How will D&O insurance evolve with the coronavirus?
Although the product did not catch on until the late 1960s, after the Escott v. Barchris decision from the Southern District of New York determined that corporate directors and officers could not recoup their losses from the company, it has since become a staple of most corporations’ insurance portfolios. Like many insurance products, it has evolved continuously to meet the needs of insureds as the landscape of liability shifts and, in many cases, grows.
Today, D&O insurance looks very different than it did in the 1930s — or even the 1980s. With the advent of “Side C” coverage, which insures the corporate entity itself, and the passing of the Private Securities Litigation Reform Act of 1995, designed to limit frivolous securities lawsuits and overhaul the rules for bringing class-action suits, the coverage landscape changed significantly. Today, we are riding the wave of another major shift in D&O coverage — one that is sure to continue to grow as claims related to the novel coronavirus (COVID-19) make their way into the courts.
Traditionally, the most litigated claims implicating D&O insurance involved securities class action suits brought by investors who bought, or sold, a company’s publicly traded securities and suffered an injury as a result of the corporation’s alleged violation of securities laws and regulations. Over the past decade, however, “event-driven” claims have become increasingly common; such claims involve catastrophic events and resulting market fluctuations in stock prices and necessarily rest on the theory that the corporation is to blame for concealing or misrepresenting some key aspect of their corporate governance.
Most recently, D&O insurance has been called upon in connection with high-profile sexual harassment and assault claims that have garnered national attention due to the #MeToo movement. In 2018, for example, Wynn Resorts, CVS Corporation, and Papa John’s were all targets of shareholder derivative litigation arising out of sexual harassment and assault allegations. Insurance coverage plays a large role in the resolution of these lawsuits, just as it did in November 2017 when a $90 million settlement — paid entirely by insurers — was reached in the derivative action stemming from former Fox News anchor Gretchen Carlson’s sexual harassment suit against ex-CEO Roger Ailes.
Industry commentators all seem to agree that event-driven litigation is a troubling development, namely because the claims lack solid proof of intent (“scienter”) or causation. Despite this, the trend is likely to continue, or even pick up speed, as corporations and their shareholders suffer tremendous losses from the COVID-19 pandemic. There is a myriad of potential liabilities that creative plaintiffs lawyers may allege against corporations relating to how they protected — or failed to protect — their bottom line during the pandemic and shutdown crisis. For example, shareholders may likely claim that corporations failed to properly disclose the risks that COVID-19 posed to the company’s business and financial performance, or mismanaged the company’s response to the pandemic.
Marc Johnson, CPA, CFF, and president of Lowers Forensics International, helps policyholders mount a defense against these types of shareholder claims. “When policyholders are faced with misrepresentation or mismanagement claims, our professionals work with policyholders to review pre- and post-operating results to dispel any financial basis for the claim. This will support an insured’s defense that the best executives in the world could not have mitigated the effects of the pandemic and the related financial impact, and that the company’s actions were prudent.” Careful tracking of data is critical, relating not only to the financial impact of the pandemic on operations but also of any extra expenses and costs to defend such claims. “We also track defense-related costs and expenses to allocate properly between covered and not covered claims, as well as any amounts subject to policy retention,” added Johnson.
Policyholders may also find themselves turning to their D&O insurance for employment-related claims: as employers re-open and call furloughed employees back to work, claims alleging age or racial discrimination, or even wrongful termination, may develop. Employment practices liability insurance, often packaged together with D&O insurance, may respond to such claims.
Although D&O policies may contain bodily injury or pollution exclusions, insurers should exercise caution in how far they push their policy wording. Exclusions which bar coverage “for” bodily injury are likely entitled to a narrower construction than those that bar coverage for claims “arising out of” bodily injury. Similarly, pollution exclusions that do not explicitly refer to viruses may be interpreted as applying only to traditional environmental pollutants, and not to a contagious disease.
Event-driven claims, however, are not the only type of litigation that will implicate D&O insurance as a result of the COVID-19 pandemic. As the pandemic continues to cause global economic disruption, we will almost certainly see an increase in companies declaring bankruptcy. Companies’ directors and officers will be looking to their D&O policies to determine what protection they may provide. Savvy policyholders may look to address some of the following issues in their upcoming renewals, to avoid the common pitfalls implicated in bankruptcy-related D&O claims:
In our experience, many insurers offer these protections in their standard forms or are willing to offer the modifications upon request by the policyholder. Insurers should be prepared to negotiate these changes with their insureds at renewal.
Indeed, whether an insured’s policy will be renewing in a month or six months, policyholders will likely be much more proactive in their renewals this year. D&O premiums are continuing to increase with no end in sight. Aon’s first-quarter 2020 D&O pricing index report indicated that policyholders are seeing a 26.2% increase in premium for primary policies that renewed with the same limit and deductible. Policyholders can expect to pay significantly more for the same coverage and may shop around to save money on premiums.
In an interesting development, major news outlets recently reported that Tesla’s founder and CEO Elon Musk decided to forgo traditional D&O coverage due to the exorbitant increase in premiums. Instead, Musk agreed to personally provide coverage “substantially equivalent” to a D&O policy for one year. This unusual arrangement may beget significant issues. Are there sufficient funds to back Musk’s “policy”? What are the terms and conditions? How might the “policy” interact with a D&O policy that the company may purchase in the future (for example, claims that include interrelated wrongful acts)? Lastly — and probably most critically — will other major corporations follow suit, or is this an artifact of a unique company and its even more unique founder?
In any event, insurers should expect to see an increase in notices of circumstances from policyholders for COVID-19-related claims before policyholders renew their policies or switch carriers. Most policies provide policyholders an option to provide a “notice of circumstances,” whereby any future claims arising out of those circumstances will have been considered to have been “made” during the policy period.
When providing a notice of circumstances, the insurer will want as much information as possible (i.e., the names of potential claimants, the nature and type of potential damages, and a description of the circumstances that may give rise to a claim). However, providing sufficient detail under a “notice of circumstances” provision can be difficult for a policyholder who does not know the precise contours of a COVID-19-related claim. Insurers and their insureds should work collaboratively together to ensure valid claims are appropriately submitted and documented.
D&O insurance has undergone several major metamorphoses in its 90-year life span. All indicators suggest that the policy will continue to play a major role for corporations and their directors and officers as new liabilities emerge. The stakes are high — perhaps higher than ever — as we come to grips with the COVID-19 pandemic and the economic toll it will take.
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