Investigations of stock options backdating could have a big effect on the directors’ and officers’ liability insurance market. Although observers say it is too early to tell whether the controversy will lead to large D&O losses, underwriters are likely to tighten terms and conditions in response to regulatory changes.
The U.S. Securities and Exchange Commission and Department of Justice are investigating at least 54 companies they suspect allowed executives to backdate stock options grants to take advantage of share price movements. And on July 26, the SEC issued new rules on executive compensation requirements, requiring public companies to provide details of the total yearly compensation for CEOs, CFOs and the next three highest paid executives. The disclosure will have to be provided in plain English.
Nick Conca, managing principal of broker Integro’s management risk practice, says D&O providers will start underwriting executive liability business more aggressively.
“The new rules are going to require companies to provide greater disclosure of executive compensation, including stock options,” he says. “The rules were in the works before the advent of the backdating scandal, but my understanding is they were significantly enhanced [because of the scandal]. Insurers are very interested in this issue. They are asking prospective insureds whether they compensate executives with stock options and they are also requiring them to fill out very detailed questionnaires.”
Rival broker Aon also believes the increased regulatory focus on the backdating of stock options could have ramifications for the D&O market. In a July 24 statement it said: “Insurers offering D&O policies are gearing up for increased claims activity from both criminal and civil actions. Some carriers are even contemplating whether to include backdating as a policy exclusion going forward.”
Conca says it is not clear whether the scandal will lead to large losses. But it is likely that D&O insurers will have to pay at least some legal costs for defending companies.
“My view is that the insurers that participate in the primary layers will be far more affected by the backdating issue,” says Conca. “As far as I can tell, the major exposure is the incurring of defence costs rather than settlements. Only time will tell if these claims will lead to significant settlements.”
Some insurers seem unconcerned about the furore over stock options. John Degnan, vice chairman and chief administrative officer at U.S. insurer Chubb, said in a conference call on July 26 that the options scandal may not be a big problem for D&O insurers. “The early hype about the impact of backdated stock options on D&O insurers may well be overblown,” he said.