As anyone in the directors’ and officers’ (D&O) liability insurance market will tell you, 2008 is shaping up to be an important year to monitor, as current
trends and conditions take form.
Three major areas to keep an eye on are
the subprime lending crisis, litigation
trends and environmental concerns,
according to Jerry G. Kysela, resident managing director of Aon Risk Services Inc.
“While the D&O liability marketplace has
been relatively soft for the past several
years, underwriters are becoming very
nervous about the direct and indirect fallout from these factors,” he says.
Smart Business spoke with Kysela
about current D&O concerns and what
companies should watch out for in the
coming months.
How will the subprime lending crisis affect
D&O liability insurance?
Well, the main concern is the direct
impact this will have on financial institutions. Besides that, there’s an indirect concern about how this will affect businesses
and their ability to grow, expand and
invest. Lenders are being more careful
with just how much and whom they lend
to. D&O carriers will pay specific attention to companies who are reliant upon
relatively significant levels of debt to
finance business and growth. You have to
follow their business plans and see how
they’re planning to weather the storm.
These strategies need to be discussed
with your D&O underwriter. Other areas
to watch are corporations who invested in
subprime investments, such as mortgage-backed securities. These investments may
not be worth near what they were, which
will affect portfolios, pensions and retirement investments.
What about litigation trends?
Coming off an eight-year trend of high
frequency of securities class action claims
against directors and officers, 2005 experienced a 22 percent decrease in the number of claims filed and a 39.5 percent
decrease in 2006. 2007 reversed this trend
with a 40-plus percent increase in frequency over 2006. Most of the increase in
frequency materialized in the second half
of 2007. The recent increase in frequency
is most likely indicative of the recent
stock market volatility as well as the sub-prime lending claims, which plaintiff
attorneys began to file near the end of
2007. Further, this increased frequency in
securities litigation has not been contained only to the financial services sector, despite the headline risk from the sub-prime crisis. Several independent sources
have commented that they expect 2008 to
be a robust year for securities class action
filings, basically a return to historical
average annual filings versus the recent
trend experienced in 2005 and 2006.
How about environmental concerns?
In late 2006, the SEC voted to propose
interpretive guidance for management to
improve Sarbanes-Oxley 404 implementation. The proposed principles-based
guidance, issued Dec. 20, 2006, is organized around two important principles.
First, management should evaluate the
design of the controls that it has implemented to determine whether there is a reasonable possibility that a material
misstatement in the financial statements
would not be prevented or detected in a
timely manner. Second, management
should gather and analyze evidence
about the operation of the controls being
evaluated based on its assessment of the
risk associated with those controls.
The proposed rule notes that significant
accounting estimates and critical accounting policies — both characteristic of environmental liabilities — present a higher
risk of material misstatements and control
failures. Thus, in the wake of earlier public
financial scandals (Enron, WorldCom,
etc.), the SEC increased its focus on
accounting practices in order to better regulate corporate disclosures. Now, the SEC
seems to have turned its attention on environmental financial disclosures. Corporations and corporate executives should
take special note of the heightened attention that the SEC is now giving to these disclosures. We expect further activities and
guidelines from the accounting profession,
as well, through developments in GAAP
(Generally Accepted Accounting Principles) procedures for estimating and
developing environmental and sustainability risk exposure reserves.
If these factors are not watched closely, what
will the consequences be?
The outcome will be potentially expensive litigation with the management — the
directors and officers — of public companies facing allegations of misrepresentation and mismanagement.
So, what’s the resolution to all of this?
The resolution is additional due diligence
and the necessary disclosure on the part of
pubic companies. From an insurance perspective, now is the time to make sure your
corporate directors’ and officers’ liability
policies — those that protect corporate
and personal assets — are tailored to
address potential litigation stemming from
environmental exposures.
JERRY G. KYSELA is the resident managing director of Aon Risk Services Inc. Reach him at (216) 623-4150 or
[email protected].