Governance Bites #89, directors and officers insurance part 2, with David Burroughs

In this episode, Mark Banicevich talks to David Burroughs further about directors and officers (D&O) insurance. Mark asks who provides D&O insurance in NZ, policy limits and excesses, and optional features and common fishhooks of which directors should be aware. They also discuss how policies work for businesses operating internationally. David briefly outlines the application and claims processes, and shares the best governance advice he has received. 
David Burroughs is a founding partners at Long Burroughs (https://longburroughs.co.nz/), a business risk advice business based in Auckland. Prior to establishing the firm, David worked at two major international broking firms, Willis and Marsh. David specialises in advising on all aspects of liability risk and provides detailed contractual risk mitigation advice and specialised insurance solutions. His expertise in these areas is enhanced and complemented by his law degree. David has comprehensive experience advising professional service firms, publicly listed companies, and privately owned businesses, across various industries.
#governance, #leadership, #corporategovernance, #boardcraft, #decisionmaking, #makingadifference, #governancebites, #boardroom , #cgi, #charteredgovernanceinstitute, #director, #insurance

Transcript

0:00

Hi everyone, Dave Burroughs here again from Long Burroughs Insurance Brokers. Here with Mark to follow on from the first video and look into the D&O [directors and officers insurance] world a little bit deeper. Hi, welcome to Governance Bites. My name is Mark Banicevich, and as you just heard, today I get the pleasure again to spend some more time with David Burroughs. David, thank you very much for your time. I really appreciate it. No problem at all. We talked last time about a bit of a high-level introduction. You, I think you introduced it as D&O 101. Maybe today then is D&O 102, just digging a little bit deeper. So, a few more questions for you. A starting point: who are some of the common providers of D&O cover and this sort of insurance around New Zealand? Okay, well, pretty much every intermediary-operated insurance company will write a D&O product, but most of them will have different appetites, so that's probably the best way to say it. So, everyone will write it, but it depends on the particular outcome that you're after. So for the publicly listed companies, you've got your international insurers like the Berkshire Hathaways, the AIGs, you know, the QBE, the Vero liabilities, those sort of companies will, you know, and Chubb, and, you know, they will rite these policies for those larger operations. Looking for the more mid-market area, then talking more management liability suites is probably more of their sort of sweet spot. The NZIs, the underwriting agencies like Delta and Dual, and other sort of smaller players will provide some capacity. But again, it's probably better to describe it as what capacity do you need, because the larger operators will provide greater capacity than the smaller operators. So, there becomes a strategic choice depending on what the company is, what they do, what industry, what jurisdictions they're operating in, and all those sort of things, which I'm sure we'll get into shortly. Which is, again, another reason why it's very important to get advice on this topic rather than just ring around some insurance companies and say,"Can I get some cover?" Correct. Yeah, there's a few moving parts to this, which you'll see. What are common policy limits for D&O policies? I look, it varies, right, but for most small businesses, you'd be looking at, you know, a million-dollar cover for damages, and then there'd be an equal $1 million limit for defence costs. Is pretty much your standard piece. Then it all becomes—it's not really a number that you can say for each person. It's, for each company, it's a "horses for courses" approach. You know, if you're a publicly listed company, you'll be looking at $50–100 million of cover, depending on which jurisdictions you are. Those that are dual-listed with Australia, for instance, will certainly be more than $100 million as a total policy limit, but those in New Zealand might have $50 million. It depends on what it looks like. And even then, is it relatively closely held with a publicly listed company versus a very broadly listed stock, as well. So, you've got to think about your position in the market as well before you sort of start putting a number to it, if you follow. What are the risks, and particularly in terms of the magnitude of those risks? Yeah. So, different industries, presumably, would want different cover levels as well, because some industries would have much higher litigation risk. Correct. Yeah, and there's more of a regulatory oversight on some industries, so you'd be taking higher limits on those sort of things because you've got a greater propensity, I suppose, for regulatory investigation or something along those lines. It was interesting noting the change that happens to PI [professional indemnity] cover in particular. In our space in the insurance-broking world or the insurance advice world, when the new regulations came in force. Because we, as we talked about earlier, about lifting the bar of quality of those businesses. And so, you'd think the risk would actually reduce that bad things would happen, but with the regulatory power in play now, the liability is a lot higher, so the cost of that insurance went up quite a lot, didn’t it. Yeah. Yeah, it did. It all comes into play a little bit. And probably just to finish that little section off, is that even if you're looking at setting it, if you're a board of five, you'd probably want to be aiming for a million dollars’ worth of cover for each director. So, it's another way to kind of maybe get a sense-check of what you think is fair. So, that might be a $5 million limit with $5 million worth of defence cost. It could be a total $10 million policy that might be deemed appropriate. So, that's just a little way of, sort of, you know. Do they tend to be aggregate cover amounts, or do they tend to? They are, yeah. Right. They're all aggregate limits, and the defence costs are obviously shared with everybody, as well. Right. So, it's not $1 million for each director. It is, there’s a $5 million pool potentially that will be dispersed depending on who needs it. And that's per policy period, not per claim? Correct. Yeah, per claim and in the aggregate. So, that means that if it's $10 million, you've got $10 million for this financial year, but it can be multiple claims within that $10 million, if you know. But it doesn't reset. Right. And so, also, if you have a claim that bridges multiple financial years, that would also be limited to that $10 million, as well? Yes, correct. So, if the claim relates to this financial year, then it will be this policy that responds. Right. The policy will reset for the next financial year, but it won't add to that current claim afoot. Right, okay. That makes a lot of sense. Do policies tend to have an excess for claims? Side B does. So where the company is being reimbursed, there is an excess that applies to that. So that could be anywhere from $10,000 to$100,000, depending on what the negotiation point is, because that will have some influence on what the premium is, because there's more of a, - Yes. - you know, self-retention there. Importantly though, Side A has no excess. So this is where the individual directors have personal indemnification, because the company can't reimburse them, or will not defend them. There is no excess payable on that. And the Side C securities claim, there's always an excess on that. Depending on what the scenario is. That was a question that kind of arose for me last time. You say that Side B is a policy that covers the company for reimbursing directors for their costs of - Correct. - these sorts of things. Side A reimburses the directors directly, or covers the directors directly. Covers the directors directly, correct. Why would a company not just say, "Use your Side A?" Well, they've got an obligation to indemnify, and so the ability for them to not indemnify is relatively limited. So, and if the company... of course, you want your directors to be indemnified, - Yes. - because they are effectively the key management of the company, so they should be allied to that fact. But it's only where they can't do it because of insolvency, because of breach of the good faith obligations, or other, you know, legal reasons why they can't indemnify. Then that's where Side A comes into it. It's the same limit;- Right. - it's just a different trigger and how they put it through. Okay, so it's important for a company to have both Side A and Side B. Every D&O policy has Side A and Side B. It is just the way it's structured. Right. It's just depends on which tower is triggered, effectively. Right, okay. Oh, that, great. I hope I haven't confused anyone on that. That makes a lot of sense. No, no. I think that makes a lot of sense. Because I was thinking, you know, as I say, why would the company not just say, "Well, use your Side A policy, we're not paying anything"? But it's a bit like having a car accident where you claim on your insurance, but your insurance company then goes for the other - Subrogates against somebody else. - Yeah. And in the case of D&O cover, the Side A directors would be making a claim, and the insurer would then be saying, "Okay, well, we'll cover you, but we're going to get it back"from the company you work for." And that's where the side B kicks in, so you have to have both forms to cover in the policy. Yeah. Right, that does make a lot of sense. Are there optional features on D&O policies that directors should be aware of, say,"I definitely want that option, I definitely want that option in place"? Yeah, there are. I think it really comes down to those extended reporting periods, is probably the biggest one. We talked about in the last episode around run-off cover and the claims-made cover, so I think that's a key one to really consider. The other one, it's probably more important what you should be looking into some of the exclusions, I think, rather than what you want onto it all. Because in growth companies, when you're doing capital raising, it's probably a key fish hook here that, you know, the D&O policy doesn't cover liability arising from misstatement in a prospectus [PDS, product disclosure statement]. We need to seek that cover specifically. Just Side C? Not Side C, no. Ah. That's more of a regulatory, this is just in a capital-raising scenario. Yeah, right. That it won't pick it up automatically. You would have to apply to the insurer to say, "Hey, can we have some prospectus cover"under the policy?" Right. And there'll be additional premium paid. So that's something that, if you are going to be going through a capital- raising process, then you want to make sure you have got securities — not securities cover but capital-raising cover — on the policy. Your actually buying it. Right, so it's separate from your securities cover that you were talking about. The alternative is to go and get a prospectus liability policy, which is a totally different policy. And those are generally put in place for, you know, when you're taking a company private, when you've got a big prospectus that you're going to list. But if you're just raising with habitual investors and other investors, then you want to have a chat to your broker and look at that capital-raising - Right. - to specifically put onto it all. That's really interesting, because there's a real risk there, a real risk, when you're making an offer, of misleading and deceptive conduct and those sorts of things that exist under the Financial Markets Conduct Act [2013]. Correct. So, you'd certainly want some cover there. And also very interesting that it seems to be called"prospectus cover" where we don't call those documents prospectuses in New Zealand anymore — the name has changed. [PDS, Product Disclosure Statement.] We call them POSI [Public Offering of Securities Insurance] for short. You know, so it's probably just the acronym that we use that we sort of carry over. POSI, Yeah. Okay. Anyway. So I think that's the key one there. It can trap a few people. And again, because most capital raising is probably done with private citizens that are — we used to call them habitual investors, but people that have got - Wholesale investors, now. - wholesale investors, now. Then, you know, the regulations don't necessarily provide too much protection for them, so it's probably less of a concern if you're doing it with those. Yeah. It's the retail investors. It's the retail investors that you have to put your, you know, there should be some warning bells going off there. Yeah, absolutely. Right, okay. So, a key thing to draw out there is, if you're doing a capital raise, particularly that involves retail investors, and you have got a registered offer document in place, then it's really important to talk to your broker, and make sure you get some special cover for that. Correct. Because it's not included in your D&O cover. It will be excluded, unless we seek that cover to be put into that. Right. Are there any other fishhooks that directors should be aware of? Any other exclusions and things that, you know, directors should just really be aware that it doesn't cover this situation? Look, I think it's common-sense stuff, too. There's a material change obligation to notify the insurer of any material change. Now, that can mean simply a change in control. It can mean a change in shareholders at a material level. Or, obviously, if you're making an acquisition and adding another company or starting a new subsidiary, you know, those things are all what we call a notifiable circumstance. Now, failing to do that doesn't necessarily invalidate the cover. It just means that, you know, we've got to go back and, you know, do some work with the insurers to get them comfortable. So I guess the key thing is that you should be talking to your broker more regularly than not. And if there's any big moves that you're going to make, then it's best to sort of talk that through and figure out what is notifiable and whether or not any cover can be specifically noted to extend cover. So do you tend to have an annual review with all of your clients on these policies and talk about what's going on? Absolutely. Yeah, because these things are evolving contracts. Business doesn't stand still. And so, every year, it's a good opportunity to review. But I do recommend, if there's anything, you know, if there's a big strategic change to the business, then that needs to be briefed, and work with the insurer to make sure that it's still fit for purpose. Right, right. You talked about customisation before. How are policies customised for different companies, different industries, different regions? What sort of customisation comes into play here? Customisation, most of them will probably be more specific exclusions more than additional affirmative cover. Cover. You know, if you're a tech company, there's going to probably be more privacy-related endorsements that will come on board. You know, if you're in heavy industry, there'll be more health and safety kind of exclusions that will sort of come on board. But really, when we're talking about customisation, we're really looking at the wording of some of the definitions that may need changing. It may mean that they have to be extended, because, you know, the definition of "shadow director" might not be enough. Or we do that. So, when I say customisation, it's not as if we go and break it and rebuild it. It's really just tweaking to make sure that something that's grey, we want to have affirmative confirmation of cover. Yeah. So in a way that, you know, we want affirmative cover rather than subjective cover, is probably the best way. Sometimes subjective cover is good, because you might be able to squeeze something through. But it's affirmative cover that we always seek. So presumably that's more likely for your big companies than for your SMEs, your small and medium businesses? Correct, yeah. Where they have a lawyer that would be reading through the policy and saying,"I don't like these two words." Absolutely, yeah. Where legal counsel is involved, that's generally where we see a lot more tweaking of language. For the mid-market and smaller companies, you know, the coverage is kind of what it is, except we can often negotiate exclusions to be removed if that's really the core risk that we're trying to place. Right. Because insurers also have an obligation to make sure the policies they offer are fit for purpose and actually provide cover. So if there is an exclusion that specifically takes out 80% of the exposure, then they're not necessarily doing the right thing. Yes. Yeah, right. A lot of business these days is essentially global, or at least international. Do these policies tend to cover multi-jurisdiction, or are they limited to New Zealand? How does it work if, for example, a company, you might be a small business that's operating New Zealand and Australia, New Zealand and Asia, or worst-case scenario, the US [United States]? Yeah, well, the US. Okay, we’ll come back to the US. The policies can provide worldwide cover; it just becomes a negotiation point at renewal. So it’s the territory and jurisdiction clauses that we need to focus on. The territory is the one that says, the territory is where a claim can occur. The jurisdiction is where a claim can be heard. Right. So the territory should always be worldwide, if you are doing, you know, internet, usually it’s worldwide as the widest. Then it’s worldwide excluding the USA and Canada, so North American exclusion. And then you can get down to New Zealand only, Australia, Pacific Islands, and that kind of thing. But generally speaking, worldwide excluding the US would be what most policies should have if you’ve got an international footprint. Now, into the US is a bit more of a problem because we all know how litigious it is. And what you’ll find is this is where the appetite for New Zealand insurers will be more limited. So where you might be able to get $10 million here in New Zealand, no problems, getting a $10 million limit that will cover the US may be a little bit harder to achieve. And then they’ll probably put more US exclusions in there around no cover for, you know, superannuation schemes. They may reduce some of the sub-limits that are in place for IP [intellectual property] breaches or something like that. So it’s always the US endorsements, are the ones you have to focus on, because they can be more limiting than they are providing cover. Right. So one way to do that is potentially, if you are having a US presence and you’re looking to expand that presence, then aligning with an international insurer that has a US presence is probably a good strategic choice to make. Because then we can put a local policy in place in the US and build the limits up in the US, which provides (a) more capacity availability. And (b) it’s also going to be more of a robust policy response because it’s going to be built on the US requirements. Yes. So I don’t want to scare people out there, but the US is a totally different beast,- Yeah. - and it needs to be taken, you know, seriously and strategically. And it’s not something you can just put in place, you know, quickly. It’s going to take a wee while to actually get insurers on board, underwrite it in the US, and have a look at that. But generally speaking, if you’re just sending products to the US, then you can have the policy responding to the US, no problems at all. It’s really only when you’ve got a company in the United States plus you’ve got boots on the ground, and all those key strategic moves you make, is when things change to be a little bit more, you know,- Right. - multinational in flavour. The jurisdiction clause that you mentioned before is an interesting one. So you’re then saying that the policy will cover you if the case is brought in New Zealand, but if it’s brought to a foreign court, it won’t cover you essentially? No, it can, as long as the jurisdiction clause is also worldwide, then that’s the widest cover you can get. Yeah. So a claim could be brought in the Fifth District of California or wherever it needs to be, – or in Bangladesh - or in Bangladesh, depending. Yes, and therefore that cover would be a lot more expensive. Correct. So generally, if you’re a New Zealand company and you’re, you know, writing contracts with your customers, you probably want to have a choice of jurisdiction clause in those contracts to say - That's right.- that cases are brought in New Zealand. Yeah, look, we always advocate that any contract you sign in the US in particular is on your own terms. You know. So you are saying, "Well, hey, look, we were only going to provide $5 million worth of indemnity."We’re not going to provide unfettered, unchecked indemnity language."And we’re going to say, well, every claim has to be heard in New Zealand." That’s great. But we know that that’s not always going to be the way you win business. And insurers know that as well. Yeah. It just means you have to make sure that your territory and jurisdiction align to those contractual obligations and making sure that we don’t miss anything on that. Yeah, right. Look, it’s the US. Coming back to the US again, it’s not just one beast, right. It’s a multi-headed beast. Being a federal system, it’s got legal systems in each state as well as its federal. Well, that’s right. And, you know, we’ve all read a John Grisham novel, right, where you’ve got these ambulance chasers, you know, they’re out there looking for litigation as their way to live. And you’re also going in there against established market leaders, and so they’ve got unreasonable powers within that industry. So if you’re a small New Zealand company going in there, the risk is even greater because you simply just don’t have the financial assets to take on a billion-dollar behemoth, you know. And there’s been a recent case of a software company in New Zealand that had to be liquidated because of an argument around potential IP and copyright infringements, where they simply didn’t have enough ammunition to go and fight a market leader. Yeah. So the US is big – it’s the Holy Grail because we know the economy. It's a massive market and a big economy. But it involves more risk. It’s risky and it's complex. And from an insurance perspective, it’s not an easy off-the-shelf product you have to buy. You have to be strategic on who you align with, how much capacity you buy or you can afford, and then looking at which state you actually, you know,- Yeah. - focus on as well. Because, you know, Delaware is well known as being the home of most companies, but, you know, Texas has got other tax benefits for other companies. So, you know, that federal versus state, versus, yeah, state kind of setup is also there. Single state setup. Yeah. So, yeah, get advice from lawyers, accountants, everyone you can, and then insurance will become part of that. And that would apply equally to your public liability cover and things like that as well, right? Which would be even more scary for the company itself. Well, that’s a whole different topic. But, you're right. Yeah. Like, that’s personal injury and people. So it becomes a very much a heightened exposure. And for directors, that should be important because we’ve got obligations to make sure that our staff are, you know, are safe at work. Directors would be dragged in if there’s death or bodily injury in any function in the US, as well. So, you know, making sure that you’ve got an overview of what the insurance requirements are in those jurisdictions is also a big director obligation. And so they’ll have interest in making sure those policies are put in place correctly - Wow.- and are of significant capacity to cover that exposure. Yeah. Taking a little step back, how does the application process work for this type of insurance? Oh, look, it starts as, like most applications, with a proposal form and also accompanying documents such as the, sometimes the constitution and almost every time copies of the financials. You know, your broker will work with you to figure out the best way to put forward the risk. And that may be business plans. It may even be meetings with a director or CFO [Chief Financial Officer], depending on what the, you know, the complexity - The scale. - and the scale is, right. So, but nine times out of ten, it’s a proposal form, financials, and maybe a bit of supporting information around what the business strategy is. And then the broker will write a submission and then talk to the underwriters and figure that out. The constitution, I think, would be a key one, because that’s where a lot of the liability would sit for directors. Would be what sits in the constitution. Okay. And the claims process, how does the claims process work? The claims process works in the fact that as soon as you become aware of a claim – we call that a circumstance, something that may give rise to a claim – that’s when we notify the insurer. The insurer will consider that and figure out at what point they will appoint counsel. And then once the counsel is appointed, they’ll operate and look at whether coverage is affirmed, and also look at the defence opportunities that they have there, as well. And of course, with the D&O policy, every director is entitled to their own counsel. So you don’t have to share one counsel for the whole board. Everyone’s got their own counsel. So depending on, again, the likelihood of the claim being successful, or the severity, or what’s been claimed, how quickly we appoint counsel to everybody will be determined based on need. But effectively, most times it is just simply you make a notification of a circumstance, it goes nowhere, it’s noted, and the insurer is on the hook when and if it actually pops up again. But it’s, wait. Is there an obligation on the policyholder to notify as early as possible? Absolutely. And what happens if they don’t? If you don’t, like if you should have notified in the current insurance period, and you notify in the next insurance period, then generally speaking, if you’re with the same insurer, they’ll treat that fine. But the problem is that if you do change insurers that year, and you fail to notify with the previous insurer that it should have been, then the current insurer may decline that claim, basically saying, "Well, we weren’t on risk when that wrongful act was committed or alleged"to have been committed." In which case, the other policies have that extended, you know, the extended reporting period piece there, as well. So there is some safety net there too. But. Right. So it’s always important to notify as soon as you become aware of it, even if you think it’s got no legs. Yeah. More notifications, the better, in a way. Right. So it really feels like the choice of insurer is a really important one. And it will become a long- term relationship for the company to, in most cases, stick with the same insurer for long periods of time because of these risks of changing insurers. That’s right. I think you’ve got to treat, you know, your D&O relationship just like you would if your professional indemnity relationship as being a partnership with your insurer. It’s not a commodity that you want to go and shop and change every couple of years just to chase a bit of premium. Now, premium is important, we know that, and you have to balance that expectation. But, you know, our viewpoint is that you want to make sure you’ve got continuity with your insurer, particularly if you’re going into different jurisdictions and making the change like that. Yes. So that, and that’s where the strategy of choosing the right insurer for the right course of action your company’s taking, is important. Does it differ in any way for not-for-profit organisations than it does for companies? It does and it doesn’t. You know, they still have the same sort of obligations that they do, just like a trustee would, you know. So the trustee’s obligations and the director’s obligation aren’t too dissimilar in a sense. Right. So all those sorts of risks are treated relatively the same. So the nonprofits obviously don’t have the money to buy large D&O policies. They’ll be more on a nonprofit management liability policy that will be a bit more, you know, watered down in some of those areas that aren’t so important, and all of that. Yeah. Right, okay. So there might just be not such a wide expanse of cover in order to keep the premium down? Yeah, correct. It will just be the basic sort of, you know, breach of duty and other sort of benefits like that. They may not have the assets and liberty expenses, or they might not have the tax liability sort of obligation. You have those sorts of things that are more tailored for a corporate setting. Yes. They may just sort of have those watered down, or they may even have smaller sub-limits of cover, you know, - Yeah. - where it might be $100,000 compared to half a million, depending on what it looks like. Right. It’s just horses for courses again. Okay, right. One final question for you. You’ve, in establishing this company, you’ve got on your own board of directors. So what’s the best governance advice you’ve received? Best governance advice I've received? Well, it's probably to stop and think, is probably what sort of resonates with me. The early stages you're hungry, you want to grow, and you got great ideas, but you just have to sort of wait and sort of figure that through and seek advice. We've only recently established an Advisory Board, which is probably one of the best things that we've done because then, all of a sudden that brought accountability, and we had time to sort of question decisions. Whereas for the first five or six years of our being, we operated relatively freely. Thankfully, my other business partner and I agreed on most things, so it wasn't such a problem. But, it's really having that accountability and stopping to think, I think, is probably how I'd sum it up. Cool, David, thank you very much again for your time. It's been really interesting to cover this topic. No problem at all. I greatly appreciate it. I look forward chatting again soon. And see you next episode. Thanks very much. Thank you for watching this episode of Governance Bites. We have more episodes on YouTube and your favourite podcast channel, where I interview directors and experts on various topics relating to boards of directors and governance. We'd love to see you back, and please like, subscribe, and share the videos and podcasts.