I know that much of this blog’s readership is located outside the United States and that many readers have substantial business dealings overseas. One of the countries that I know many are focused on is India. For that reason I am pleased to be able publish the following guest from Michael Lea and Abhimanyu Malkan of JLT Specialty Limited (pictured, left)..Mike is Partner and Head of Management Liability in JLT’s Financial Risks Division and is based in London. Abi is a Research Analyst in JLT’s Financial Risks Division and is based in Mumbai.
I would like to thank Mike and Abi for their willingness to publish their article on this site. I welcome guest posts from responsible commentators on topic of relevance to this blog. Readers interested in publishing a guest post are encouraged to contact me directly. Here is Mike and Abi’s article:
The Indian government has decided to replace almost six decades of company law governing the companies in India, i.e. Companies Act, 1956 (CA1956) by new law, the Companies Act 2012 (CA 2012). The proposed Indian Companies Bill (CA 2012) has been passed by the lower house of Indian Parliament, however, approval by the upper house is still pending.
In this post, we examine the directors & officers (D&O) insurance market in India which is of particular relevance to many companies who deal with India, particularly the US. The current regulations in the proposed bill along with D&O related issues have created a conducive environment to selling D&O insurance in India.
Most company executives generally understand that D&O insurance is useful given the changing landscape of regulations in India coupled with the recent spate of global claim experiences which has brought risk factors associated with directors and officers into significant prominence. The expansion of global footprints of Indian companies coupled with a complex regulatory environment, increased shareholder activism and litigation has made the job of directors and senior executives onerous and exposed to its own set of risks. Increasing awareness and extensive coverage of erroneous decisions taken by senior executives (for example Satyam scam and sexual harassment cases in the year 2000) have also brought D&O liability insurance issues into the Indian board room. Further, the economic downturn along with a rise in sub-prime related law suits has brought an increased awareness of D&O insurance. Recently India, Inc. saw as many as 340 independent directors resigning from their positions fearing that their reputation might be at stake if the company fails to live up to investor expectations. The Satyam case brought to fore issues related to protection for independent directors and other innocent executives. I believe that Satyam was dubbed as the "Indian Enron" when it was revealed in January 2009 from the company’s founder and Chairman that more than $ 1 billion of revenues the company had reported were fictitious.
Earlier, many firms resisted the need for D&O insurance because of a less litigious environment and hence the assumption that they would never have a D&O claim. We believe that this perspective overlooked the fact that there are claims such as racial discrimination, sexual harassment and unfair dismissal which have resulted in regulators actions under various statutes, such as the Companies Act 1956, Securities and Exchange Board of India 1992, Foreign Exchange Management 1999 etc. Further, the reports on Corporate Governance such as the Kumarmangalam Birla report 1999; the Narayana Murthy Report 2003 and Clause 49 of the listing agreement with stock exchanges state explicitly the board’s responsibilities. These statutes set the standards for directorial behavior and at the same time increase the potential for actions against directors who fall short of these standards. In our view, actions can come from various D&O claims plaintiffs that include customers, vendors, employees, competitors, suppliers and a host of other stakeholders. In this globalized world, anyone anywhere can be a prospective claimant and when a company has a claim, costs can mount quickly. In such cases, suits with little merit can be also expensive to defend and resolve. There could be significant defense costs and damages in such actions which can vary from thousands to millions of rupees. The length of time taken to settle these cases can also extend from several months to several years.
Why sell D&O insurance in India?
The general awareness of D&O related liability risks amongst the Indian corporate sector and the financial services industry has given an opportunity to the Indian insurance industry to provide insurance solutions to cater to the need of their clients. This is evident in the number of the companies that offer D&O insurance. The leading companies in India that offer D&O insurance include Tata AIG, HDFC Ergo, Bajaj Allianz, ICICI Lombard, New India Assurance and Raheja QBE.
In our view, the Indian economy is expected to be in high single digit growth in the current decade. Indian companies are listing on foreign stock exchanges, acquiring or merging with non-Indian companies. The listing requirements, the litigious environment in overseas jurisdictions and the prohibitive legal costs all make D&O insurance a ‘must-get’ policy. Further, we believe that the risk of claims and litigation for the directors and officers of a company would continue to see a significant increase, both over the short and long-term as more Indian companies become globalized. There are companies in India that have taken maximum D&O cover ranging from $1 million to $100 million. Recently in a landmark development in the Indian insurance industry, Tata Steel purchased consolidated global cover (including its European operations) worth $160 million for its directors and officers. So most Indian multinational companies are buying or consolidating their D&O covers in India because of premium efficiencies, choice of the best-in class policy wordings, limits, deductibles and also because of close proximity with the insurance companies and intermediaries.
Currently most multinational companies already have D&O cover for their subsidiaries currently operating in India. This is imperative for them due to operational, working and cultural differences in each country’s environment. However, despite the increased awareness of D&O, the cover purchased by publicly listed companies in India is very limited with only 10% of listed companies having D&O policies of any sort. So there are advantages for insurance brokers and insurance companies to demonstrate the features of D&O cover (what should and shouldn’t be covered) to the management of publicly listed companies in India. The attitude amongst Indian entrepreneurs for purchasing an insurance cover was considered a cost rather than an investment with companies believing that they are unlikely to need the insurance because they believed that they would never have a lawsuit and moreover because of the less litigious environment. But we believe that with the Satyam scam, the sexual harassment in Infosys and other D&O related issues, the importance of having a D&O insurance cover would increase and as a consequence of this increased interest, the quality of D&O covers available in the market will improve.
Historically, Private companies in India resisted the need for D&O insurance as they felt the number of shareholders was minimal. However recently, more Indian privately-held companies with their share of employment disputes and minority shareholder issues are increasingly showing more interest in buying D&O cover. The fact is, the right time to buy insurance is when you think you don’t need it. Indeed the costs for private company D&O insurance is relatively low compared to publicly listed companies and for the relatively low cost, private company D&O insurance buyers can obtain coverage that is quite broad. Since private company D&O insurance policies provide broader coverage at a relatively low cost, we believe that D&O cover should be part of every private company’s risk management portfolio – not just private companies with a broad ownership base.
Regulation is also one of the strongest drivers for purchasing insurance in India. The fact that the Securities and Exchange Board of India (SEBI) intends to make D&O mandatory for publicly listed companies, is fueling demand for D&O insurance products. The purchase of management liability policies such as D&O liability is driven more by regulatory compliance and corporate governance rather than a risk management approach.
Lastly, we believe that the motivation for buying D&O cover does not rest solely upon factors such as financial misstatements, sexual harassment, etc. The possibility for litigation can also arise due to other genuine reasons. For example, although directors and officers have a duty of care to make decisions that are in the best interest of the organization and its stakeholders, there is always a risk of getting it wrong and being sued as a consequence. The possibility of litigation against individuals can result in an unwillingness on the part of boards to take risky decisions or actions as they can stand to lose a lot in the event of a legal challenge. As the management of Indian companies gain a broader understanding of the benefits D&O insurance, the demand for cover will most definitely increase.
Combined or Separate Limits?
The most popular cover across India within D&O liability is the Excess Side A Cover, which is the directors & officers own personal dedicated limit of liability, where they are not indemnified by the company. For example, D&O policies are often written to include coverage for lawsuits brought directly against the organization which has resulted in sharing policy limits among the organization and its directors, officers or members. In certain situations, the bankruptcy courts have seized the D&O policy as an asset of the bankruptcy estate, leaving the directors, officers or members without coverage. These policies are written with very few exclusions and will provide coverage on a primary basis where coverage is broader than the underlying primary D&O policy. Further, insurance buyers should ensure that small premium differences do not deter them when making important insurance decisions which could leave them vulnerable without sufficient protection should the hour of the need arise.
What to look for in the Proposed New Indian Companies Bill?
For the first time, duties of the directors have been defined in this bill. The bill states that the director of a company shall:
- Act in accordance with its constitution document.
- Act in good faith in order to promote the objects of the company for the benefit of its members as a whole and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment.
- Work with due and reasonable care, skill and diligence; exercising independent judgment
- Not be involved in a position or activity that may be in a direct or indirect conflict of interest with company or possibility of conflict
- Not take or attempt any undue advantage either personally or for relatives, partners or associates. If any director is found guilty for achieving undue gain, the director will be liable to reimburse an amount equal to the gain to the company
- Cannot hand over his office and any such assignment shall be void
Besides this, the new proposed Bill CA2012 bill has widened the definition of the "officer who is in default" to include key managerial personnel that includes
- Chief Executive Officer or the Managing Director or the Manager
- The Company Secretary
- The Whole-Time Director
- The Chief Financial Officer; and
- And such other officer which may be prescribed
The proposed Bill CA2012 has no provision corresponding to Section 201 of the CA1956 Act (indemnification of directors) stating that there is no restriction on the companies to indemnify its directors. The only reference to the provisions of indemnity to directors is given in Section 197 of the CA2012 stating that the premium paid on the insurance policy shall be treated as part of the remuneration of the officers only if such officer is found guilty. The critical distinction between Indian Companies Act 1956 and the proposed bill CA2012 is that insurance companies can now indemnify directors even before the judgment of the court. The advantage of this policy arrangement is that now directors or officers would not have to worry about defense costs.
The proposed Bill CA2012 also introduces the concept of class action suits to provide that a requisite number of members or depositors may file an application before the Tribunal on behalf of the members and creditors if they are of the opinion that the management or control of company affairs are being conducted in a manner that is against the interests of its members or creditors.
Future Outlook for D&O Insurance in India
The landscape in India with respect to D&O insurance has changed rapidly in the last five years. We believe that because of recent developments in D&O related issues, we have transitioned from concept selling to general awareness about the D&O product. Directors would want to shield themselves from the risk of huge liabilities in the event of fraudulent activity stemming from poor corporate governance policies. The surge in demand has been fuelled not just by recent high profile scandals but also due to higher judicial and regulatory scrutiny by the regulatory authorities. For example, there have been talks about the Securities and Exchange Board of India (Indian capital markets regulator) making it mandatory for all listed companies to buy D&O insurance. Further, the proposal to hike Foreign Direct Investment in Insurance to 49% is likely to be taken up in parliament for the budget session. If passed and ratified, capital would not be a limitation for expansion.
As more and more Indian companies become multinationals, and more foreign entities invest in them, companies employ people of various nationalities. So with this, the Indian D&O market is poised for a rapid growth. Companies, who want to deal with India, should note that currently, entry of Insurance Companies into India is permitted only through joint ventures, with FDI limits (Foreign Direct Investment).