On the Coattails of United States v. Trek Leather, Make Sure You Have Suitable D&O Coverage

This post was written by Andy Moss and Stephen Winter.

Corporate directors and officers have a long list of things that can keep them up at night. Personal liability for civil fines and penalties arising out of negligence or even gross negligence committed in the course of their service to the company should not be one of them. But recently, in United States v. Trek Leather, Inc., 767 F.3d 1288 (Fed. Cir. 2014) (en banc), a federal appeals court held that the government could hold a corporate officer liable for a civil penalty based on gross negligence committed by the officer or his or her agents acting in the scope of their duties to the company, and without the government establishing fraudulent intent or attempting to pierce the corporate veil. Following the decision, a representative of the Department of Justice, although speaking for himself and not the DOJ, sought to downplay the effect of Trek Leather by—perhaps unwittingly—stating that the result in Trek Leather simply reaffirms long-standing government policies. In light of the decision in Trek Leather, as well as at least one Justice Department attorney’s belief that it is wholly appropriate to pursue individual directors or officers in their personal capacities for fines and penalties without even having to establish fraud or wrongful conduct by the director or officer himself or herself, a director or officer might understandably sleep a little less soundly.

For directors and officers facing similar risks, it is important to ensure that the company’s directors’ and officers’ liability (“D&O”) insurance program includes comprehensive coverage for non-indemnifiable Claims against corporate directors and officers (“Side A” coverage), including coverage for civil fines and penalties (to the extent insurable under applicable law), in the event the company is unable or unwilling to pay or indemnify for civil fines and penalties. Excess Side A-only/Difference-in-Conditions (“DIC”) policies may further provide an additional, critical backstop to personal liability. A comprehensive DIC policy may provide both excess Side A D&O coverage and also may “drop down” and serve as primary Side A D&O coverage in the event civil fines and penalties or other loss assessed against directors and officers cannot be indemnified and the company’s full-side D&O policies cannot respond to the claim due to exhaustion, insolvency or a coverage issue.

Don’t wait to ensure that your officers and directors are covered. If your company’s D&O insurance program lacks this coverage, request that your carriers extend coverage for civil fines and penalties levied against directors and officers at the company’s next renewal or placement. If your company is inheriting or potentially inheriting liabilities through a transaction or merger, assess and address these risks during negotiations, and put in place (or require the seller to put in place) adequate indemnification and insurance protections to shield directors and officers from personal liability. As the insurance maxim goes, you’ll be glad you have it when you need it.

Insurance Coverage Legal Audits are Not a Luxury

This post was written for  Boardmember.com

Most executives view insurance with disdain, because it makes no immediate contribution to production, research and development or marketing. Ordinarily, insurance has no tangible results and does not improve the balance sheet. It does not increase stock value. Generally, insurance represents a pure expense detracting from the bottom line. Few officers and directors truly appreciate insurance and even fewer actually understand it. Properly assessed insurance, however, can be one of the best investments the corporation will hopefully never use.


Insurance protects directors’ and officers’ personal assets if the corporation runs into problems. Officers and directors wear many hats today, and their actions are scrutinized more than ever before. Serving as trustee for an employee health or welfare plan, or on the board of a subsidiary or other corporation can present personal liabilities. Litigation arising from employee workforce decisions may come home to roost with directors and officers. If the company’s financial projections founder, or unforeseen economic circumstances such as the subprime mortgage crisis affect the corporation, directors and officers may be targeted in class action investor lawsuits. Proper directors and officers insurance can protect against personal economic effects from these risks, as well as protect the company.

And what about protecting the company assets, both financial and physical? Physical plants and equipment, whether bricks and mortar production facilities or technological, can be wiped out by catastrophes. The wide-spread effects of the World Trade Center attacks and Hurricane Katrina illustrate the potential devastation. Proper property insurance, including different types of business interruption coverage, is an absolute necessity. Separate flood or earthquake policies may be required. Fidelity insurance protecting against theft and other dishonesty can be critical.

Liability insurance, in its myriad forms, is necessary. Insurers have trimmed the scope of formerly standard general liability insurance, so they can sell additional specialized coverage for increased premiums. Negotiated enhancements to today’s standard policies must be explored. Product liability, professional liability, media liability, personal injury liability, and product recall coverages are just a few of the additional types of liability insurance that must be considered. Your corporation’s needs may require tailored manuscript policies. In day-to-day operations, these coverages may make no difference. But nothing teaches their value better than an uncovered liability, once it happens. Worry about insurance then comes too late; survival of the company may, instead, be the issue.

If a cataclysmic event –whether natural disaster, economic downturn, or potential liability –shakes the company’s financial foundations because proper insurance was not in place, shareholders and others will look to the officers and directors for an explanation. Assuring there is proper insurance means more than just buying standard insurance offerings in the marketplace. Assuring proper insurance health requires a check-up in the form of an insurance coverage legal audit. These audits require engaging lawyers working for policyholders and schooled in the arcane and nuanced law of insurance coverage. Policyholder insurance coverage lawyers are independent of the insurance industry and, through a coverage audit, can assess the quality of your coverages, gaps in your coverages, potential enhancements to your insurance program, and wording in your phone-book-thick policies ripe with the potential for denied claims or litigation by your insurers.

An insurance coverage legal audit assesses your needs and identifies potential problems with your coverage before a loss or claim happens. This allows you to negotiate around the pitfalls or buy additional needed coverages. The time to do an audit is now. Once a loss or claim happens, it is too late to ask the insurer to clarify or broaden the coverage terms. For better or worse, the battle lines are then already drawn.

If they want to sleep well at night, directors and officers should view an insurance coverage legal audit as an absolute necessity. It is an ounce of prevention against potential financial catastrophe for which no pound of cure may well exist.

When will the chickens come home to roost? Insurers Use Reserve Releases to Buff Up Underwhelming Financials

Releasing reserves based on early developments is an optimist’s view, [Evan Greenberg, chairman and chief executive officer of ACE Limited] said. “Good news comes early in the casualty business. The bad news always comes late,” he said.

“I do think some companies have released reserves early in an effort to goose earnings,” he said. “It may come back to bite them.”

Link to entire story Here.

As discussed in my prior post P&C fundamentals are pretty bad. According to reports, the only way that insurers showed profits in recent periods was by playing games with their reserves. That is, they revised downward their view of prospective losses to allow them to release reserves, improving the bottom line (on paper, anyway). Such releases covered up “a multitude of sins.”

A report of a Standard & Poor’s June conference on the subject is enlightening and alarming:


… insurers will likely face “temptation to help earnings by underreserving,” particularly if there isn’t a strong recovery. “And we’re not expecting that either,” [John Iten, a Standard & Poor’s credit analyst] said. “We think that any hardening of the cycle will be fairly modest over the next couple years.”

The trend in the industry of releasing reserves possibly prematurely raises questions on reserve adequacy for the future. “Currently, we are witnessing a healthy amount of reserve releases for recent accident years, with a particular focus on longer-tail, commercial product lines,” Mr. Gross said. In 2008, prior-year commercial line reserve releases nearly doubled to approximately $11 billion in 2008 from $5.7 billion in 2007.”

D&O line reserves are of particular concern according to Michael Angelina, Chief Risk Officer and Chief Actuary at Endurance Specialty Holdings Ltd..

"Now is not the time to be releasing reserves," he said. "It's a little premature to be taking good news on that business." At the same time, he said insurers are celebrating that rate decreases have declined, which is not a sign of a hard market. Also, in the 2007-2008 period, given the credit crisis and the associated exposure to directors' and officers' (D&O) liability for financial institutions of a number of commercial lines writers, he said it's unclear whether insurers have underreserved. Many market observers expect a $6 billion-$10 billion reserve need for the D&O product line.

This week, alarm bells have gone off concerning Chubb, a major D&O writer:

The investor report released Monday by Barclays Capital, a unit of London-based Barclays Bank P.L.C., said D&O insurer losses could reach as high as $10 billion, which “implies up to a $2 billion loss (over several years) at (Chubb) based on its market share.”

Barclay's said, “given a potential for a wave of D&O litigation, Chubb does not appear appropriately reserved because its 2008 U.S. D&O loss ratio (estimate) of 78% is mostly in line with its median developed loss ratio over the past 10 years, despite D&O prices declining 50% from the peak in 2002.”

Michael Gross, an S&P analyst said:

“Predicting future claims is key to profitability and financial strength,” … “The question for me is why are they emptying their tanks?”

The answer is obvious, to make abysmal quarterly financials look better. As the Wall Street Journal reported in April:

At Travelers, 34% of net income came from reserve releases in 2008, up from 7.6% in 2007. For Chubb, 31.3% of net income in 2008 was due to reserve releases, compared with 16.2% in 2007. 

But this “buffing” cannot go on forever. 

"You just won't be able to keep your combineds low based on reserve releases, the way you could in '07 and '08," says [Adam Klauber, director of U.S. equity research for Fox-Pitt Kelton Cochran Caronia Waller]. 

Earlier this spring, Moody's issued a report estimating that, of the $5 billion to $12 billion in excess loss reserves the industry had at the start of 2008, about $9 billion had been depleted in the first nine months, with estimates rising to $14 billion for the entire year. Moody's Vice President Paul Bauer says he believes the industry has exhausted its cushion, portending dipping profits for 2009.

"In addition, the decline in reserve adequacy implies a further weakening of balance sheet strength in what is already a difficult market environment," he says.

Link to full story Here.

Eventually, analysts will sit up and take notice, as S&P did last month and Barclay’s did this month. After those flares have gone up, soon-to-be-released second quarter reports should be interesting. Stay tuned.