Now, D&O insurance is not only becoming de rigueur for middle-market players–Willis' Longmore estimates that between 93% and 98% of midsize companies have some form of coverage–it is also less frequently being bought as an add-on to EPL policies. The reason is simple: A loss in one category (EPL) dilutes the coverage limits available in the other category (D&O). And given that directors and officers can be liable to the full extent of their personal wealth in lawsuits alleging such wrongdoings as malfeasance, misrepresentation and breach of contract, it is hardly surprising that most are insisting that their companies make sure that coverage is more than adequate. "If there is one thing that puts the fear of God into a board director, it is being named in a lawsuit and not having any coverage left to fall back on," says Christian Plath, associate director of the global corporate governance research center at The Conference Board in New York.

Coverage Shortfall

Even an insurer like the Chubb Group of Insurance Cos., which was the first carrier to unveil blended D&O-EPL policies, is now recommending against blended coverage. "Even though we know our agents have told their clients that blended policies are cost-effective, companies must understand where they are treading if they buy blended coverage," warns Paul Sullivan, vice president of the private and not-for-profit insurance practice at Warren, N.J.-based Chubb. "Ten years ago, there wasn't the degree of accountability that there is now for corporate executives and board members. To the extent a company suffers a large EPL claim, an outside director would lose available coverage limits for personal liability. It does not make sense in this era to share personal limits of protection with corporate limits of protection. So we advise against blended policies now."

But that doesn't mean everyone is following that advice–particularly since purchasing a separate D&O policy holds the prospect of being quite expensive in the current climate. Instead, some might consider trying alternative blends that offer more protection for directors and officers.

Among the most popular and cost-effective approaches is the split-limit strategy that specifically divides the financial coverage limits between D&O and EPL exposures. While such split-limit policies also are less expensive than buying separate policies, there are some risks. A blended policy with $10 million in financial protection that is cleaved in half, with $5 million going to EPL and the other $5 million to D&O, may not afford enough financial protection per exposure. "Before, you basically had recourse to $10 million in protection for a large EPL or D&O claim," says Charlie Lyons, senior vice president of New York-based Marsh Inc. "Now, you have half that. Consequently, many companies that do split out the limits must also add greater coverage limits." For example, a $10 million blended split-limit policy may go to $15 million or $20 million, with $7.5 million or $10 million directed to each exposure. "You want to analyze your particular risk in each case and buy enough aggregate insurance to protect you," Lyons advises.

Of course, advice like this can put some onerous costs onto a company's ledger. A recent study by the Tillinghast business of Towers Perrin showed that D&O premiums on average increased by 33% between 2002 and 2003, but appeared to be leveling off in the last quarter of the year. Surprisingly, numbers from the same study also indicate that the threat of a shareholder lawsuit declined in 2003, with fewer suits filed and a 40% drop in average awards to $14.2 million, down from $23.4 million. While that is good news for public companies, the slack was offset by a serious jump in suits filed by employees against directors and officers.

When employees are feeling litigious, it affects all sizes of companies, and even midsize private companies are under pressure from D&O in the current climate. Beyond employee suits, some private companies have also been burned by the corporate governance bonfire. While not subject to Sarbanes-Oxley scrutiny, private enterprises are being held to some of the same tests by their bankers, investors and insurance carriers. For example, the recent mutual fund scandal has resulted in some D&O claims against several of the privately held funds, industry sources report.

Trickle-down anxiety makes its way to companies with only seven-figure revenues. A recent Chubb survey of 300 private companies with less than $10 million in annual sales indicates that 40% of companies believed it "likely" that they would be either fined or sued by a regulatory body.

As a result, many are voluntarily elevating the bar on their corporate governance practices and buying more D&O coverage to placate nervous directors and officers. "Our D&O clients in the private sector, in terms of the number of companies, are up 27% in the last year, on top of a 30% increase in 2002," says Chubb's Sullivan. Chubb, along with insurer American International Group Inc., underwrites the lion's share of D&O policies nationwide.

The next wave of recruits

But when midsize companies–public or private–beef up D&O, it is not just in response to pressure from current directors and officers and investors. Companies also worry about their ability to recruit for the executive suite and the boardroom. Today, no prospective director will join a corporate board–even a nonprofit's board or an advisory board for a privately held concern–unless an adequate D&O policy is in place. What's more, vetting of D&O policies gets the same degree of attention once reserved for employment contracts. "In the past, directors might glance at a D&O policy without reading the fine print," explains Julie Daum, U.S. board practice leader at New York-based executive search firm Spencer Stuart. "They've now learned that these policies are notoriously vague. Anything that might eat away their limits of protection gives pause in the current environment. Nobody wants to be left facing a D&O lawsuit without insurance, not when everything you own is at stake."

'And that's the biggest knock against the blended policy. "A smart lawyer will see right off the bat that a blended EPL-D&O policy creates the potential risk of little or no coverage left for one or the other exposure," says Willis' Longmore. "Anything that dilutes or erodes the available limits of protection for a board director or corporate executive will not sit well."