For starters, underwriters now require greater financial transparency, including wider disclosure of financial transactions and reporting procedures, copies of board minutes, audit committee attendance records, incorporation of CEO and CFO certifications in the policy application and background on audit committee members serving as financial experts.

In addition, many insurers have introduced new policies for directors and officers, or imposed new endorsements or exclusions to renewal policies that may significantly limit coverage.

It's also possible that Sarbanes-Oxley will alter securities litigation trends -- which could dramatically expand the potential liability of directors and officers, and consequently affect the insurance available.

Sharper Focus on Governance
Insurance underwriters seeking to gain a better understanding of potential liability exposures of directors and officers are focusing attention on corporate governance matters. Indeed, financial inquiries from underwriters have become more sophisticated and detailed -- a growing number now rely on outside financial experts or have hired certified public accountants away from public accounting firms to analyze financial statements.

Items relating to auditor independence top the list. Underwriters may request copies of minutes from board meetings and ask to review the audit committee charter, and with a five-year rotation of the senior auditing partner now required, underwriters typically ask about the length and scope of these relationships.

Underwriters often want to know the professional background of the audit committee member serving as the financial expert, and they may also want to delve into recent transactions, including related-party transactions in past three years and the existence of special purpose entities (SPEs). Also, underwriters are concerned about executive accountability, frequently wanting to examine the company's code of ethics and the steps management has taken to ensure high levels of integrity and ethical values. Additionally, firms generally need to describe outstanding loans to executives and explain how the loans will be eliminated.

Underwriters may want to review the firm's insider trading policy, including its efforts to comply with SEC Rule 10b5-1, as well as procedures for complying with new accelerated reporting requirements. They will want directors to describe the company's practices and procedures for contact with securities analysts, and they'll want copies of reports prepared by outside financial or investment analysts during the last 12 months.

They are also checking on company safeguards against corporate and criminal fraud, as well as any pending investigations or regulatory actions, and are likely to inquire about the company's processes for whistle-blower complaints.

Most underwriters now insist on meetings with senior corporate officers, including the CFO, general counsel and CEO, which previously was not a part of the process. They also routinely inquire about the firm's process for having the senior executives certify the financial statements.

This increased scrutiny signals a changed relationship between businesses and their insurers, one in which financial executives should communicate with underwriters as though they were potential investors. Companies need to make senior executives available to underwriters, who may ask them to describe the company's business plan and its corporate governance initiatives.

D&O Policy Terms Tighten
Besides increased retentions, higher premium prices and less capacity, there are also significant changes in terms and conditions. Underwriters now typically require completed applications for every renewal and long-form applications for new layers of insurance. In some cases, underwriters are adding exclusions for claims arising from financial restatements, improper remuneration, disgorgement, failure to maintain insurance, terrorism and certain pollution exposures.

In other cases, underwriters are expanding existing exclusions, such as those related to "personal profit and dishonesty." A change from the more favorable "final adjudication" to "in fact" wording may make it easier for an underwriter to deny coverage in situations involving alleged dishonesty.

Underwriters are now unwilling to automatically extend the definition of the insured to include individuals other than the directors and officers. This may not be a bad result in the following context. The D&O policy contains an "insured vs. insured" exclusion. Thus, suits brought by one insured against another insured are excluded by the policy. So, the broader the definition of an insured, the broader the scope of the insured vs. insured exclusion.

Also, the definition of an "insured party" under most D&O contracts is evolving. For example, underwriters are seeking to end coverage that provided protection for the corporation's own liability in securities suits. Instead, insurers are attempting to replace this coverage with an endorsement that predetermines their exposure in suits naming both the entity and its directors and officers.

In additional tightening of policy terms, underwriters are trying to limit or remove coverage for administrative and regulatory actions, and criminal and investigative proceedings.

Underwriters may want to exclude inside attorneys due to increased exposures set forth in Section 307 of Sarbanes-Oxley. Businesses should discuss this issue with their brokers; many firms will want to try to keep this coverage or consider purchasing a separate employed-lawyers contract.

As a result of the changes, no two D&O liability insurance policies are alike, and at renewal, nearly every feature of the previous insurance policy is technically off the table but remains negotiable. Preparation is key. It begins by working with your broker -- before meeting with the underwriters -- to develop and prioritize a list of specific coverages. Thus, when negotiating with the underwriter, you're aware of where you have flexibility and where to stand firm.

Securities Litigation On the Rise
The changes in D&O liability coverage stem largely from the dramatic growth of securities-related litigation, and underwriters' expectations of more lawsuits. In view of Sarbanes-Oxley, a measurable decrease in the volume of shareholder suits is unlikely -- at least in the short term. As elements of Sarbanes-Oxley are implemented, there is likely to be a wider range of forums for litigation, including administrative proceedings, actions seeking injunctive relief, fines and penalties and criminal cases. Notably, many of these forums may not be covered under new D&O insurance policies.

Additionally, Sarbanes-Oxley requires more extensive and faster disclosure, which initially could lead to more litigation. Besides a requirement for real-time disclosure of material events and transactions, accountants must assess and report on adequacy of a company's financial reporting, and executives must disclose trades within two days.

Sarbanes-Oxley has extended the statute of limitation for filing securities fraud suits from one year from discovery or three years from the wrongful act, to the current two years from discovery or five years from the act. The result could be longer class periods, larger classes and ultimately greater damages.

The D&O insurance marketplace is evolving rapidly in step with the securities regulatory and legal environment. As a result, financial executives need to understand when their D&O insurance policies will respond to claims and when they won't.

LOU ANN LAYTON is Managing Director of Marsh Inc. (www.marsh.com), a global risk and insurance services firm. She can be reached at louann.layton@marsh.com.

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