The price of prominence

FINANCE & ECONOMICS
Directors and officers insurance

Jan 13th 2005
From The Economist print edition

Insuring America's corporate bigwigs may become more expensive

WHEN a company and its directors are sued for mismanagement or worse, who pays for the settlement? Usually, an insurance company. Each year, America's biggest firms spend a few million dollars apiece on premiums to cover their directors and officers in case disgruntled shareholders, employees or regulators take them to court. During the first six months of last year, claims worth more than $1 billion were paid by (or came due from) insurers who write directors and officers (D&O) coverage, according to Willis, an insurance broker.

Although directors are used to being sued, they are not in the habit of opening their own wallets in order to pay. Last week's settlements of investors' class-action suits against former directors of Enron and WorldCom are therefore unusual.

In both cases, insurers of the scandal-shattered companies are expected to fork out the bulk of the money ($36m for WorldCom; $155m for Enron). However, ten former non-executive directors of WorldCom agreed to pay, in addition, a total of $18m from their own savings, although they neither admitted nor denied wrongdoing. This is equivalent to one-fifth of their personal wealth, leaving aside their principal homes and pension money. Ten of Enron's former directors will cough up $13m—a disgorgement of insider-trading gains, say plaintiffs. (The WorldCom settlement was challenged this week by several investment banks, which are also defendants in the suit brought by shareholders. The banks, unlike the directors, have not settled.)

The circumstances at these companies were surely exceptional, or so one would hope. And the directors' contributions (for Enron, anyway) are dwarfed by those of the insurers. Still, the settlements have already sparked hot debate about whether it will now get harder to find qualified recruits for company boards. It may be too soon to judge that; but it is clear that the settlements will embolden America's armada of class-action lawyers to redouble their efforts.
“Institutional investors in the US are more and more interested in seeing officers and directors considered to be malefactors make contributions out of their own pockets,” says Melvyn Weiss, of Milberg Weiss Bershad & Schulman, a leading plaintiffs' law firm. Last year the number of new federal securities fraud class-actions, which can trigger the largest D&O payouts, rose by 17%, to 212, according to Cornerstone Research, a litigation consultancy. Often, such suits are filed after a sharp drop in a company's share price, causing losses to investors. The sums sought in the suits are rising. Mr Weiss says this is “because conduct is more and more egregious, and the amounts of losses have become so huge.”

The rise in the number and size of lawsuits probably means that rates for D&O coverage will firm up. Oddly, they fell by 10% last year, according to Tillinghast, an actuarial firm, after rocketing during the few years after America's corporate scandals first broke. The drop did not reflect a reduction in claims but a surfeit of capacity: start-up insurers in America and Bermuda have rushed to provide D&O cover. But the future looks grim. Rick Welsh of SVB, a British insurance underwriter, says that plaintiffs are seeking $60 billion-80 billion in class-action suits in America that are yet to be settled.

In Europe, the lawyers are not as fierce. Plenty of firms on the continent—in particular, family firms or companies not listed in America—do not bother with D&O coverage at all. In Britain, rates can sometimes be merely one-fifth of those in America, according to Nick Ward of Hiscox, a specialist insurer. One case to watch involves Equitable Life, a British life assurer that nearly collapsed in 2000. The company is suing 15 former directors, including nine non-executives, for up to £1.8 billion ($3.4 billion). A trial is due to start in April. The former directors are believed to have only £5m in D&O cover. That may not be enough even to pay the lawyers.

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