Liability insurance in China

Following the economic reforms of the last two decades, China has grown to become the third largest economy in the world with a GDP of over US$720 billion, and is now widely recognised as one of the most exciting economic regions of the world.

Since 1991, when the Shanghai and Shenzhen stock exchanges opened, the number of listed companies has surged from 14 to over 1,200.

This economic growth has been accompanied by a surge in corporate governance activity. The China Securities Regulatory Commission has formulated in excess of 300 laws since 1992, with new bankruptcy laws expected later this year.

As more and more foreign companies enter the Chinese market, the emphasis upon corporate governance in China is increasing rapidly. Many observers are suggesting that China needs to draw upon international examples to establish robust corporate governance requirements, such as the American Sarbanes-Oxley.

As Shareholder rights are strengthened and directors are placed under greater scrutiny, the value of Directors’ & Officers’ (D&O) Liability Insurance in the Chinese market is starting to be realised.

The Chinese economy is becoming increasingly sophisticated; therefore the D&O Liability product offered to the directors of Chinese companies must be capable of a sophisticated response to allegations of wrongdoing.

The following is a brief checklist for purchasers of D&O Liability Insurance operating in China, to ensure their cover is adequate.

1. Severability. It is essential that a D&O Liability Insurance contract is between each individual director and the insurer(s). This ensures that insurers cannot rescind the entire policy for all directors if one of their number provides false or misleading information to insurers. One scenario where this protection is important is where a Finance Director has deliberately misled insurers and there is a subsequent corporate problem. Cover for the directors not involved in this deception may be rescinded unless the insurance contract is clearly at an individual level.

2. Fraud and dishonesty. Directors, of course, cannot insure themselves for fraud. However, a good D&O policy will provide defence costs to a director where he or she has been accused of fraud or dishonesty. The cover will only cease once the alleged fraud or dishonesty has been proven.

3. Major Shareholders exclusion. Most D&O insurers will exclude claims made by shareholders in a company if they own a significant amount of stock. The figure is usually set at 15%. If a Company does have a major shareholder, it is important to negotiate with insurers to explore the possibility of reducing the impact of this potentially damaging clause.

4. Bodily injury/property damage. This exclusion appears on all D&O policies to clarify the position that they will not pay claims that ought more properly be insured by a Public or Employers’ Liability policy. Great care must be taken when reviewing the policy language used. Whilst any direct claim for bodily injury would rightly be excluded, a good policy will provide cover for a secondary regulatory action against directors – a vital enhancement in an age of greater corporate governance.

5. Public offering exclusion. Typically D&O policies now exclude IPOs, however insurers may provide cover for IPOs at an additional premium, if presented with specific underwriting information. It is advisable to inform insurers as soon as possible (on a confidential basis) so there are no unexpected surprises. It may also be appropriate to investigate the purchase of specific Public Offering of Securities Insurance.

6. Failure to maintain insurance exclusion. This exclusion is designed to ensure that company directors do not use their D&O policy to pay for claims emanating from their decision to save money by under-insuring elsewhere – i.e. general liability insurance. It is usually a negotiable clause, particularly when the company can demonstrate that their insurance portfolio is strong.

7. Claims provisions. A close review of the claim notification provisions is essential. In particular, companies must ensure that the policy allows for notification of circumstances that could give rise to a claim. Notification would be lodged under the current policy period and that policy would be called upon, if and when the claim is actually made against the director.

This list is not exhaustive but demonstrates that D&O policies are highly technical documents that must be tailored to each client. The objective of each company, especially when entering rapidly changing environments like China, must be to broaden their coverage as much as possible.
Given that the purpose of D&O is to protect individuals; there is clearly an incentive for board directors to become personally involved in negotiations.

For further information please contact:

David Walters
Director - Professional Risks

Figures taken from 'Corporate Governance in China: Recent Developments Key Problems and Solutions.'

Thomas W. Lin - published June 2004 - USC Marshall Research.