Magazine

Running for Coverage


Buck naked. That's how many executives and company board members facing multimillion-dollar shareholder lawsuits may feel in the post-Enron era. Fearing an explosion of litigation over alleged executive misdeeds, insurers are retreating from writing Directors & Officers (D&O) policies to cover execs against court costs and fines if they are named in suits ranging from sexual harassment to insider trading. Insurers were already jittery about the growing number of dot-bomb class actions. Now the Enron Corp. (ENE) debacle is "making everyone in the business recognize the potential severity of D&O losses," says John Keogh, president and COO of National Union Fire Insurance Co., American International Group Inc.'s D&O unit.

Less than a dozen companies--including AIG (AIG), Chubb (CB), and Great American--underwrote 98% of such insurance in the U.S. in 2001. Eight insurers, including Aegis, Lloyd's of London, and St. Paul may face claims from Enron directors or officials. Aegis, as lead insurer, could be looking at $100 million alone. On Jan. 18, Enron asked the Manhattan bankruptcy judge to make its insurers advance cash to executives and directors for legal fees.

Even before Enron collapsed, all major D&O insurers in the U.S. were taking stock of the business. Lloyd's of London, the third-largest player behind AIG and Chubb Corp., has cut back its U.S. D&O operations since early 2001, competitors claim. A Lloyd's spokeswoman would only say: "We have become extremely selective [about whom to insure]."

Premiums were slated to increase by 25% to 400% because of the jump in shareholder litigation after the Nasdaq crash, says Willis Group Holdings, a London insurance broker. And insurers were increasing deductibles. Now they're drastically scaling back the scope of policies.

Typically, companies take out D&O insurance for high-profile execs and board members. Costs vary by business size and industry. Premiums averaged $242,000 a year for utilities in 2000, reports Tillinghast-Towers Perrin, an insurance-industry consultancy, but were just $67,000 for health-services companies.

Now, just getting coverage will be hard. Companies that a few years ago could buy all the D&O insurance they needed from one insurer may have to visit 8 or 10 to get covered, says Mark Larsen, a consultant with Tillinghast-Towers Perrin. Insurers are "being very stingy with their coverage. They're only giving a handful of policies out to their best clients."

Enron is a worst-case scenario for D&O insurers. The pension holders and investors who have filed suits against the company, its officials, and directors know they'll get little from Enron, which is bankrupt. Instead, plaintiffs' lawyers say, their clients hope to recoup some of their losses on the approximately $350 million in coverage that Enron had purchased for its directors and execs--which the company had increased substantially after 1999. The insurers will surely fight any claims in court, and it's far from certain that they'll lose. As a rule, D&O insurance doesn't cover instances of fraud or criminal wrongdoing.

Insurers deserve some of the blame for their rising D&O risk. After Congress passed the Private Securities Litigation Reform Act of 1995--which, among other things, gave executives a legal safe harbor when good-faith projections didn't pan out--insurers thought securities litigation would all but evaporate. They rushed headlong into the D&O market, cutting premiums and offering bonuses such as longer contracts and extra coverage to companies that upgraded their policies. Total available D&O coverage sold annually to U.S. businesses rose 70% between 1995 and 2000, to $1.5 billion.

Instead, after the Nasdaq crash in spring, 2000, shareholders went on a litigation rampage against tech companies and their investment banks. Securities class-action settlements more than doubled between 1995 and 2000, to $4.4 billion. Average damage awards jumped from $25 million per case to $200 million in that period. Much of that money ultimately came from D&O coverage.

Now that Enron makes the market look even riskier, some companies may find that they can't afford D&O insurance at all, says Fred Podolsky, CEO of executive risk practices at London's Willis Group. If that happens, top brass will have more reason than ever to make sure that their company is run well. After all, their wallets will be on the line. By Heather Timmons in New York


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