Insurers Demand Full Disclosure

Clients who don't open their books could see their policies get cancelled

Since the wave of scandals that have engulfed Corporate America began last fall, some of the most vociferous calls for reform have emanated from disgruntled shareholders, Congress, and the enforcement community. Now, a new player is stepping up -- one that, while far quieter, could ultimately have a big hand in forcing companies to clean up their accounting and governance practices.

The tough new enforcer? The insurance industry, where companies that write the policies covering corporate execs are threatening to cancel policies if executives don't open their books to scrutiny and prove that they are squeaky-clean.


  Indeed, in recent months, top providers of so-called directors and officers (D&O) liability coverage -- including American International Group AIG ), Chubb (CB ), and Lloyd's of London -- have been demanding all that and more. That's hardly surprising. After all, these insurance companies are the ones left paying most of the damages when investors sue over financial restatements, bankruptcies, dubious accounting, or other practices.

Spurred by a rapid escalation of shareholder lawsuits -- and the fear of more to come as senior officers at large U.S. companies are forced to swear to the accuracy of their financial statements--insurers are demanding a lot more corporate prudence. "They've definitely caught the attention of our clients," says Steve Anderson, a managing director at Marsh Inc., which arranges insurance for corporations.

Leading the charge is AIG -- the U.S.'s largest underwriter of D&O coverage. It's hiring more specialists in forensic accounting, demanding more financial data from clients, and grilling top executives on their track records and knowledge of the numbers. Others are doing similar due diligence and demanding top-notch management practices, accounting standards, and a strong board. The alternative: vastly higher premiums or no coverage at all. No wonder Ralph E. Jones III, president and CEO of Chubb Specialty Insurance, is finding that execs are "willing to give us a lot more information."


  Not that they have much choice. Chris Warrior of Faraday Underwriting Ltd., a Lloyd's insurer, says his company is rejecting coverage for clients that have dubious revenue-recognition practices, poor internal controls, or other red flags. "We're very much turning away business," says Warrior.

Indeed, insurance companies claim that their corporate clients are tripping all over themselves to meet the new demands. Anxious CEOs are giving them unprecedented access in an effort to hold on to adequate, affordable coverage at a time of increased risk. Warrior says senior executives are actually asking what they can do to lower premiums. Some are even coughing up confidential outside audit reports. "We would ask for that a few years ago, but we wouldn't get it," says John Keogh, president and chief operating officer at National Union Fire Insurance Co., the AIG arm that underwrites 22% of America's D&O policies.

Even so, D&O premiums have surged in recent months in tandem with a rise in federal securities-fraud class actions and costlier settlements. Last year, corporations might have paid a few hundred thousand dollars a year to protect executives or directors from litigation. Today, the same coverage costs at least $1 million. Moreover, AIG and its rivals are imposing multimillion-dollar deductibles and forcing companies to split the cost of any claim beyond that.


  Despite the higher costs, the newly assertive insurance industry should ultimately be a boon to shareholders. Companies can't afford to have inadequate coverage at a time when recruiting directors and pleasing investors is tough enough. It's especially challenging for those in the technology or telecommunications sectors -- not to mention companies that have already been in the headlines.

Clean books, real numbers, sound management, and strong boards. Call it an insurance policy.

By Diane Brady in New York