Although they play a less visible role than the Securities and Exchange Commission, insurance companies carry a big stick today when it comes to enforcing accounting reform. Companies that don't measure up to insurance company standards can find their D&O policies canceled or their rates raised.
D&O stands for directors and officers liability coverage. Insurers of these policies, (American International Group, Chubb, Lloyd's of London and others), often end up with the bill for damages in investor lawsuits involving financial restatements and unexpected bankruptcies.
Not surprisingly, the premiums have surged in recent months. "Last year," writes Business Week, "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."
To keep the costs down, companies are agreeing to clean up their books, strengthen internal controls, and provide sound management and governance. Key concessions insurers are demanding and getting:
- Access to outside auditors' reports.
- More grilling of the CEO and CFO.
- Increased scrutiny of financials by accounting specialists.
- A closer look at senior executives' track records and how involved the board is.
- Higher (multimillion dollar) deductibles and cost-splitting beyond the deductible.
It is all part of a trend toward more due diligence by the insurers, who are hiring specialists in forensic accounting and demanding more financial data from clients, along with top-notch accounting standards and a strong board. One underwriter says his firm 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," he says. In a scramble to avoid cancellation, companies are even turning over confidential reports from outside auditors that weren't meant to be used to provide assurances to third parties.