“It’s cool, we’re covered.” (No, you’re not.)

February 9, 2015 by Ronan O'Beirne

The directors & officers insurance landscape began to shift more than a decade ago on a modest patch of soil.

In 2004, an environmental site assessment was carried out at 695 Bishop St. North in Cambridge, Ont.—then the home of Northstar Aerospace, which manufactured parts for helicopters. The assessment found contamination from trichloroethylene (TCE), a colourless degreaser.

TCE is not automatically dangerous, nor is it only an industrial product; it’s also been used in regular household products. But there have long been concerns that prolonged exposure to the chemical could be connected to diseases like liver cancer, kidney cancer and lymphoma.

Inspectors found out later the substance was also in the air in some Bishop St. houses, where it had probably been seeping in over the 40 years since the factory started using it. The tests found higherthan- usual, but lower-than-dangerous levels of TCE. The levels were “not expected to result in an excess of cancers that would be detectable through a community health study,” according to a 2011 report from the Ontario Agency for Health Protection and Promotion.

Still, the provincial government ordered the company to pay millions of dollars in cleanup costs. There was one problem with that order: in the intervening eight years, Northstar had filed for bankruptcy. That left a group of 13 executives and directors personally on the hook, even though some of them had only joined the company in its later years. They settled with the government in 2013, agreeing to pay $4.75 million for cleanup costs—not as much as the original order of $15 million, but probably more than they wanted to pay out of pocket.

Northstar busted what Greg Irvine, Zurich Canada’s national director, management solutions, calls “myth #1” about D&O: the notion that pollution cleanup costs are covered.

“About four years ago, the D&O carriers started deleting the pollution exclusion out of their D&O form,” but there’s still a narrower exclusion for cleanup costs. “So we deleted the [pollution] exclusion, but there’s also exclusion within the definition of loss.”

Thanks to that misunderstanding, Northstar has “been a hot topic for a lot of our insureds,” he says. “Given the nature of the Canadian stock exchange— it’s a commodities-based economy up here—you can see how this is more of an issue in Canada than it would be in other jurisdictions.”

Irvine says the industry has responded well after the misunderstanding about pollution coverage. There’s a bit of a lingering perception that “if you’re in bankruptcy and no one can pay your bills on your behalf, everything’s covered. But no, there are still exclusions, there’s still conditions of the policy, even in bankruptcy.” There are three solutions to the gap, he says: buying a separate environmental insurance liability (EIL) policy; buying an extension on the primary policy for Side A (non-indemnifiable) cleanup costs; or buying an excess difference in conditions (DIC) product.

The controversial payment order in Northstar is just one thing remaking D&O in Canada. The market has gotten busier, policy wordings have gotten more sophisticated, and we’ve become a more litigious bunch in the last five years. In an interview with Top Broker last summer, Steve Mallory, president and CEO of Directors Global Insurance Brokers, said, “If there hasn’t been a D&O comparison done recently, you’ve got an outdated program.”

Would you like fiduciary with that?

Mallory says one reason brokers need to revisit their clients’ D&O coverage is interest rates—they’re incredibly low, and have been for some time. That’s pushed some pension funds underwater, bringing fiduciary liability insurance to the fore. “When you’re buying directors and officers insurance, the insurer would say, ‘And you’re also buying fiduciary to go along with that, right?’ And you would say, ‘Yes, we want this and we want that.’”

He adds that there are more people to buy from, too. “Fast forward from five years ago to today, and there may be sixty-odd insurance companies that can be accessed from Canada offering directors and officers insurance. And I would probably be safe to say… that’s likely twice what were available five years ago.” This has made D&O an “extremely soft market,” with very competitive pricing and expanded— and more sophisticated—coverages.

One area closely related to D&O that’s more of a focus than it was five years ago, Mallory and others say, is cyber liability. Going by the headlines, that’s top of mind for publicly traded companies like Target and Home Depot, but it’s not just the big players who need to worry, says Mark VanHelden, assistant vice-president, middle market, at Liberty International Underwriters. Everyone is a potential target of a cyber privacy breach, and VanHelden says the new anti-spam law—though so far untested in court— creates more liability for smaller, private companies.

Despite VanHelden’s concern, some say that small- and medium-sized enterprises are not taking cyber as seriously as they ought to. In July, Insureon, an American insurance provider for small businesses, said that only five percent of clients had requested cyber coverage in the half-year since the massive Target breach. Before the breach, nine percent of clients had requested it. “The reality is that small businesses get hacked far more often than big ones,” CEO Ted Devine said in a news release. “But you’re not going to turn on the evening news and hear about the florist on the corner getting breached.”

Cyber awareness aside, VanHelden says more private companies are hopping onto the D&O boat because many of them are undergoing succession or being snatched up by bigger parents. “What’s driving some of that as well is some of the founding shareholders of the company are aging and… some of the succession’s not necessarily staying in the family. So then what happens is a company gets sold to maybe a private equity firm or another company, and now all of a sudden the directors and officers are going, ‘Oh, we don’t have D&O insurance.’ So they’re sometimes coming to buy the insurance for the first time when they’re about to be sold.” That’s obviously not the best practice, he adds—ideally, they should have had it from the start. He says the competitive pricing that Mallory alluded to has also helped boost D&O penetration among private companies.

“The analogy I sometimes use is that, for example, I pay probably more for my personal auto insurance than some of these small companies could pay for a D&O employment practice policy. So… why would you not buy it, right?”

“If Somebody Wants to Sue You, They Can Sue You”

Despite abundant capacity, broader coverages and higher penetration, Greg Irvine of Zurich says three myths about D&O persist. The first has been the confusion over whether pollution cleanup costs are covered, and myth #2 is that all policies have passports. Take Brazil, for example: you can’t send insurance proceeds into the country; you need to buy it locally. So your Canadian D&O policy won’t help, but you can still buy from, say, that company’s Brazilian affiliate. “And we also know that a claims trend recently is when South American governments, including Brazil, they have been naming individual executives in tax disputes. We think they’re doing this to apply pressure on the foreign parent to expedite payment. So they’re bringing in the individual to help pressure quick settlements….

So we’ve got foreign executives in foreign countries that could be named, individually, in a lawsuit, [who] believe they have insurance out of a master policy controlled in Canada, but when they submit their claim, which is covered for defense costs, they may not be able to get insurance proceeds down into that country.”

Irvine says one barrier to pickup on local policies like these is that each local D&O policy has an issuance fee. “But you know, if it was my personal assets at stake, a $2,500 issuance fee for peace of mind sounds like a no-brainer.”

But you don’t have to go as far as South America for trouble. Private companies working in the United States have to come to terms with a very litigious society, where claims aren’t uncommon. “Any private company that touches the U.S. litigation environment is difficult to price,” Irvine says. “A real challenge—I wouldn’t say it’s a changing trend… is employment practices liability claims in the U.S. We’ve seen some severity there.”

As far as risk management goes, there’s not a lot of mitigation to be done—by the insurer, broker or the insured. Irvine says there’s “just a growing acceptance in the risk management community that no matter what you do, you can’t help yourself from getting sued. So you can have risk management controls in place in corporate governance… if somebody wants to sue you, they can sue you and the plaintiff ’s lawyers take up to one third of the settlement, so they’re incentivized to bring a lawsuit, especially a class-action securities claim.” This could cause some minor sticker shock at a company that’s done all the right things in terms of its corporate governance. “We can put some faith in that as D&O underwriters, but it’s not going to give you the… premium discount that you think you probably deserve for all of that effort and work.”

Mallory says that if and when a claim does come in, defense costs are “a very important consideration in the D&O coverage.” No director or officer wants their carrier to turn the tap off while an action is still moving through the courts, which can take a long time. “If, for example, it’s a case of fraud and they’re alleging that the director was involved in fraud, the director may vehemently defend themselves, and they need to do so with the funding from the D&O policy. So it must cover until final adjudication.”

This is a particularly big problem in Quebec, Irvine says, and there’s no quickand- easy solution in sight. The province requires defense beyond the limits, but what that means is a little murky: is it the primary policy carrier’s limits, or the excess carrier’s? “And I think the risk to our insureds is, [if] your primary is exhausted, the excess carrier said they will not recognize payment of the underlying primary limit as eroding the underlying limit, you have a gap in coverage. So they’re not attaching where they had promised to attach, and [that could] stop the entire defense.” (Myth #3: “Your excess carrier will attach where they promised to attach in Quebec.”) He adds that there’s one such primary vs. excess dispute working its way through the Quebec courts right now, and raises the alarming specter of such a dispute happening in a big-bucks D&O claim.

“So imagine if Nortel was a Quebec company, and now you had a billion-dollar bill. How do you allocate that amongst your insurers—is it the primary’s liability? Is it all of the excess carriers? We don’t have an answer for that.”

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This story was originally published by Canadian Insurance Top Broker.