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Using captive insurance alternatives to protect companies and their directors and officers for FCPA-related exposure

Increased regulatory enforcement exposure continues to present directors and officers (D&O) insurance challenges for corporate policyholders. Policies that cover the costly expenses incurred in connection with regulatory investigations, liability payments, and resulting securities litigation are becoming increasingly more difficult and expensive to obtain. This post discusses key considerations for corporate policyholders in procuring, renewing, or seeking D&O coverage, including evaluation of captive insurance alternatives to the hardening commercial insurance market.

The FCPA Blog’s ten biggest FCPA cases of all-time based on penalties and disgorgement assessments have a combined value of over $13 billion. Six of the top ten cases date from 2018 or later. In 2020 alone, SEC investigations, including those involving foreign corruption, resulted in over $4.7 billion in fines and other amounts, leading to shareholder litigation for several companies.

The first half of 2021 has been similarly active with both new regulatory investigations and culminations of existing ones, such Swiss bank Julius Baer’s agreement with the DOJ to forfeit or pay nearly $80 million for its alleged role in the FIFA international soccer corruption scandal. Earlier this month, in a clear signal of more aggressive enforcement to come, the White House named fighting transnational corruption “a core United States national security interest.”

At the same time, securities lawsuits, including shareholder derivative suits, continue to proliferate and settle for record amounts. In the last five years, there have been six settlements of at least $90 million, two of which exceeded $200 million.

In this hyperactive cross-border regulatory and litigation environment, global insurers are increasingly seeking to narrow coverage terms, broaden exclusions, and increase pricing, or have withdrawn capacity at certain layers of coverage. It is reasonable to expect these trends to continue.

Policyholders seeking to protect their company, directors, and officers from far-reaching and expensive proceedings related to FCPA risks are facing markets charging higher premiums for insurance that contains more exclusions, or worse, insufficient limits at any price. Such policyholders should consider using an insurance captive to supplement and fill in potential gaps caused by the challenging commercial insurance market.

Insurance captives are an important, tax efficient tool enabling companies to protect all stakeholders fully from D&O Side B (indemnifiable loss), Side C (securities claims), and even Side A (non-indemnifiable loss). While captives have traditionally not been used to insure Side A claims due to directors’ preferences and challenges under certain states’ corporate laws, the tight commercial market and new creative structures satisfying the most restrictive corporate laws are making captives more attractive.

When establishing a successful Side A captive, consider the following factors:

  • Structuring the captive to meet all IRS insurance company requirements including, insurable risk, risk transfer, risk distribution, and common insurance practices.
  • Setting premiums and reserves based on independent third-party actuarial study.
  • Maintaining separateness between the captive board and officers and those of the insured entities.
  • Establishing and following clear, objective, and independent claims handling protocols to approve and resolve any D&O claim insured by the captive.
  • Use of a reinsurance arrangement, either on the front or back end, to provide independent claims adjustment and to share a portion of the insured risk.

Companies can form a captive insuring all D&O coverages as a pure captive wholly owned subsidiary, a cell captive part of a protected cell structure sponsored and established by a third party, or a group captive jointly owned by similarly situated companies. Tailored to meet a company’s specific D&O coverage needs and requirements, a captive is becoming an increasingly attractive alternative to the expensive and constrained commercial insurance market.

Whether choosing the commercial market, the captive option, or a combination of both,  policyholders will want to negotiate key protections in their policies, including ensuring that:

(i) definitions of “claim” and “loss” extend to the costs of responding to informal and formal government investigations and requests for information, subpoenas, or investigative demands,

(ii) defense cost coverage is provided until final adjudication by a court with no further right of appeal,

(iii) policy language covers fines and penalties subject to most the favorable jurisdiction and venue,

(iv) the policy contains both application and exclusion severability clauses to preserve coverage for innocent insureds, and

(v) the policy’s coverage territory covers activities and wrongful conduct across borders.

Policyholders will need to be mindful of potentially applicable policy exclusions that could eliminate or substantially narrow FCPA coverage. For instance, policyholders will want to avoid any regulatory exclusions; ensure conduct exclusions define intentional acts and fraud as “deliberate and willful” and personal profit as “illegal personal profit;” and replace any “insured v. insured” exclusion with an “entity v. insured exclusion” (which would not preclude cover for whistleblower claims against the entity), or at least amend the “insured v. insured” exclusion to include a carve-back for whistleblower claims.

As noted above, a captive can issue coverage that fills in any gaps not covered by commercial insurers.

The rising costs of FCPA enforcement exposure leave policyholders facing significant challenges to insure the risk. Where the commercial market fails to provide complete solutions, D&O insurance captives have emerged to assist in managing regulatory and attendant litigation risks.

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Daniel E. Chefitz, pictured above left, is a partner at Morgan Lewis, based in the firm’s Washington, DC and New York offices. He’s a Chambers recognized lawyer who advises companies on the diverse benefits of using captive insurance companies to insure a variety of risks ranging from cyber and D&O risks to legacy environmental and product liability.

Sergio F. Oehninger, above, right, is a partner at Morgan Lewis, based in the firm’s Washington, DC office. He counsels multinational corporations on insurance coverage and risk management issues arising in various industries, particularly in the cross-border context.

The authors would like to thank Cara Arnold, an associate at Morgan Lewis based in the firm’s Washington, DC office, for her assistance with this post. She represents clients in government and internal investigations and white-collar litigation.

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