Direct exposure

One of the particular challenges that brokers face is keeping abreast of new and developing products that sit alongside the traditional products of property and liability insurance. Not only are they required to be fully conversant with the product, but also have to be able to identify the specific exposures a customer may have and relate them back to the product to enable them to make the right recommendation.

Despite being available in the UK since the mid 1970s, directors' and officers' liability insurance is still seen as a specialist product, one that requires particular expertise to be able to handle with confidence.

Certainly the larger international brokers are able to utilise specialist teams within their organisations, but smaller brokers on the whole do not have the kind of resources to deal comfortably with more specialist products.

In these circumstances, the specialist insurer has a key role to play in ensuring that the product is easily understood and to provide sufficient support in terms of training and access to quick expert advice that enables the broker to go about the business of advising the customer correctly.

D&O liability is an evolving product and today's cover would look very different from that written 20 years ago. Also, whereas employers', public liability or property covers are largely uniform in content, D&O policies can vary in terms of both style and content. Some are suited to particular types of customers such as SMEs or charities, while others are designed to deal with specific situations such as public offering of shares and listing on the stock exchange. Others blend in additional covers such as employment practice cover and legal expenses. All of this makes the job of negotiating though the maze of D&O covers and explaining the need for protection to the customer even more complex.

As well as understanding the product, the other challenge is to enable the uninsured company to understand the need for protection. Zurich's recent survey showed an alarming three out of 10 company directors were not even aware of its existence.

Insurance brokers will face the common response when talking about the exposures directors face: "it would never happen to us" or "it only happens to the large multinational public limited companies". However, the entire claims experience of Zurich Commercial involves UK private companies with no overseas exposure with settlements ranging from a few thousand pounds to £250,000, with larger claims on similar types of companies in the market place.

So, it can happen to an everyday SME and it is always worth remembering that you do not have to be wrong in order for someone else to think you have done wrong. Most D&O claims involve defending directors from spurious or unfounded allegations incurring significant legal-defence costs that would otherwise be picked up by the individual themselves.

Directors of companies, particularly of smaller companies, are often unaware of the personal liability they face in their capacity as director of a limited company. Under current legislation, companies are only able to indemnify - that is, pay the legal defence costs incurred in a legal action directed at a director - when that director has proven innocence.

Without any D&O protection, the director is required to fund any legal defence out of their own pocket.

In addition, if such allegations are proven and result in a civil award or settlement, this also must come from the director's own funds - the company is powerless to protect the director. If the allegation is of a criminal nature, again the director has to establish innocence before being able to access companies' funds. If found guilty, any subsequent fine or other penalty cannot be covered by a D&O policy.

A further challenge for insurance brokers is the proposed change in company law regarding indemnification of directors, which is to be established in law by April. This has the effect of further complicating the broker's task in explaining when directors can be found personally liable without any recourse to company funds. The Companies (Audit, Investigations and Community Enterprise) Act 2004 details new provisions regarding when directors are able to be indemnified by their company. This only applies to directors and officers and any other persons normally insured under a D&O policy.

Broadly, the position from April will be that, if acts of a civil nature are brought by third parties (this does not apply to in-house claims), then the company will be allowed - but not required - to indemnify directors for legal costs, awards and settlements even when the allegation is proven.

But, if the act is of a criminal nature, then fines, other penalties and the legal-defence costs associated with an unsuccessful defence will not be allowed to be indemnified by the company.

Although this has no impact on the way D&O cover is arranged and does not in any way lessen the exposure of directors, it may result in more claims being dealt with under the company reimbursement section of the policy, which deals with company indemnification claims, as opposed to the personal liability section. The key point is that personal liability still exists for directors and the desire to offset the D&O risk from both the balance sheet of a company as well as the personal assets of directors still remains, and that risk is always increasing.

However, the trend also exists at the other end of the scale, as we see increasing numbers of notifications to D&O policies by small and medium-sized UK private companies as directors become the target of a whole range of claimants including employees, creditors, shareholders and regulatory authorities (see box, far right).

To conclude, as the need for directors and officers to adequately protect themselves grows, it is vital that insurers look for ways to simplify, as far as possible, the cover and the way it is explained. It is also important to make it easy to do business as, clearly, the next growth area for D&O will be the SME sector.

Research confirms that SMEs are at risk. Over one-quarter of a million owners of SMEs admit they have been sued or threatened with legal action because of decisions made by the firm's managers.

Department of Trade and Industry estimates suggest there are four million SMEs in the UK, of which, at the start of 2003, 7% admitted in the survey that they had either been sued or threatened with legal action.

This equates to 280,000 - over one in 10, or 15% - of small-business owners and directors that do not know they can be held personally liable for the actions they take in day-to-day business.

On average, a direc-tor of an SME can face legal bills costing anything from £25,000 to £50,000, based on experience of the typical legal costs for breaches in government legislation. Examples include fraud, theft, unpaid VAT or for being deemed unfit to perform the duties of a director. Despite the threat of personal ruin, nearly three in 10, or 27%, of the UK's SME directors said they did not even know if they had insurance to protect them from being personally culpable in the event of being sued.

Almost six out of 10 (59%) said they did not know what protection is offered through D&O insurance. Nearly one-third (31%) thought their EL or PL insurance would cover them.

PARTIES AFFECTED BY A D&O POLICY

- Shareholders - the director's main duty is owed to the company, which has a legal identity separate and distinct from that of its management and shareholders. Various case law makes it very difficult for shareholders, especially minority shareholders, to bring successful actions against directors, but there are remedies available.

- Creditors - the common-law duty of directors towards company creditors and, when it arises, is not clear in UK law as decisions of the UK judiciary vary. However, the Insolvency Act 1986 creates potentially serious personal liabilities for directors towards creditors where their company is declared insolvent. In addition, other statute law creates liabilities for directors in respect of amounts that may be owed to the Crown, mainly those relating to taxes or duties. It is worth noting that, in such cases, the company need not be insolvent in order for the director to be liable.

- Employees - there is no duty in common law for a director to consider the interests of the company's employees. However, Section 309 of the Companies Act 1985 does place a statutory duty on directors to consider the interests of employees as well as shareholders, although it does not give the specific right to employees to bring action against a director.

- Regulators, customers and others - a wide range of third parties (regulators, competitors, vendors and suppliers) can also bring action against directors. A director's liability is likely to arise by way of either contractual relationship, a duty in tort or by statute.

Jim Gaskin, Speciality lines manager, Zurich UK commercial business

The Zurich Small Business Survey was conducted in September 2004 by Pickersgill Consultancy and Planning. Interviews were conducted with the owners of 1000 SMEs in the UK with a turnover between £50,000 and £2.5m.