Coffee & Conversation - D&O Insurance: The Bumpy Road Ahead and Tips to Avoid the Potholes
In this latest installment of Coffee & Conversation, Partners Jessica Magee and Michael Stockham sit down with Kara Altenbaumer-Price, a senior vice president with McGriff, Seibels & Williams, to talk about current trends in the directors and officers (D&O) insurance market and what companies can expect moving forward. They talk about recent changes in the market, including consolidation, increases in litigation and settlement sizes, and constriction. The conversation also covers changes in the underwriting process and insurance companies' expectations as well as offers tips and takeaways as companies prepare for policy renewal.
Michael Stockham: Welcome everybody back to another episode of Coffee & Conversation, another installment. We're very pleased today to have with us Kara Altenbaumer-Price. Kara's an executive risk advisor from McGriff, the country's sixth-largest insurance broker, and has been in the management liability industry for more than a decade. Prior to joining McGriff last year, she led the Executive Risk and Professional Services Team for USI Southwest Division. As team lead, she personally handled many of the group's more challenging clients, such as those with tough balance sheet, claims histories, new IPOs and hard-to-place industry classes. Prior to her insurance career, she practiced securities litigation and corporate investigations in the Dallas offices of Hughes & Luce and Andrews Kurth for seven years, where her legal fees were often paid by the D&O policies she now brokers. Between her insurance brokerage career and prior legal practice, she has developed a unique expertise in management liability insurance with a keen understanding of how to marry coverage terms without management. Liability insurance ultimately gets used by the companies. She offices in Dallas, and she's going to join my colleague and I, Jessica Magee, today, from Thompson & Knight to talk about changes in the D&O market, developments in the underwriting process, COVID's impact on the whole market and other situations and maybe get to some considerations for the renewal process. As we know, a lot of companies, boards and management are currently looking at renewing their D&O in the September-October timeframe. So welcome, Kara. We're happy to have you for an hour for Coffee & Conversation. Everybody's coffee is hot, so I guess we can get started. Want to kick it off just a little bit by talking about some of the recent changes in the market, maybe talking a little bit about consolidation of primary insurers and some of what's going on?
D&O Insurance Market Trends: Consolidation, Increasing Costs, Fewer "Bells and Whistles" and More
Kara Altenbaumer-Price: Sure. We'll just start with consolidation. Well, we'll take a step back for a second. Any of you have renewed in the last year or so know that it's become a much more painful process than it even was in the past. And a lot of that has to do with dramatic increases in what you pay for your insurance. Part of that is because of the consolidation in primary carriers. You may have noticed over the last decade or so as your clients placed their insurance that you started to see just four or five carriers that tended to show up over and over and over in the primaries. You had your AIG, your Excel, Chubb. It just really depended on the industry class, but there were just a few carriers. So as a result, over time, as we saw litigation increase and we saw the cost of litigation increase and the cost of settlements increase, then those carriers kept getting hit over and over and over to a point that became problematic in the industry.
Michael Stockham: Both Jessica and I, as you know, practice in this area. We've been doing securities litigation investigations for a very long time. Jessica spent some time as a senior officer at the SEC. So this is what our clients are dealing with. This is one of the main issues that comes up at the very beginning of an engagement, is whether or not there's any insurance at all. And we're trying to figure out how to navigate new exclusions, new issues, making sure that our clients have the best protection when they get hit with this kind of incident.
Jessica Magee: Yeah, and just before we throw the mic back to you, Kara, one thing that I really want to hover over for people that haven't had the chance to meet you and work with you like Michael and I have is something that Michael hit on in your bio, which is that you practice law. You've been in this space. You've lived and breathed this, and now you're on the business side of it. That's something that you and I have in common because I've been in private practice, I've been in government, but I've also been a general counsel having to buy services, think about insurance, think about what you have to have, what you want but maybe can live without. And so you really have a sweet spot that a lot of other people don't have, which is that you're able to look at it because you've lived it from really all sides. And I think that adds so much value to our audience because your views are really holistic and you've got your head on a really good swivel. So that's just my two cents to plug why I think you're the best person to be talking to us, frankly, to tutor us through what we need to be knowing and doing right now and our clients as well. So sorry, Michael, that I hijacked it.
Michael Stockham: No, no.
Jessica Magee: What do we, what do our clients need to be thinking about on these issues right now? So sorry, Michael, take it back.
Michael Stockham: No, no, it's back to Kara.
Kara Altenbaumer-Price: OK, so I think we were talking a little bit about what happened, how we got here. In the course of our conversation, we'll talk a little bit about some thoughts and solutions. I think the big picture that I would tell people is there's not a lot you can do about the price right now. So where there are some creative notions, but really, it's more about getting your money's worth for whatever budget you have, and we'll get into that in a little bit. But to talk about what's happened. So we have the consolidation of carriers. Another couple of things that have happened, and I'll throw up a, I don't know if any of you read some of these reports, but if you don't, you should check out the Cornerstone report and NERA report. They come out twice a year. They'll give you basically all the statistics that get us to this point. But a couple of ones I'd like to highlight in there is, other than the first half of 2020, we had seen an increase in the number of cases filed year over year over year. It's down a little bit in 2020, but to be fair, a lot of it, we don't really think that's a trend that it's down, we think it's just simply the anomaly of COVID. And hope it's going to produce litigation in the back end at some point, but right now, people are just, they're not rushing to the courthouse. Frankly, the courthouse weren't all open at times to file the suits. So it's down a little bit this year, but overall the trend is up. So there's more litigation. The other, more important trend that is even continued in 2020 is that the size of settlements is increasing. I think the average — NERA is the place I always go to for the size of settlements. I think they have the best statistics there. But I think the median settlement these days is around $13 million, and that's in just any run-of-the-mill securities cases. You look at the averages, they're quite high, but we all know that averages tend to be impacted by outliers. The median is at $13 million, and for many of your clients, if they have, if they look at how their insurance programs are put together, they could be in primary layers. Your primary might be 15 or 25, but a lot of companies, particularly in the middle market, a lot of those companies here in Dallas, are going to be 10 million in terms of their layers, maybe five. And if your median settlement is $13 million, that means that primary gets blown through every time, and that's not even thinking about defense costs, which those have gone up dramatically. I know all your clients know, whether they're talking to you or another law firm, the rates, even in Texas, are getting very high. So you put all that together, and the insurance companies, they're not making money, per se, on primary coverage anymore. So as a result, they are trying to correct that. The rudder has turned with the major carriers, and so once the major carriers turn their rudder, everyone else gets pulled into that way. So you're seeing it throughout the entire market.
Michael Stockham: So talking about defense costs, I mean, how, I know that they're increasing. Is it because the duration of the litigation is going longer as well, or is it just rate pressure? Are more cases making it past motions to dismiss and therefore creating a longer arc of litigation, or is it really just market pressure on the law firms with rates?
Kara Altenbaumer-Price: I think it's all of those things. So we'll start with rates. You know, even here in Texas, it used to be that you could say that the rates were substantially cheaper if you were in the middle of the country as opposed to on the coasts. I think that's not as true anymore. So I think we're seeing just rate pressure going up. Your question about duration, that is definitely true, that cases are taking longer, and particularly securities cases. There's a couple of reasons why. One is that it used to be there was kind of what we call the tier one plaintiffs' firms that were filing in the cases. But in the last couple of years, the majority of securities cases were not filed by them. They were filed by three firms that are considered tier two firms. There's a different tier of firms that are now filing. And those tier of, that tier of firms, just, they take longer. And I don't know if they've figured out that this is a way to make money or if they're not as good at evaluating how long a case should last, but in any event, cases are lasting longer because we have a whole secondary tier, of what we call Tier B plaintiffs' firms filing them. And then the third thing I think that we're seeing just in the last two and a half years since the Cyan case was decided by the U.S. Supreme Court, is that when cases are filed in state court, those judges just, they're not as equipped to be willing to dismiss the cases as fast. And so those cases linger a bit. Of course there's no discovery stay, so those cases are more expensive. So I think there's just a lot of factors that are increasing the rate, or the legal bend, I should say.
Jessica Magee: Well, and as we know, I mean, it's easy to think about it in terms of there's an action that's filed, there's a defense counsel that's engaged, they're going to deal with the plaintiff's counsel, there's going to be motions to dismiss, a motion to dismiss, all that briefing, maybe an amendment and another round. But you also, I think frequently, more and more frequently, you tell me if I'm wrong, my experience says more firms involved. Because you're seeing it's the company, it's officers, it's directors, it's employees, maybe even down to sometimes controller level that you've got, that the company needs to be going out and getting additional counsel for and what are their rates going to be and what's the insurance company going to be comfortable with? That costs time. It adds fees. And so I think that also contributes to it, among other issues that certainly brings in terms of the atmospherics of navigating increasing securities class action filings.
Kara Altenbaumer-Price: Oh, absolutely. I mean, I think and this is something that dated back to, it's been 10 years since I was technically in private practice, but we started seeing this even when I was in private practice, this notion of the lack of shared counsel. And so that trend has increased. And then, interestingly enough, in the insurance soft market a few years ago, just up to a couple of years ago, we started seeing some of the major carriers put language in their policies that allowed people to hire additional counsel, explicitly allowed it, and said they wouldn't put them through a conflict proof on that. So it used to be this trend that you had to say, OK, well, CEO needs his own counsel, this person needs their own counsel, and you had to identify what that potential conflict was. Some of the major carriers actually put language out there that said, No, no, we're not going to, we'll let you deal with that, that's up to defense counsel, we're not going to start putting an automatic requirement that you prove up that you need the additional counsel. And that was good for the insurance carriers when it was the stock market and everybody was chasing the same client. So insurance helped further that trend.
Jessica Magee: That's really interesting, and I can think of a couple of experiences recently in my own practice where a company has counsel. It's regulatory investigation, it's not, it's not, there's no pending class action, but you can sort of see that's something that you can always see on the horizon as a real possibility. But you've got one defense firm that's aptly enabling handling a regulatory investigation. But ultimately an officer or an employee is going to be asked to give an interview or testimony, and they're looking at the form that comes from the agency, SEC, whomever, that says there may be a conflict. And they read that, you want them to read it carefully, and even the person is self-selecting out. Maybe there's not an actual or even real potential conflict, but they want their own counsel. So it's interesting because I think that, just from my conversations with you, these experiences, they take time. But as the insurers or whomever sort of see that data. Do we need to tighten those reins? To your point on the rudder turning, how is the market constricting, softening, and what can we expect to see going forward? So I think that those are considerations that we shouldn't take for granted. We shouldn't assume that the way it has been is going to continue to be state of play always going forward.
Kara Altenbaumer-Price: Absolutely. So some of the areas where we're seeing constriction. So for example, if you're a company that maybe had a tough placement a couple of years ago, maybe it had have been after a stock loss, and you didn't get all the bells and whistles. You're not getting them now. No, carrier is expanding, so if you, for example, if you're with a particular carrier that is one of the ones with an entire page of all the extensions — you got shareholder activism coverage, you got crisis communication coverage, all those extensions — if you change carriers, you're going to lose some of those extensions. So that's one thing. The carriers are using any movement to reduce some extensions. One of the things, though, I think for your clients that is probably the most important, is the pullback on the derivative investigation supplements. So a derivative investigation isn't technically a claim under a D&O policy because no one has filed suit yet. They've said to the board, "There's something you need to investigate. Go ahead and do that, and then we'll decide whether to file the claim." It's something, it's the pre-claim work that's being done. So you have to have that derivative investigation supplement for there to be coverage. So what we're seeing is the carriers are pulling that back. So you may still have it your primary and you may lose it in your excess, for example.
Jessica Magee: Yeah. So let me ask a question on behalf of audience members that may not have dealt with these sorts of issues. Derivative investigation that you just reviewed, not considered a claim, not covered. What about a company that is sort of doing it right, trying to get it right? Something bubbles up through their compliance system, and they think, "We, we need to deal with this, we need to launch an internal investigation we think we need to get independent counsel," the whole shooting match. Is that something that they can be looking to insurance for? I assume they need to be looking to what their coverage says and if they've got any bells and whistles, is that ever covered?
Kara Altenbaumer-Price: Not really. There was, I think, one carrier a couple of years ago that drafted an extension for that, and that was kind of a thing they were touting again in the soft market. Interestingly enough, they were a carrier that didn't have a lot of primary placement. And just from a pricing perspective, they never got quite cheap enough to have a lot of them. So the one carrier that was offering that, as far as I'm aware, they're definitely not offering it now, and nobody seems to have it historically. But no, I mean, if it's internal, it's viewed as just part of your internal risk. And the whole point of a D&O policy, the way claims are defined, the claim needs to be coming externally. Now, I would put one caveat, though. Some people do have shareholder activism coverage. So sometimes there is coverage that you can use to hire the communication firm. It's not really the legal fees, per se. It's designed, it'll like $100,000 coverage, some low supplement like that. And the idea it's really more of a crisis communication, PR kind of coverage, for dealing with whomever it is that's being noisy.
Jessica Magee: That's helpful. I think that's something that first principles are always, in-house counsel should be, I think, always to communicate with the other people that need to be in the conversation about, do we think this is covered and why and understanding what will and won't be in those. You said something earlier about sort of the bells and whistles, extensions, and if you move carriers right now, a company should just not expect to have that, those options in play. In renewals with same carrier, are you seeing those being pulled back or getting more expensive to keep what you had before, anything like that?
Kara Altenbaumer-Price: The only thing we're seeing is pulling back on the derivative supplements. We talked about that. If you remained with the same carrier, typically they're not going to reduce coverage. Now they may very well raise retentions. So sometimes some of those coverages that, things that would trigger the policy that turn out not to be that expensive de facto you're losing some of that. If retention is now $2 million, $2.5 million, some of the smaller litigation is just out of coverage now.
Jessica Magee: So retentions are going up across the board.
Kara Altenbaumer-Price: Absolutely. I would say we're seeing increases. I had client recently who, the retention doubled. Now it was, if you are a company that already has, so if your clients already have a retention that's north of $2 million, you may not see that. It's for the companies that have the lower retentions historically. So there's a few outliers you'll still see with a half million retention or a million, something like that. Those are the ones that are more likely to increase to really get you out of the nuisance litigation category. The other thing I would say if you change carriers, there are carriers now that it's just a minimum two and a half for any new business. I would expect that in a lot of carriers
Jessica Magee: If you don't mind, I've got one more question on the bells and whistles topic or extensions, and it sort of relates to something you said earlier as well about having and needing, and I know we've talked about that a lot before. What are, for people that may not live and breathe this, but want to know more, when you talk about bells and whistles, extensions, what are the things? You've talked about some of them. Give us a laundry list, doesn't have to be exhaustive, of the things that typically you were seeing companies were able to negotiate for, get coverage for, that are, I'd say, less likely to be on the table or considerably more expensive or just not available. And share with the audience your thoughts, because I think you have really good views on this, about looking inward and saying, what do we as a company really need, what do we have to have, what do we want, in terms of corporate self-awareness?
Kara Altenbaumer-Price: Right. So what I, when I think about bells and whistles, so if somebody is looking at their policy and they're wondering, kind of as I go into this, what can I potentially get rid of? So you don't start with the base form there. You look at all those endorsements that are added on the back, which tells you that when that policy was originally drafted, and a lot of the forms that people are working off of were drafted in 2010, 2010 to 2012, 2014. So they're a little bit older, and they were drafted when the prices were going down. So you start to look, and you see aiding and abetting coverage, for example, which is the coverage that would allow, so if you are the buyer of a company. You probably know anytime there's an M&A action between two public companies, or a merger and acquisition between two public companies, you're almost certainly going to have litigation. And that litigation is typically against the seller company by the shareholders who say the price wasn't enough. And so sometimes the buyer company is brought in to say that they aided and abetted that disenfranchisement of the seller shareholders. So that's the coverage that got added, aiding and abetting coverage. Well, if your retention is now $2 million, you're not going, that coverage isn't going to kick in anyway. So it's one where you can say, you know what, carrier, take that back, take that back. Maybe we can take that bell and whistle off, as we were, or maybe we can just say, you know what, that's not that important, it's not worth fighting for. If my retention is so high — and typically an aider and abettor is going to get out of that suit for less than a million dollars, often significantly less than that. So maybe that's a coverage you don't need. One that's gotten added in recent years is books and records requests have been pulled into the derivative supplement. Now that could be valuable, absolutely. That's something you want to hire legal counsel for, because you know that's sort of a precursor or a free discovery to a future security suit, but you didn't have coverage for it until three or four years ago. So you were OK for a long time without that being part of your insurance coverage. So it's those things people need to be thinking about, about the things that are relatively recent add-ons you didn't expect. I was trying to think of another one, like the activist shareholder coverage. Do you really need to use your insurance policy for a $100,000 supplement for hiring a PR firm? It's those sorts of coverages that I would say people really need to think about in terms of do I need to negotiate every little thing. One of the things that started showing up in the policies the last couple of years is the notion of notice prejudice. So for a long time, if you didn't get your claim in on time, there was no coverage, so the companies that had a little bit more leverage started getting prejudice language in their policies. That's great, but how often are you not going to know about a securities class action and not get that in on time? So those are some of the ones where you could start to give a little, I think, on that. Extradition coverage for your executives if somehow they are imprisoned in a foreign country, probably not going to happen for most clients, right? If it's a true risk, then pay attention to it. If you are a company that just doesn't send your CEO to Bolivia, then maybe you don't need it.
Potential Effects of Government Investigations
Michael Stockham: That's interesting. One of the things, maybe a little bit of a pivot, is curiosity on how the market is tightening, not tightening or how it's dealing with not just securities litigation, private litigation, but government enforcement, white collar type stuff, SEC. When something comes over the transom from the OIG or from the SEC, are there differences in how the insurers are dealing with that as far as coverage?
Kara Altenbaumer-Price: Yes and no. The reason I say both is because, as you know, any of your clients, you probably, that's probably one of your biggest struggles over time, figuring out how to get insurance coverage for those big investigations because of the way the trigger language works. Securities policies are supposed to be, D&O policies are supposed to be for directors and officers before they're for the company. And as a result, those triggers for investigations tend to be pretty far down the road for the corporate coverage. So what we, what we saw for a few years there is carriers, AIG is a great example, started selling sort of extensions to allow people to pick that up in their policies. Either they had an actual investigation policy, which, excuse me, very few people bought because it was pretty expensive. But AIG pioneered this extension, then other people started copying, which was the idea of what they call a look-back, an investigation look-back. You have the investigation, it's not covered, but then when the securities case comes down the pike, then you go backward and you pick all that up and apply it to the retention. So that's the sort of thing, there was a standard in the industry that investigations don't trigger policies. That's my "no" part of the answer. And then the "yes" part of the answer is we started seeing some things get added. Now that kind of stuff, unless you're willing to pay a lot for it, that's thrown away. It doesn't make sense to the carriers.
Michael Stockham: Is there impact on sort of the Side A policies, the executive, those things targeted towards executive coverage when it's not indemnifiable by the company?
Kara Altenbaumer-Price: So the Side A policies don't really respond from an investigation perspective. So the answer to that, from an investigation perspective, governmental perspective, not really. You do occasionally see some fines and penalties-type coverage in the Side A that you wouldn't see elsewhere. And what I mean by that, the more likely situation is when an individual faces responsibility for a corporate something, like taxes for example, and you'll see that some foreign entities will, foreign governments will, put a tax obligation on a C-level executive simply because they are the C-level executive. So you will see some of that in a Side A get picked up. But no, the Side A doesn't really respond much more to investigations than the primary policy does, the ABC tower down below. Now, the Side A is getting used more these days because people are being a little bit more creative about how to bring suits. And so you're seeing, for example, derivative investigations that have a big cash outlay with them. And that's a relatively new phenomenon. And the Side A, just like everything else, expanded, and expanded a lot during the soft market. And so it's getting hit as well. The pricing pressure, though, on the Side A is not nearly what it is on the ABC tower.
Michael Stockham: Well, sometimes you hear, and I've heard C-level suite people telling me this or certain executives, that they worry about buying too much insurance because they think by having a tower, a big tower or any sort of significant amount of insurance, that makes them a target from the plaintiffs' firms. I don't necessarily agree with that, but I'm curious about your opinion about that, that the idea that you want to get just the bare minimum of insurance, otherwise you're sort of a fat juicy target for a plaintiff's firm.
Kara Altenbaumer-Price: No, I mean, I will say it might have some impact in the course of a mediation. If everyone knows what's there and available, it might increase the settlement value. I do not think it leads to being sued at all. I think you get sued because you get sued. There's a stock drop, there's something else that gives them a reason to sue, and at that point, don't even know what your insurance is. They do not know, because you don't report the size of your tower in your securities filings. So it doesn't lead to litigation. It may increase the settlement value slightly. But if you look at the statistics like I was talking about, these Cornerstone report and NERA report that are sitting in front of me. When you look at, most settlements are a percentage of what's called the maximum loss. So the notion of this much stock value fell, and then there's basically a calculus to it. And that calculus bears out with or without insurance. So again, might have a little bit of impact in a settlement, but honestly, I think the impact is coming more from the defense side on that. It's a little easier to say yes and make the thing go away if you know there's ample insurance. And I've literally heard Darren Robbins say before in a presentation, "I don't care how much insurance you have. If I think it's $100 million case, then it's $100 million case, period."
Jessica Magee: Yeah, the event study is going to be what the event study is, the stock price dropped as much as it dropped, you'll establish the elements or you won't, and I agree it's a largely, not entirely formulaic, but largely formulaic, so I tend to see the wisdom in that, in that view. Can I ask you just to take a minute to, for people that watch our Coffee & Conversations who are young attorneys that are in house, they've just gone in house or they want to learn more on this topic, but they don't know a lot yet, they're a novice. When you talk about the tower, when you, when we're talking about Side A, etc., just give a quick benchmark about those vocabulary terms. I remember when I first went in-house from the government, I was somewhat familiar, but I was also like, I don't really understand and I needed a baseline. And I know you're good at giving those baselines, so can you level set some of those big vocabulary terms for some of our viewers today? I know they'll really appreciate it.
Kara Altenbaumer-Price: Absolutely. So I'll give my 60 second D&O 101. In a public company policy — and these sections are pretty well true of private policies, too, and I'll talk about the caveat between the two. But there are three sections in a D&O policy. I always start with Sections B and C. So they're called A, B and C, and that term is used throughout the industry. So it's going to mean the same thing to pretty well any carrier, any policy. So B and C are the balance sheet protection for the entity. The B is what reimburses the entity for the losses of individual insureds — so individual directors and officers — whether it's a settlement on behalf of them or defense costs on behalf of them. The C side of the policy is for when the claims come against the entity itself, so for the entity settlement and the entity's defense costs. For a public company, that is only a securities claim, so it has to relate to the buying and selling of shares - buying, selling and regulating the shares. So it could be different triggers, but it has to do with basically being a public company. So all your just regular commercial litigation is not covered for a public company. Now a private company, it's going to be a lot broader than that. So it's not going to be limited to investors and securities. On the A side of the policy — so that's the part we didn't talk about a minute ago — A side is what helps individual officers and directors when the company cannot indemnify them. Generally, it's not when they do not, it's when they cannot. And that's either going to be by reason of law or by reason of insolvency. The other thing it's important to remember is the retention, which is the, this part of insurance is a fancy word for deductible. The difference between the two is not that important right now, but it's basically a deductible. That applies to B and C. It does not apply to A. So if you have a situation, company's in bankruptcy, the CFO has been sued, he's not going to personally — or she, I hope — is not going to be personally responsible for that $2 million retention.
Jessica Magee: That was very helpful. And I know we also have, we have directors that watch and officers that watch also. They ask a lot of questions about, well, gosh, if there's been a claim filed or a regulatory enforcement action filed that says I knew or should have known that I contributed, that I aided and abetted, where am I looking for coverage? So that was very helpful. And I'm curious, and Michael I would like your views on this, too, if you don't mind, and then I'll shut up for a minute. You know, after the Kokesh decision from the Supreme Court, in the SEC case Kokesh, which said for statute of limitations purposes, disgorgement would be treated like a penalty so that there would be a five-year statute. I know that there are at least a couple of cases that went through the courts where courts ultimately sided with insurers that said, yeah, it's a penalty, therefore it's not covered and insurance isn't going to cover that disgorgement. I know that got a lot of coverage. And I'm sort of parachuting in with this question, but I'm curious your views about that or what you sort of hear in terms of the bloodstream and industry think about state of the art on that right now. About, I think people that work in the SEC space know you can't really use insurance for penalties. For disgorgement, it's a historically different issue, but we've seen some courts go in a different direction. What are your views on that?
Kara Altenbaumer-Price: You know, I know that it got some coverage, but to be fair, most insurance policies already excluded disgorgement. The general view is the insurance policies for damages, it is not for anything that would create a moral hazard. In other words, you can't do wrong and have to return, intentionally do wrong. And the premise is, if you're paying a penalty, you've clearly, there's some intent there, there's a view that there had to be some scienter involved. So between the penalty perspective as well as the disgorgement perspective, the idea is it's not loss, it's not damages, if it wasn't your money. And that's the idea, right? If it's disgorgement, it was it was ill-gotten gains, profit you shouldn't have had, something along those lines. So the insurance industry for a long time has viewed that as, "It's not lost, because it wasn't yours." And so I don't think it changes the insurance landscape a whole lot. And then the other thing, I'd turn it back to you. I've always told people that if you're dealing with the SEC, it doesn't really matter what your insurance policy says. In your settlement agreement, you are signing off to say you're not going to look to insurance to pay this settlement. Is that right?
Jessica Magee: I mean, for penalties, sure. And I think in instances for disgorgement, I can see this as an area where companies really would look to counsel to grapple either with the insurer or others to say, look, this is a cost of doing business settlement. We could have fought this for you — talking about the SEC, for instance — we could have fought these allegations, which we strongly denied for years. We feel confident that we could go to trial and get a unanimous verdict from a jury, if not summary judgment, but we want to get on with business. We've got other things to do. We want to operate. And so cost of doing business, good business acumen says pay to settle right now. We're not admitting anything. We're not denying anything. But a classic no admit, no deny says we're agreeing to disgorge dollars, but we're not saying we did anything wrong and that any of this is ill-gotten. So as a cost of doing business to get rid of this, we should be able to look to insurance. I have not seen that fight always go well, for reasons you previously identified, but I do think it's an area where there at least is boardroom, if not conference room, discussion. It's certainly in the calculus of OK, we've received a Wells Notice from the SEC and we're going to start putting pen to paper on what dollars and cents might look like to get rid of this thing or fight it. I think those conversations do still happen.
Kara Altenbaumer-Price: Well, and they should happen. I mean, you should look to your insurance carrier with the entire kitchen sink of everything you spend, but know that it's still a contract, and if that contract says disgorgement is not covered and you sign a disgorgement agreement. I would suggest that you use your broker to fight it, push, but I wouldn't launch coverage action on it. That's just throwing good money after bad.
Jessica Magee: Yeah, yeah, I get that.
Michael Stockham: It gets down to the ultimate, being on the defense side, it gets down to the ultimate horse trade. When you finally are trying to eliminate a suit or get to the final end of a suit, it's pretty much just a basic calculation: where's the money going to come from to pay what they want or what you're willing to pay. And there are different factors, different variables all the time that make it more complicated. This disgorgement or penalty thing makes it complicated on the insurance side. The longer you fight a securities class action, the more the plaintiffs' attorneys put into it, the more they need on a return on investment, so the actual litigation cost goes up, which can make it more difficult to settle. People get themselves in a bit of a bind by spending too much on maybe something that isn't very worthwhile or worth a lot of money. Or, if you have a very small D&O policy, we found that if there's not much coverage there and a plaintiff's firm goes whole hog, it makes it much harder to settle, especially if the company is in some sort of distress. And then, there's always, from sort of a governance standpoint, the idea of, OK, so we can't pay. We don't think our executives did anything wrong. It's a nuisance settlement. We're going to, they're going to disgorge or pay some sort of penalty, but then the executives want the company to somehow indemnify them or see if they can be paid back because they're really just taking, they see it as taking a hit for the company to get on with it, get on with just the cost of doing business. But the internal affairs doctrines, there are a number of states that don't allow indemnification of that kind of behavior. So once you start getting in the settlement realm and start putting together that particular bowl of gumbo, there's so many different factors that make it very difficult sometimes to negotiate out a settlement. And they get tense. Those are normally the periods of the highest heat, not only with the regulators or the plaintiffs firms, but you've also got your internal executives, your internal general counsel, probably exhausted, tired, ready to be done with it. So it's an interesting dance.
Kara Altenbaumer-Price: I think Jessica is right, though, and your comments too, that insurance may need to be part of that calculus, not just looking at it at the line of credit behind you, but if you know there's a limited, there's a limited amount of money and you've got to decide how to get out of this and you don't want to hurt the company in the end. I mean, sometimes these are, this is a bet-the-company situation, right? So you may want to not sign the disgorgement agreement and continue to push it into some sort of damages case if insurance is the only thing that will keep the company running. It's part of the calculus.
Michael Stockham: Well, I think it pays to, I mean, you have to, both defense counsel and plaintiff's counsel and the company have to think three or four pieces, moves down the chessboard at all times. Because one decision to characterize something may make it absolutely impossible to settle a claim if there's no way to fund it. And some of these decisions you can't go, you can't really go back on. So it does, it does pay to think ahead, to strategize it out, not just immediately take a, not really take a hard line first thing. You know, we're going to pound them into submission, we didn't do anything wrong, we're going to fight this 'til hell freezes over, then we're going to fight them on the ice. That kind of attitude can get you really, sort of give you some blind spots as to an overall strategy. That doesn't mean that you ought to go in thinking that you're just going to settle it, but a lot of these settle, a lot of people resolve before going to trial, that's just the fact. And you want to have all the pieces on the board in the correct place so that it is least impactful on the company and the stakeholders when it finally comes to resolution.
Kara Altenbaumer-Price: Well, and remember, too, that if it's a situation, we all know, we can see it right? You could see three or four steps down the road and see that it is coming to an ultimate settlement at some point, that this is not going to just, we're not going to fight it 'til we win. You see that, and there's some intractability somewhere in the process, your insurance carriers are going to get in there, and they're going to start pushing hard to say, "You need to come up with a plan to make this go away." And you really, what's interesting is you'll see that pressure not from your primary carrier or your first excess carrier. You see that from the carriers higher up, who are starting to say, "There is no reason I should ever have to pay." They're seeing it, they're seeing it get toward them. So just know that some of that additional pressure is also coming externally from the people who have to foot the bill.
Michael Stockham: Well, that's anecdotal. I've noticed that the secondary carrier, you didn't ever really use to see a secondary carrier early on, but we've been getting more contact from the second and third layers, not only wanting to know what's going on, but also wanting to be updated. They're watching what's going on in that first level of the tower very, very much.
Kara Altenbaumer-Price: Well, I mean, if you have a median settlement of $13 million and a lot of people have $10 million layers, they're saying, OK, we have a median settlement, we defend it. Even the third carriers are now thinking, OK, we're right at the edge for me.
What Are Undertakings, and What Role Do They Play in Policies?
Jessica Magee: Yeah, I was a political philosophy major and I can do that math, so those are not hard dots to connect. Michael, let me let me ask you a question. I'm going to turn the turn the tables and ask you something. I was at the SEC, now doing the work that you and I do together. We talk about the potential for individual liability, either in regulatory enforcement actions, private actions, and we talk about undertakings and where individuals may need to agree to undertakings, things of that nature. Just sort of in a vocabulary sense for people that are watching that may be new to this area, what do we mean when we're talking about an undertaking? What is that issue?
Michael Stockham: Right, so an undertaking, the company, generally under its bylaws, has agreed to indemnify the executive. And so the executive is going to request or make an indemnification demand on the company, and at that point, the company is going to ask them to sign an undertaking. And the undertaking basically says that the company is going to advance fees, they're going to cover the cost of the investigation, litigation, whatever it particularly is, whatever that particular danger the executive is in, but ultimately, if there is found to be intentional fraud or intentional wrongdoing or something that the company probably couldn't indemnify for, then the executive undertakes to pay all that back. So it's a way for the company to protect the executive in the short run by making sure they have defense counsel fees paid and that they can mount a full defense, but then also protect the stakeholders on the back end, because if there's something that the executive did that's actually intentionally wrong, then they can essentially recoup that amount. So it's a small transaction done by the company, but it's something that, quite frankly, a lot of people forget to do. I mean, it's maybe one page each way, a small letter demanding indemnification and an undertaking is maybe a paragraph long or can be that short. But if your counsel doesn't jump on that at the beginning, we've had companies refuse to pay back or refuse to reimburse individuals for fees. So it's definitely a small place to stub your toe.
Jessica Magee: So it's an agreement between a company and one or more of its people when they find themselves in that situation. In your experience, Michael, over the last 20 years or so, sorry to date you there, is that something that you see companies then communicating with the insurer about? Is that a conversation that is had with an insurer, that we're indemnified, but we may look to this for coverage? Do those streams not really cross?
Michael Stockham: I haven't really been in the conversations that those stream cross, but I can't imagine that it's not a conversation that is being had with the broker and the general counsel and others, because some of those costs may be picked up and paid by insurance. So I'm assuming that the insurer wants to see that the proper undertakings are in place and that coverage is there.
Kara Altenbaumer-Price: Well, I would add that, interestingly enough, the policy echoes this language. Every D&O policy basically has language that there's a presumption that indemnification is granted to the fullest extent of the law. And so they go ahead and presume that whatever indemnification may have been owed under bylaws, indemnification agreement, undertaking, what have you, that it gets done. And then if that fails, then the policy switches to Side A. But there's always language, pretty well in every policy, that we call advancement language, which sounds very much like an undertaking, which says, effectively, you make a demand on the entity and the entity refuses or just ignores, that after a certain number of days, the policy goes ahead and advances the individuals without the retention. Now, the company remains on the hook for that retention or that deductible. And I have seen situations in which the carrier then follows a separate action against the entity to get that deductible. What I do think is interesting is the policies do have the same language that basically says, if we go all the way to the end of this and we find out you did wrong, there's some sort of settlement to that effect, they can pull that money back from the wrongdoer. You just don't see it done. Typically, I think the view at that point, well, where are you going to get those assets? If you've done wrong, maybe they're all been seized by the court or something like that or the SEC has taken them, what have you, and the individual can't pay it back anyway.
Jessica Magee: That's an interesting practical outcome. I hadn't thought it that far through, but yeah, that makes sense.
Michael Stockham: Or it'll settle well beforehand. I mean, if you're defense counsel and you're starting to see a really dark cloud coming in on somebody, you're working to figure out how to stop that short of a conviction or a adverse verdict or whatever you can. And again, putting all those different pieces in to make it, to make it the benefit of the company and the client.
Kara Altenbaumer-Price: Yeah, absolutely.
Changes in the Underwriting Process: What Are Insurance Companies Asking for?
Michael Stockham: Let's talk just a little bit about, we had, when we were prepping for the call and the visit with you, you talked about some of the new things you were seeing in the underwriting process, changes in what the insurance companies are asking for, perhaps a little bit deeper dive on companies that are coming in. Give us a little bit of flavor on that, if you can.
Kara Altenbaumer-Price: Sure. So ultimately, D&O insurance is balance sheet protection, right? And thus, the underwriters are writing, are looking to the balance sheet. That's what they're actually trying to figure out, what are you going to look like in 12 months? And their goal, for any company they write, is that company is still in business in 12 months and hasn't been sued. So to evaluate that, you got to look, again, what do the numbers look like? The problem right now is that companies are either, they're not offering guidance, so there's just simply no guidance being given, or they're having to give whatever guidance they're giving with a magic eight ball. And as a result, underwriters really are wanting to look under the hood a little more. So they're requiring underwriting calls, and a lot of times, as a broker, we're trying to make sure that they're video calls so that you can get a little bit of that flavor, watch the CFO talk, because it's typically the CFO who's going to be delivering whatever messages it is to underwriters. They're looking for that. They are asking, if the financials are a little old, they're asking for basically insider information, for all intents and purposes. Because they're wanting to know, OK, it's been three months since you last put out a filing. What is the next filing look like? So what we're kind of advising a lot of our companies is if you don't want to put yourself in that position of having to potentially give insider information. I mean, you can go the non-disclosure route, but that's still a little, it's uncomfortable, to do something like that. We encourage people to try to have their underwriting meeting around the time of a filing. And so, for example, I had one recently where we didn't do the underwriting meeting until about three weeks before the renewal because their annual report was going to come out on the 29th of the month of July, or June, 29th of June, and their insurance renewed on August 1. So we didn't do their underwriting meeting until July 1 because we wanted to make sure that they had the most recent information and there really was nothing additional that the underwriters could ask that was beyond what had just gone in the filing. So that's one of,, one of the things I would say is that, just know that they're not going to take old numbers.
Jessica Magee: So what's an old number, a stale number? I mean, I'd always use the rule of thumb of, like, you know, I would try to hew closer to six months. If these financials are within the last six months, they're not yet stale. Is it, is it closer to a three month?
Kara Altenbaumer-Price: It's getting closer to a three month.
Jessica Magee: Wow! That's a great tip. That is a great tip.
Kara Altenbaumer-Price: Charting further out, but carriers are just not given their numbers until much closer to the renewal. There's, we been in situations where the primary carrier won't quote until within 30 days of the expiration, and there's a $100 million tower built. Some craziness with that. But I would say, really think about when your filing date is, around your underwriting call, for your underwriting meeting.
Jessica Magee: And make sure, I mean, this isn't specific to insurance, but I just think about my old job and your old job. Make sure that the people whose expectations within the company you need to be managing and the people you need to be educating and the people whose authority you're going to need, know what that on ramp looks like and know what's going on, what conversations are going to be happening and what that cadence is. Because directors that are involved in this are not going to want to be told when they're trying to get financials approved, "Oh, by the way, we're also renewing insurance," and they're going be like, "Whoa, whoa, whoa, what's going on?" So you really have to be thinking dynamically about that to keep all the stakeholders happy, I think, and informed.
Kara Altenbaumer-Price: And another thing I've seen, too, in the last few months is because these price increases are so dramatic, and any of your listeners out there, they can see the reports. Depending on which broker you ask, these price increases on a tower are anywhere from 30 percent to 100 percent on good risks. Bad risks, it can be multiples of whatever the tower cost the year before. And one of the challenges I've seen from some of our C-suite are that the board is pushing back on them, saying, "You didn't give me enough warning that you were going to be asking for these." In some cases, these might even be reportable expenses. So you have to think about making sure the board has visibility to, this is going to cost a lot, and we know that the board is often who makes that final yes or no, let me way veto power, over the tower. And so it's a tough dance with them. The board wants the insurance, right? It's their personal assets at risk. They've got a little bit outsider view of the company, to some degree, the management's going to know a lot more, so there's always that tension when you're placing the tower. So not only would I give the advice about thinking about your filings in relation to your underwriting meeting, I would say you need to be talking to your board before that even. Right now I'd say talk to your board six months out, to use your number, to ask your broker, where's it going, what do you think?
Jessica Magee: That needs to be on board and committee agendas, is at this point, we're going to be renewing insurance, here's what we're seeing in the market, here's where we were, here's where we may be, and just benchmarking and getting them there. Because the last thing you want when you're on a deadline to renew is one or more directors sitting on a rock, not unreasonably, but because they want to make sure they understand exactly why there's a price hike, what they're getting, what their exposure is. I think more and more directors right now are starting to have conversations about, we've been we've been governing our companies and we're doing the best we can, but we've been doing it remotely. Are we, do we have our, do we have a real sense of what the risk profile is in our company and what's coming down the pike? And are we covered for that risk? So just another plug for healthy and continuing engagement with the boards, especially on these insurance issues right now.
Kara Altenbaumer-Price: Well, and their sensitivity just to, when you suddenly find yourself spending another million dollars and you realize that part of what you're spending a million dollars for is to protect individuals. And that creates some sensitivity that you've got to manage.
Jessica Magee: Yeah, especially when that million dollars may be harder to come by in a liquidity crunch market, which a lot of companies are in right now.
Kara Altenbaumer-Price: You know, I had a recent client who had asked about financing their D&O policy. Because it was so much more expensive, they had to think about using a financing arrangement, which is not atypical in occurrence-based insurance, where as long as the policy was in place at the time the thing occurred, the policy will still respond. Claims made insurance, the policy has to be in place at the time that whatever suit is filed, whatever he matter triggers it, which is how executive risk insurance works. So if you finance it and you miss a payment, then theoretically, you've lost all your executive risk coverage. That's one of those things of, if you know, like if you're really in a cash crunch, you need to be planning for that so you don't find yourself in a financing arrangement, which, and it's the language, those financing contracts are pretty rough looking in terms of the power that the financing company has to consider.
Jessica Magee: Not a lot of bargaining power. That's great advice. That's great advice.
Michael Stockham: I'm assuming that COVID is just, the COVID situation as we come to the close of the third quarter here soon and people are working on their books, that this is just going to add more tension and turbulence to all these discussions.
Kara Altenbaumer-Price: I would expect so. At least one good note in all this discussion about it's all getting harder to get, it's more expensive, all of this, is that D&O insurance claims that would have otherwise hit D&O insurance that COVID sparked, they're still going to be covered. There's not, there's no exclusions. If you end up in a situation, if you planned badly, you forecast badly because COVID gave you a lack of visibility, you're good from a coverage perspective. So that's a positive there. But you're right, in terms of the longer this goes on, the longer we are in these positions of getting tired of it, not knowing how long it's going on, it just makes it, it makes it harder financially for companies. And as a result, that's going to ultimately lead to claims.
Jessica Magee: All those, all those cases and claims that we're not, we're not seeing, they're still there. The demand, sort of "pent up" demand, if you're a service provider or a product seller, that it's there. That channel's filling, it just hasn't, the valve hadn't opened yet, is my strongly held belief.
Kara Altenbaumer-Price: Well, and you've got, I mean, I think it was AIG, I'm just looking down at a note I have here, has already announced, I think, something like $700, $730 million in COVID-related losses. Now those aren't necessarily executive risk losses. Those are losses across the platform. But in a in a macro sense, insurance is related to how much capital market is available to the insurance companies. So at some point that starts to impact all of it. And that's just one carrier's numbers.
Conclusion: Considerations and Tips Heading Into Policy Renewal
Michael Stockham: I know a bunch of companies are going to be seeking to renew policies coming up here in September-October timeframe. Any other considerations or tips of the trade for the renewal process as some of these folks go into it, you think?
Kara Altenbaumer-Price: We've talked about just kind of preparing for that it's going to be harder, it's going to be more expensive. One thing I would say prepare that you may need to have additional carriers involved. It may not just be the same players you've used forever for two reasons. One is there are people starting to not renew. Know that you may have to replace some layers, know that you may have to break some layers in half. Just be prepared for, you may have had 10 carriers to get to a number, you may now need 20 to get to that same number. And these things take a while to build. I would say be prepared for some creativity. And what I mean by that is we've started to see situations in which in large towers, the middle of the tower is hard to fill. So sometimes there may be a gap in the middle of the tower. And so you may need to think about filling above and below simultaneously, and you may need to think about taking your own layer right in the middle if you just can't find anybody to fill it. We've seen quota share arrangements, which we haven't seen in years. The idea of multiple carriers take on the same chunk of risk, and they just, they just take a relative percentage.
Jessica Magee: What do you mean when you say take your own layer? Like, I am self-insured for that band?
Kara Altenbaumer-Price: You can, yeah. It's just when you look at your sort of list of the tower, there's a, there's a spot in there, and it says the company itself is responsible. Now we are not seeing that really come to fruition as much as it's on the table as an idea to get us to the next layer. And then we can come back and fill in. But it can be done, and so I encourage people to just think about there's more than one way to do this and the way you've always done it isn't always working right now.
Jessica Magee: The perfect lesson for 2020.
Kara Altenbaumer-Price: The other thing I would say, I would say more for companies that are struggling, struggling financially or struggling to either pay the premium or not really knowing if they're going to be here in 12 months, that whole 12-month window that you're insuring, is focus on the language that's most important. And the anecdote I would give, I had a client recently who, they're teetering on insolvency. They have enough cash right now that they're going to make it about 10 months. And then the last couple of months, this here is a little challenging. So for them, a lot of what we talked about was, OK, bankruptcy language needs to be the most important thing to you. Bankruptcy language, M&A language, those sorts of things. Let's not worry about some of the other things in the policy. Let's focus on what's most important to you. And so as companies are — and this is good advice any time, even outside of this market — but sometimes we've gotten, because of the soft D&O market, people have come to the process expecting all the things. And that's that whole thing, to go back to the beginning of our conversation, not all these bells and whistles are important, but different companies have different ones that are important. So counsel selection may be super important to some people and not important to others. The idea of having individualized limits for outside directors that you'll see in some A Side policies, that may be particularly important to a given company that, there may be companies that have a little bit of tension. You know, if you've got a situation where the founder still involved and there's a little bit more tension there, so you may want to have a, think about those A Side, protect officers and directors from each other a little bit more in those companies. So there's just, sit down, with your broker in particular because your broker is going to know sort of what you can get from the insurance world and what you can give up. They're the ones that are best in a position to do that. And just talk through, "These are the things that keep me up at night," and a good broker should be able to kind of steer those conversations toward how they relate to insurance. We know everybody is kept up at night by the bottom line. We know that. I mean, that's not a specialized question, but I had one the other day, and we were talking and they were like, "You know, the original founder's child is still involved, and we have proxy fights a lot." So that was one where OK, that relates to, let's think about protection of having individual limits for everyone, that kind of thing.
Michael Stockham: You mentioned about the company, the company having a good relationship with the broker. I think part of the calculus there, too, is when folks select counsel to, to run a litigation or something that's going to be covered, it's important to have folks that play nice with the broker. I mean, it can get contentious, but relationships mean a lot, and knowing what you're doing and sort of polite pressure and having a good relationship can mean a lot to what's going on. So I encourage that too.
Kara Altenbaumer-Price: Absolutely. It's all a dance. You want to like your dance partners.
Michael Stockham: Yeah, chest thumping doesn't do anything except get everything sideways fast.
Kara Altenbaumer-Price: And cost more money.
Jessica Magee: Ultimately, it's more expensive and more painful. Michael, my mug is empty.
Michael Stockham: Mine, too, shall we let Kara go?
Kara Altenbaumer-Price: Mine's all cold.
Jessica Magee: You need to get one of those little, one of those little mug warmers.
Kara Altenbaumer-Price: I do. I do. I appreciate the time, guys. I am, I am very nerdy about these insurance issues, and I can talk about them all day. I know they're remarkably boring for some other people, but I love talking about them, and I get, I appreciate you guys giving me a chance to come visit. It was an enjoyable conversation, and if any of your listeners out there want to talk a little bit more about it, I am happy to talk about it. And one of the things I couldn't really talk about in this conversation is what's happening with individual carriers. I know I threw a few names out there, but I didn't really talk about what they were doing from a rate perspective or renewal perspective. So if anybody just wants to say, "Hey, what's x y z carrier you're doing these days?" Give me a call, and I can kind of tell you what to expect from given carriers as well.
Jessica Magee: Absolutely, and for everybody watching, listening, Kara's contact information was on the intro slide, it'll be on the outro slide here as we finish up in just a minute. Please do contact her. I know I go to her with, as you've seen here today, for questions, for tutoring, for help, and what she described as nerdy I find quite charming. And maybe that's just because I'm a nerd myself, but we've just loved having you join us today for Coffee & Conversation. I'm sure we'll continue the conversation going forward. Everybody that's watched today, again, feel free to reach out to Michael and me, reach out to Kara, to any of us, with questions, want copies of the reports that she was referencing today, the cases that I mentioned, or if there's anything we can do to help you or your teams, we would be glad to do so.
Michael Stockham: One more plug for Kara, if you guys are LinkedIn users, go ahead and try to connect. Kara puts out a lot of good information, McGriff and others, that you can stay up to date on the markets. So another great resource.
Jessica Magee: All right, guys, I'm going to go back to teaching first grade and my never, never completed cycle of washing and folding laundry in addition to my practice of law. I hope you guys have a great day. Everyone out there, stay well, and we'll talk to you soon.