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Directors & Officers (D&O) liability policy primer and claim modeling potential Casualty Loss Reserve Seminar

September 15, 2011

Presenters

Connie Kurpick Senior Ernst & Young

Moderator

Mark Millard Senior Manager Ernst & Young

Presenter

Benny Yuen Senior Manager Ernst & Young

Presenter

Directors & Officers (D&O) liability policy primer and claim modeling potential

Page 2

Purpose of D&O insurance

►Protect the personal assets of directors and officers in the

(2)

Who are the officers of a company?

Past, present and future duly elected or appointed director, officer, trustee or governor of a corporation, management committee member of a joint venture and member of the management board of a limited liability company (or equivalent position);

Past, present and future person in a duly elected or appointed position in an entity organized and operated in a foreign jurisdiction

Directors & Officers (D&O) liability policy primer and claim modeling potential

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position in an entity organized and operated in a foreign jurisdiction that is equivalent to an executive position listed in Definition (j)(1); or Past, present and future General Counsel and Risk Manager (or

equivalent position) of the Named Entity.

Responsibilities of directors and officers

►Duty of care

► What a prudent person would do in a similar circumstance

►Duty of loyalty

► Act in good faith for the companies best interest

Directors & Officers (D&O) liability policy primer and claim modeling potential

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State statute example – Delaware

A corporation shall have power to indemnify any person who

was or is a party, or is threatened to be made a party, to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative.

(3)

Corporate by-laws

►Corporate by-laws

► Outline the firm’s indemnification obligations to the directors and officers

► Are based on the statute of the state of incorporation

► Set the stage for how directors and officers liability policies will

respond in the event of a claim

Directors & Officers (D&O) liability policy primer and claim modeling potential

Page 7

p

Where do claims come from?

Shareholders

Customers Shareholders’

derivative actions

Directors & Officers (D&O) liability policy primer and claim modeling potential

Page 8

Claims

Competitors Regulators

Policy coverage parts

Side A provides the individual directors and officers with coverage in the event the company cannot, or will not,

Side A

Side B reimburses the company for its indemnification obligation to its directors and officers.

Side B

Side C provides the entity itself with coverage in the event it is named in the suit (some insurance policies

Side C

(4)

How limits and retentions are structured

►D&O policy structure

► Deductible levels

► Limit options

► Tower

► Side A, B and C

► Side A DIC

Separate limits Shared limits

$10M x $15M $10M x $25M Side A $35M $10M x $15M $10M x $25M Side A $35M $36,000 $36 000

Directors & Officers (D&O) liability policy primer and claim modeling potential

Page 10 ► Side A DIC ►Sharing limits ► E&O ► Crime ► EPLI D&O $15M D&O EPLI D&O only $15M D&O Shared EPLI $15M $36,000

Consistency in the tower structure

►Does the excess form

provide drop-down coverage in the event of underlying erosion?

►Does the excess form

follow the terms of the primary?

Directors & Officers (D&O) liability policy primer and claim modeling potential

Page 11

Typical coverage exclusions

Fines and penalties Punitive or exemplary damages Tax liability

Dishonesty Dishonesty Personal profit

(5)

Impact of legal trends, laws and regulation

►Policy coverage grants and exclusions change frequently as

the market evolves ► Examples include

► Market timing

► Subprime exclusion

► Failure to maintain insurance

Directors & Officers (D&O) liability policy primer and claim modeling potential

Page 13

Definition of claim

►Understanding the variety of definitions surrounding claims

►Coverage can be triggered by

► Criminal proceedings

► Written demands for monetary and non-monetary relief

► Administrative investigations

► Arbitration proceedings

Directors & Officers (D&O) liability policy primer and claim modeling potential

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Example from Chartis D&O first policy specimen

“Claim” means:

1. a written demand for monetary, non-monetary or injunctive relief;

2. a civil, criminal, administrative, regulatory or arbitration proceeding for monetary, non-monetary or injunctive relief which is commenced by: (i) service of a complaint or similar pleading; (ii) return of an indictment, information or similar document (in the case of a criminal proceeding); or (iii) receipt or filing of a notice of charges; or 3. an Investigation Claim. means a civil, criminal, administrative or regulatory investigation of an Insured Person

by the SEC or a similar state or foreign government authority, but only after service of a subpoena upon such Insured Person and subject to the Investigation Claim Sublimit of Liability stated in Item 3(a) of the Declarations.

Policy excerpt from IRMI.com

Definition of wrongful act

“Wrongful act” means any error, misstatement, misleading

statement, act, omission, neglect or breach of duty committed, attempted or allegedly committed or attempted, by an insured person, individually or otherwise, in his insured capacity, or any matter claimed against him solely by reason of his serving in such insured capacity.

(6)

Definition of loss

“Loss” means damages, settlements and costs, charges and

expenses incurred by any of the directors and officers, but shall not include:

1.Punitive or exemplary damages or that 2.Taxes, criminal or civil fines or lti 3.Matters deemed uninsurable under the law

Directors & Officers (D&O) liability policy primer and claim modeling potential

Page 16 damages, or that portion of any multiplied damage award which exceeds the amount multiplied penalties imposed by law

under the law pursuant to which this policy shall be construed Claim examples Philip Morris Anti-trust violation Wachovia

Securities class action

Directors & Officers (D&O) liability policy primer and claim modeling potential

Page 17

Mattel

Securities class action Xerox

Securities class action

Mega-claim examples

Countrywide Financial Corporation Subprime

Bernard Madoff Investment Securities

Ponzi scheme

Broadcom Corp. JP Morgan Securities

(7)

Defense cost and settlement allocation

►Aspects potentially excluded from the claim settlement

► Professional services – failure to supervisor

► Insured capacity

► Entity coverage

►Defense costs

► May or may not be subject to allocation

Directors & Officers (D&O) liability policy primer and claim modeling potential

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► May or may not be subject to allocation

►Similar to the definition of claim, there is no standard definition

of allocation ► Use of best efforts

► Relative legal and financial exposures to the parties

► Use of arbitration if failure to agree

Characteristics of D&O losses

►Lower frequency/higher severity than commercial general

liabilities claims

►Large events, such as subprime and stock backdating, behave

more like catastrophe losses

►Case reserving philosophy varies greatly between companies

Directors & Officers (D&O) liability policy primer and claim modeling potential

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►Trigger of claims contains much uncertainties

►Expenses often can exhaust limits provided

►Settlements of cases far outweigh payment of suits

D&O loss projections

►Traditional methods, such as loss development, BF, ELR and

frequency/severity, may be appropriate

►Need to understand company’s claims-handling process

► Reported claims

► Initial reserves setting

(8)

D&O loss projections

►Differential “normal” losses from “systemic” losses

► Normal or attritional losses – random typical losses

► Systemic – event(s) driven that affect many corporations or mega-losses

► Will want to consider examining these losses separately ► Expected loss ratio should have these two components separate

Directors & Officers (D&O) liability policy primer and claim modeling potential

Page 22

Attritional losses

►Analogous to “non-cat.” losses in other PC lines

►No formal definition like catastrophe code (cat. Code)

►Need to be consistent in defining attritional vs. systemic

Directors & Officers (D&O) liability policy primer and claim modeling potential

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►Determine expected loss ratio and loss development pattern

►Projections can be easily handled by traditional actuarial

methods Systemic losses ►Examples ► Subprime crisis ► Madoff claims ► Bid rigging ► Options backdating

►Analogous to catastrophe (cat.) losses in other PC lines

► a ogous to catast op e (cat ) osses ot e C es

►Lack of similarity between events

►Need a systemic load for the expect loss ratio

(9)

Systemic losses

►Need to anticipate and identify these claims

►Ability to track and understand the book of business is

important

►Constant communication with claims department is crucial

►Need to track legal development and settlement pattern, if any

►“Bottom-up” and “top-down” approaches

Directors & Officers (D&O) liability policy primer and claim modeling potential

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► Bottom up and top down approaches

► Individual claims evaluation ► Macro level evaluation

Bottom-up evaluation

► Track by exposures and submission of claims

► Assign probabilities by types of claims/exposures

► Need to consider coverage type

► Side A may have a lower probability if entity is not bankrupt

► Need to consider retention (or trigger) level

► The higher the retention, the lower the probability

► Need to consider the status of claims

Directors & Officers (D&O) liability policy primer and claim modeling potential

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► Need to consider the status of claims

► Existence of case reserves

► Place-holder reserves

► Watch-list

► Determine size of the claims

► Limits provided

► Layers exposed

► Pure incurred but not reported provision

Top-down approach

►Macro modeling approach

►Based a set of key assumptions

►Derive a set of model parameters

►Project losses in aggregate based on exposures

► Does not predict how individual loss will fare

►Can separate out claims and reserves

►Can separate out claims and reserves

(10)

Key assumptions and parameters considerations

►Expected value of D&O losses is a function of the drop in

market capitalization

►Distribution of claim – e.g., lognormal

►Claims dismissal rate

►Severity assumptions

►Side A vs Non Side A consideration

Directors & Officers (D&O) liability policy primer and claim modeling potential

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►Side A vs. Non-Side A consideration

The next wave

►What will it be?

►Are the companies prepared?

Directors & Officers (D&O) liability policy primer and claim modeling potential

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Ernst & Young Assurance | Tax | Transactions | Advisory

About Ernst & Young

Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 141,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US.

Ernst & Young is a leader in serving the global financial services marketplace

Nearly 35,000 Ernst & Young financial services professionals around the world provide integrated assurance, tax, transaction and advisory services to our asset management, banking, capital markets and insurance clients. In the Americas, Ernst & Young is the only public accounting organization with a separate business unit dedicated to the financial services marketplace. Created in 2000, the Americas Financial Services Office today includes more than 4,000 professionals at member firms in over 50 locations throughout the US, the Caribbean and Latin America. Ernst & Young professionals in our financial services practices worldwide align with key global industry groups, including Ernst & Young’s Global Asset Management Center, Global Banking & Capital Markets Center, Global Insurance Center and Global Private Equity Center, which act as hubs for sharing industry-focused knowledge on current and emerging trends and regulations in order to help our clients address key issues. Our practitioners span many disciplines and provide a well-rounded understanding of business issues and challenges, as well as integrated services to our clients. With a global presence and industry-focused advice, Ernst & Young’s financial services professionals provide high-quality assurance, tax, transaction and advisory

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