Concept or Concrete? Are you buying insurance based off of a concept that your broker is proposing or off of facts? If you have perfect coverage with no gaps that is fine concept is fine, but otherwise you should be thinking about buying off of fact.
What do I mean by fact? As a broker, I review prospects policies and report to them what isn’t covered that easily and inexpensively could be covered. I am not talking about small issues, but issues that could dramatically impact a company’s balance sheet, six and seven figure coverage gaps. You probably believe you don’t have these coverage gaps and you wouldn’t be alone. I would say 60-70% of prospects we talk to believe they have no coverage issues or minor issues, but for 95% of the companies we have performed a coverage audit for we found at least one or more 6 figure coverage gaps.
Most brokers will come in and say we want to do this and that for you. They won’t actually do what no one, not even brokers, want to do and that is read your policies and tell you what you have and what you don’t have. Guess what? That is what we do and that is why we can sell on fact. We tell you what is good, bad and ugly and then how we can fix it.
One last nugget from my trip to Boston:
I hope everyone has a great weekend!
There is a lot of news recently that relates to D&O insurance recently and I thought I would do a quick run-down for you.
First we have Tesla and Elon Musk. If you haven’t seen or heard, Musk and Tesla were each fined $20 million for Musk’s tweet saying they were going private and that funding was secured. It turns out that neither of this statements were accurate. In addition, Musk was forced to relinquish his seat as chairman of Tesla. This penalty made clear that comments made on social media will have repercussions for companies. I doubt this is the end of this saga as there will most likely be shareholder litigation.
Will this cause D&O underwriters to greater examine the Twitter, Facebook and Instagram accounts of public company leaders? Typically, a D&O underwriter is most concerned about the finances of a company and the direction they are going in but could this change over time? We will see have to wait and see.
In other news from California, the legislator passed a law requiring public companies to have at least 1 woman on their board by the end of 2019. By 2021 companies with at least 5 board members must have two women and boards with six or more members must have at least three women on their board. Right now 25% of public companies based in California have no women on their board. Companies that fail to meet these requirements will face penalties. You can learn more about this here.
Finally, in probably the least surprising news, the insurance companies that were affiliated with Harvey Weinstein have declined coverage and have argued they do not need pay for his defense. A number of carriers have declined coverage so far with Travelers and Chubb being the most noteworthy. There are a number of policy provisions cited in their reasoning to decline coverage, including the sexual abuse & molestation exclusion and that Mr. Weinstein’s actions were outside his duties as a director and/or officer.
Directors & Officers liability has been a popular topic as of late for me. Every day there are new headlines and the one that could have the biggest impact would be the recent story about shareholders losing their right to sue corporations. The headline came from The Intercept and was titled, “Will Shareholders Lose the Right to Sue Over Corporate Fraud?”
There is a lot that can be discussed here, the first thing to mention is that Fraud is often excluded if it is a deliberate or criminal act and there is a final judgement against such conduct. A company cannot deliberately act in a fraudulent way and expect insurance to pay, this would create a moral hazard which insurance companies are not in the business of insuring. However, this article uses the word “fraud” in a broad matter and some of these so called frauds could in fact be covered by an insurance policy.
Assuming that these “frauds” are covered by insurance let’s take a look at how this could impact D&O insurance. When there is a D&O claim, a large chunk of the costs are for legal expenses and these can become rather large even when a case is without merit. Many carriers, at least for public companies, have pushed for higher retentions (similar to a deductible but an insured incurs the cost upfront instead of at the backend) because the number of small claims that were piercing the retention were increasing in frequency.
If you are a public company biotech it is not uncommon for insurers to not offer any retention below $1M, whereas a couple of years ago a $500k deductible was definitely available. If shareholders can no longer sue for “fraud” this could cut legal expenses down tremendously. The quicker a case makes its way through the system the lower the legal costs. The bad news is that insurers are quick to increase retentions but not lower them. Every now and then I see a retention lowered but it is because the risk profile has changed dramatically for the company.
How about price? Again, I think carriers will resist price decreases because when we look at pricing historically it has been trending down for year but claim costs have increased tremendously. This softening of pricing is not as true for the life science industry which has been ticking up in pricing, but rates are still low. This was accelerated because AIG in effect stopped writing life science IPOs and that drove the pricing way up for that segment of the market.
At the end of the day, this would be good for companies but insurers would work hard to now allow this change to have any meaningful impact on D&O pricing or terms. Your broker should make the argument that at the very least it would warrant either a lowering of the retention or a premium reduction if not both. Your broker should remember that the underwriter justified an increase in retention and/or premium because the policy was being used for small frequent claims instead of a large, catastrophic claims as it was intended. If the frequency issue is eliminated or greatly decreased it is the job of your broker to advocate on your behalf why that warrants a lowering of premium or retention.
The recent headline, “Opioid Lawsuits Look More Like A Tobacco Settlement Every Day” in Forbes grabbed my attention for reasons I will explain. As you know, I help life science companies develop and implement insurance programs that enables them to transfer risk to the insurance company. So when you see a headline that reads like the clients you serve will be suffering a financial loss it makes you stand up and notice. Granted, the fact that companies involved in opioids agreeing to a settlement does not come as a surprise to anyone but there are definitely things we can learn from this. Different insurance policies could play a role in such a settlement but let me explain from a high-level how Product Liability insurance might respond.
First, product liability is structured to provide coverage when a third party suffers bodily injury or property damage, it does not provide coverage for financial loss. This is important because if it the settlement is for the financial loss suffered by the government then Product Liability would not respond and the companies would be responsible to pay the settlement. Most likely this settlement is for the financial loss suffered by the government and therefore no insurance proceeds will be used.
Conversely, if this was a class action lawsuit by individuals who suffered bodily injury this could possibly be covered. This is no slam dunk though. Many insurance carriers have put opioid exclusions on their policies so companies that did not think they had an opioid exposure but were somehow involved could find they don’t have coverage. Companies could also run into issues with “batch” coverage and this can be a positive or a negative; it is a thorny issue and varies by carrier and even policy period. “Batch” coverage is essentially treating all similar claims as one claim instead of individual claims. This can be good or bad. On the positive side it means there is one deductible instead of a separate deductible for each individual claim. The negative is that depending on when claims occur and are reported you could run into and exhaustion of limits, meaning you have no insurance left because they are lumped into one policy period. This can be even more problematic when you change carriers and have large excess programs where carriers might not be in agreement with how their policy responds.
All too often earlier stage companies are under the assumption that all insurance policies are pretty much the same, but when it comes to the life science industry that is not the case. Because Product Liability policies are structured as claims made policies it is even more important that companies set their policies up correctly from the start so they do not have any surprises years down the road. If your broker is not well versed in the life science space you could be leaving yourself vulnerable to uninsured losses down the road.
Last week the issue of public companies having to do quarterly reports popped up in the news in a big way with the President tweeting and then speaking on the possibility of ending quarterly reporting. There are a lot of opinions out there on whether this is a good idea or bad idea. Some people believe this would help companies think more long term rather than operating quarter to quarter. Others believe it is too long and it allows companies to be less transparent. I see pluses and minuses on both sides. For example, I previously worked for a Fortune 500 company and I saw firsthand that companies do operate to an extent knowing they have quarterly numbers to meet. On the other hand, investors want to know what is going on and there could be much bigger surprises if investors are only updated every six months.
I am not hear to argue that either way is better but talk about how this could impact D&O insurance if it were to be implemented. I think the first thing to be concerned about is guidance, the further out you forecast and provide guidance for the more inaccurate you become. Another danger is that a CFO or CEO that has a longer time horizon could inevitably fall behind where they projected they would be but believe they can right the ship because they have more time. As we saw a couple of weeks ago with the Sonus Networks case (CFO Magazine), CFOs can do creative things to meet the quarter end (I am not saying CFOs blatantly mislead or act in a criminal way but the article demonstrates how numbers can be moved around to appease analysts). I am not sure why that would change with extending the reporting period out to six months, in fact it could exacerbate the issue because they feel they have more time to make up for lost revenue or cost savings.
Conversely, there is a lot of merit to the idea that meeting quarterly deadlines can lead to practices that might not be to the benefit of long term growth. We can look at companies that had founders/CEOs that controlled enough shares that they did not have to be bound by the share price nearly as much and could think long term. A great example of this would be Amazon, they have historically operated at a loss but that was because they invested in the business and now they are one of the most valuable companies in the world. They reported courtly earnings but were far less concerned about the volatility around the stock if they failed to meet analysts’ expectations. They were playing the long game.
How this could impact the public company D&O space is uncertain. If companies are still required to report quarterly earnings but not provide guidance I think that would result in the D&O insurance marketplace remaining stable. A company’s balance sheet is one of the most important drivers of D&O insurance pricing and terms; if this information was still available quarterly it would eliminate some uncertainty. I think carriers would take a deeper look at corporate governance and also compare past guidance to the actual results, essentially underwriting the CFO. In the end, insurers like certainty and the less there certainty there is the more cautious they are resulting in higher premiums, more restrictive terms and higher deductibles.
You can find a couple of good write-ups on the implications both broadly and in the D&O insurance marketplace here and here.
When designing an insurance program should we think about adding coverage or eliminating risk? Most brokers think about adding coverage while clients think about how they can curtail risk. You might think these opposing approaches would get you to the same place in the end but that is not necessarily true.
The problem I have encountered with new clients is that they were never aware of all of the different type of insurance coverages that are available in the marketplace. Couple that with brokers inclined to present only programs that they understand or are aware of and the result is an insured that is left vulnerable to having uninsured risks that otherwise could and should be insured. The conversation around risk management should first start with figuring out the risks that a client has and what their most valuable assets are. The risks should not be limited to what we think are “insurable” risks but all risks a company has.
Once we have identified what keeps a company CEO or CFO up at night we can then begin strategizing on the role insurance can play in reducing a client’s risk. I hear on a regular basis that a company’s patent portfolio is one of their most important assets but they have never had a discussion about insuring the portfolio despite the fact that commercial insurance is available to protect patents. Nowadays every broker and client wants to talk about cyber insurance, and everyone has that risk to some extent, but would a cyber breach or a patent infringement do more damage to your company? If you are a manufacturer is your broker talking to you about Manufacturer’s Errors & Omissions coverage? Is your company looking at acquisitions and if so how deep have the conversations gone in regards to tax liability and reps and warranties coverage? These are just a few examples and coverages that are not very innocuous but yet are still rarely talked about.
The point is, most brokers talk about coverage that is available and try to fit a client’s risks into the insurance box instead of designing the insurance program around the risks. Remember, an insurance broker represents you the client, and our job is to figure out your risks and then negotiate with insurance companies to get as much covered as we can. A broker’s job is not to take what an insurance company offers and make your risk fit into their product, but not negotiate with them to get the broadest coverage that is customized for what your risks are as a company.
I recently read that Illinois Tool Works (ITW) prevailed in a case against the IRS. The IRS challenged that a loan from ITW’s foreign subsidiary to its parent company was a nontaxable return of capital as ITW contended. The IRS dtermined that it was not a loan but a dividend and as a result a taxable event. ITW challenged the IRS and the case was brought to the US Tax Court. In early August the court released their decision and sided with ITW. A short write-up can be found here.
Why I bring this up is that many companies have tax positions they are aware of that could be challenged by the IRS. Companies rely on their accountants to determine whether certain events have tax implications and then proceed accordingly. Unfortunately, this is not foolproof strategy, the IRS can and will challenge these events even if you are using the best and biggest accountants. What few companies are aware of is that there is an insurance policy that can protect them in these instances.
Tax Liability insurance can protect against many types of tax issues, including, but not limited to, spinoffs, M&A, multinationals, tax exempts, related party transactions, and foreign investors. The policy can cover the taxes, interest, defense costs, in some cases fines and penalties, and gross-up. What is different with this type of insurance compared to traditional property and casualty insurance is that we are covering a known event, or tax position, that may not be 100% clear cut but that we are confident is correct.
The underwriting process is specific to that event and coverage is tailored accordingly. Information is collected on the event and might include commentary from a tax attorney and/or an accountant. After preliminary info is collected it is presented to the insurance market and the carriers come back with non-binding pricing and terms. At that point a carrier usually identified that would be a good fit and a more exhaustive underwriting process commences. At this stage an insured typically pays an underwriting fee that is used to pay for the due diligence (think lawyers and accountants that really dig into the info) that allows the insurer to put together the actual terms and pricing. Assuming all is in order, the insured can then bind the policy that can have up to a 7 year policy term.
If you are a company and have uncertain tax issues then a tax liability policy is worth looking into. There is no upfront cost to get a non-binding pricing indication, but be aware that policy pricing is in the 6 figures to start, however, it is a one-time premium and not annual. The policy limits usually start at $5MM and can go up from there.