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A Bug in the System: What Volkswagen Can Teach Us About D&O Insurance

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When an independent emissions testing lab found inconsistencies between Volkswagen’s claims about the performance of its “clean diesel” engines and the actual emissions from those engines, the company dismissed it for months, insisting that the testers were at fault. Finally, in September, the truth came out: Not only were Volkswagen’s diesel engines not environmentally friendly, but the company had knowingly rigged the cars’ software to show better emissions results, setting consumers up for a fall on tax credits or subsidies for cars that were supposedly energy efficient.

Understanding the supply chain of a business is becoming more vital for insurers. The Volkswagen case drives that point home since the emissions cheating scandal touches so many links in that chain. While many different types of insurance protect those links, many losses won’t be covered because the company’s actions were deliberate.

Directors and officers (D&O) liability insurance is likely to take the biggest hit from Volkswagen’s actions, although that doesn’t mean other insurers are totally in the clear yet. Volkswagen itself is likely to be paying for its actions for a long time.

The company’s situation offers the opportunity for advisors to talk with their clients about the range of insurance coverages that could apply if those clients find themselves in a similar situation, or simply find themselves involved with a company that’s gone rogue.

Insurance industry representatives declined to be interviewed or to respond to questions about specific insurance needs or what coverage limitations for a company in Volkswagen’s situation might be. However, reports have put the number at approximately $560 million annually for D&O coverage alone. Tony Galban, senior vice president and global directors and officers liability product manager for Chubb Group of Insurance Companies, did offer some clarification on D&O insurance.

Galban said via email, “D&O policies generally cover claims made against the directors and corporate officers for mismanagement, omissions, breaches of fiduciary or other ‘wrongful acts,’ as broadly defined. Claimants typically can be shareholders, regulators, customers, vendors or competitors. Shareholder claims typically assert that management has damaged the value of the company, and hence the value of their ownership; this can include areas such as brand and market reputation.” That certainly applies to Volkswagen, with shareholder suits already in the works.

He added that while “the conduct of one insured person can’t be imputed to another insured person,” actions by top execs like the CEO or CFO can be imputed to the corporate entity.

Galban said that much depends on whether a company is public or private. “Public companies typically buy much higher limits of insurance and carry substantial deductibles,” he said. “However, there have been cases where the cost of the lawsuit exceeded the insurance limits. This is largely due to the fact that defense costs for securities litigation can be extremely expensive. For publicly traded companies of scale, it’s really not likely that they can buy ‘too much’ D&O insurance in this litigious environment.”

Since a myriad of lawsuits has already been filed against Volkswagen for everything from deceptive sales practices to the one-third drop in the price of the company’s stock in late September, those limits are likely to be reached. In any case, D&O insurance doesn’t normally cover expenses such as fines and penalties.

But other types of insurance could kick in. Probably not product liability or product recall, since the company’s actions were deliberate; the same could be true for reputation risk insurance, depending on how the policy is written. Then there are the dealers who can’t sell the cars already on their lots; depending on how their business interruption coverage is structured, they may or may not get some relief. If not, there are always lawsuits, and some independent dealerships have already sued the company in California.

With some 11 million vehicles affected around the world, the reach of the scandal is broad, as will be its cost, and lawsuits filed by groups ranging from stockholders to car owners have proliferated.