability of directors and officers is one of the biggest risks out there. Increase your brokerage’s book of business while building lasting client relationships: talk to private company clients about directors and officers coverage.