Causes of loss and loss scenarios

Companies need to be prepared for anything — balance sheet fraud, mismanagement, mistakes when making acquisitions, inadequate risk management or failings in supervision and control.

There are many possible causes of loss in D&O insurance, and a few real examples are provided below:

Balance sheet fraud

A quoted US company reports vastly inflated profits, resulting in a scandal around its balance sheet. Once the balance sheet fraud is known, the share price plummets. Legal action is taken even against directors of the company not involved in the fraud, and shareholders demand compensation for the financial loss they have suffered. Loss amount: US$ 1.1bn.

Mismanagement

An overseas subsidiary of a large company signs a long-term contract with a service provider. It soon becomes apparent that the contract will result in major losses for the subsidiary. Provisons and special write-downs amounting to several hundred million euros have to be booked in the accounts. The parent company takes legal action against the former directors of the subsidiary for negligent breach of duty.

Mergers and acquisitions

The new board of a financial institution criticises the old board for acquiring a broker firm. The new board maintains that the company has suffered a loss of at least €16.4m because the purchase price paid for the broker firm was far too high. No due-diligence audit had been performed prior to the acquisition, nor had the agreement of the supervisory board been obtained.

The calculation of the loss also took account of the fact that the financial institution's personal business had not benefited in any way from the participation in the broker firm.

Inadequate risk management

A fire at a company results in a break in production and consequently financial losses amounting to millions of euros. The company has no business interruption insurance and reports a loss, causing its share price to fall sharply. Shareholders take action against the directors for inadequate risk management. The initial business interruption loss develops into a multi-million-euro D&O loss.

D&O losses can also arise from the following situations:

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  Prospectus liability for equity and debt issues
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  Manipulation of the share price
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  Incorrect ad-hoc statements
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  Restatements of financial reports
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  Deficient public information policy
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  Unfair competition
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  Inadequate safety measures
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  Delayed filing of insolvency
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  Inadequate internal organisation
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  Breaches of company articles or internal rules