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Directors and Officers Beware
January, 2012
By Andy Schwartze
We are seeing a significant rise in the interest for directors’ and officers’ liability insurance. It’s a sign of the times and one should understand what is happening, in our world, in order to wrap our heads around issues concerning what is referred to as “fiduciary” responsibility. As this article is being written it is early October, and for those who follow international markets it feels like the end of the world is nigh. For those who aren’t particularly concerned by these developments, you should be, as the in one way or another, ultimately affect each and every one of us. Financial market health impacts everything from the retail world up to and including the liquidity of pension plans. As we pen these words investors worldwide, of all types and sizes, are getting what is in financial circles often described as a “hair cut”. The world of the EU was one that we never understood. How over two dozen countries, each with their own fiscal system, some sound and others totally trashed, could pretend to use the same currency has always confounded me. The direction in which this is all going is not hard to predict. Meanwhile, the great North American (read American) empire is crumbling at the edges. Raging debt and some saddening deterioration in the American workforce makeup, not to mention a fractured political system seemingly incapable of addressing modern problems, will ultimately bode ill for the US dollar. Where is FDR when you need him? Serious debt offers few escapes. Ignore, default or inflate......take your pick because the taxpayer is tapped out. We may see the inflation rates of the 70’s at some point soon. Anyone with a good idea, put your hand up.
Some may harbour the notion that those who run companies, be they publicly traded or privately owned, can hardly be the ones to blame for the unfolding events of the world economy. Nothing could be further from the truth. People, in these positions of greater responsibility, become targets for those looking to find the deep pockets that can help relieve their own financial problems. These tougher times eventually degenerate into a search for those upon whom vengeance can be exercised. In an era of “it’s somebody else’s fault” there’s always a way to take a run at the perceived culprits. In the world of insurance, nothing scares these carriers more than the onset of hard times. In such past cycles, certain realities become big pains in insurance company back ends (so to speak).
- Claims which might normally have been paid from surplus funds are now presented to the insurer with an “I’ve paid premiums for years so why shouldn’t I claim” attitude.
- Events that are normally considered borderline claims are presented with a view to bending the facts so as to bring the event within the policy coverage. Fraudulent, perhaps?
- Maintenance expenditures begin to drop as people prefer to hang on to cash.
- The frequency of everyone’s “favourite,” the “slip and fall”, begins to rise as the financial pressure on individuals grows.
- Downward pressure on premiums goes up as insurance buyers take on the attitude that “others are reducing prices and so insurance should be cheaper too”.
- Business activity goes down and thus the insurers’ premium revenue slows or levels off.
- Increased “shopping” for cheaper insurance ties up the insurance delivery system, thereby adding more administrative costs.
- Lower interest rates (we have those now) ruin the investment income of p&c insurers who are mostly limited to rolling over T-bill portfolios and other safe and liquid instruments.
Inevitably, and we’ve seen this cycle a few times now, at some point claims overtake the insurers and there is a market snap back that results in a lemming like increase in rates. Once one major carrier starts, the others quickly follow. This can take many forms, the worst of which is the inability to even find renewal coverage. In 2002, the last nasty cycle in recent history, an albeit small number of our clients had to ride out a year or two without liability insurance. The market had closed its doors to them entirely.....well, not entirely......Lloyd’s would have taken them on at a 1000 per cent premium increase.
So what does this have to do with directors and officers who run public and private enterprises? The liability imposed upon directors has risen significantly. Over the past 30 years, litigation developments have brought class action suits and contingency fees to parts of Canada. In addition, volunteer directors can no longer hide behind their generosity and private company directors can be held to personal account in matters ranging from statutory responsibilities to fraudulent contracts. They are responsible not just for their own activities, but also for failing to oversee those who report to them. Anyone who takes on a directorship on a third party basis (meaning that you have no financial interest in the organization of which you have just become a director) should insist on having an indemnity included in the bylaws and also should insist on directors’ insurance. On an editorial note, we wonder why so many people take on directorships for which they are not being compensated. It’s like working for free, yet being personally responsible for the result. Condo directors should take note.....
As our economy becomes more stressed, as it invariably will, directors and officers will also feel a greater level of pressure from those to whom they bear a significant responsibility. Timely filings, sound management practices, ethical dealings and a variety of activities will be more carefully scrutinized and woe to those who carry out their responsibilities carelessly. Weaving one’s way through economic challenges is a pretty tricky thing to do. Directors and officers of any organization, be it for profit or non profit, need to know that their personal assets can be at risk under certain circumstances. In a legal system that allows any one person, or group of persons, to initiate an action (without permission) we can certainly expect a higher level of legal activity if the economic troubles, that seem to be looming, actually materialize. For directors and officers, a bit of attention to self preservation is not a bad strategy.
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