Limiting Liabilities

Written by Sitanshu Swain | Updated: Sep 18 2011, 07:20am hrs
While the $1.5-trillion Indian economy is gaining momentum in terms of size and sophistication, business enterprises are increasingly facing new kinds of risks known as liability risks.

Earlier these liability products were bought by a few companies in India like the ones going for ADR & GDR. They had to take these covers as part of their listing compliance, but now many companies irrespective of their size are buying liability products.Broadly liability risks can be divided into two categoriesfinancial and property & casualty (P&C). While professional liability products cover a range of professionals like doctors and engineers, the financial category offers products like Directors' & Officers' Liability Insurance, which cover various risks faced by top officials of a company including board of directors while discharging their day to day duties. P&C includes products like Public Liability, Product Recall, Kidnap and Ransom, and Clinical Trials.Among the liability insurance products, corporates in India mostly buy directors' and officers' cover. The policy is meant for the top management and senior officials of the company who may be personally held liable for any actual or alleged breach of duty, breach of trust, breach of warranty of authority, neglect, errors, misstatement, and omissions by anyone in the company. Anyone dealing with a company can sue its directors and officers alleging financial loss. Exposure varies from shareholders, creditors, business partners, competitors, regulators and even employees.

Gaurav Garg, CEO & MD, Tata AIG General Insurance, says, A concomitant of high economic growth is the increasing scale and complexity of business, which in turn expose enterprises to a variety of liability risks. Liability insurance is, therefore, among the fast growing segments of commercial or business insurance.'' Major contributors to the expansion of the Indian economy are global trade in goods and services, widening geographic footprint of Indian multinationals and increasing flow of investments into India. Each of these in turn requires sophisticated management of liability risks to which Indian businesses are now exposed, explains Garg.

Indias services-led growth requires that professional liability insurance be taken by the IT and ITeS industry, law firms, accounting and auditing firms, and consulting companies.

Major IT companies like TCS, Infosys and WIPRO and private sector banking major ICICI Bank and Tata group subsidiary Tata Chemicals are some of the well known buyers of different liability products. The manufacturing sector is also catching up.

Garg adds, Economic growth directly translates into sophistication of financial products and services, requiring financial institutions with cross-border exposure to secure themselves against risks increasingly inherent in their businesses. The IT industry, which is at the vanguard of Indias globalisation, is one of the largest buyers of liability insurance products.The Rs 44,000-crore general insurance industry, which has a liability portfolio of around Rs 860 crore, is growing at around 30% (with an accretion of Rs 150 crore in 2010-11). It has practically grown from scratch in the last 10 years when the industry was opened up to the private sector. With the partnership of foreign players, private sector players are earning almost 62% of the liability premium and dominating the business.The growth in premium in liability segment may be around 20% but the number of buyers and sum assured taken by these customers are much larger,'' says Bhargav Dasgupta, MD & CEO, ICICI Lombard General Insurance, the largest private sector general company and one of the important players in liability risks. Globally the financial crisis of 2008-2009 has accelerated some of the significant developments on the liability insurance landscape. The global evolution of liability regimes is driven by factors such as the introduction of collective redressal mechanisms to improve access to justice; an increasing willingness to sue; product liability developments, which have led to facilitated access to compensation; and environmental liability expansion, which tends to extend liability to new areas. Further with corporate governance norms in India getting implemented more stringently, the need for liability insurance is increasingly being felt. Of late, there is also a growing risk potential because of increase in environmental activism in India.

Yogesh Lohiya, CMD, GIC Re, the country's sole official reinsurer, says, On the domestic side as well, awareness for liability insurance covers has continued to increase over the past years. Demand for liability covers is now felt more as a need rather than merely meeting legal requirements. Owing to consistent growth and a profitable portfolio, this segment is in great demand for insurance companies in Indian market.''Further private equity (PE) and venture capital (VC) firms investing in India are increasingly insisting that their portfolio companies take directors' and officers' liability insurance coverage, seeking to protect their interests in such situations as a lawsuit against key personnel. At the time of fund-raising, the insurance cover is taken for the protection of general partners (GPs), who manage PE funds, against misrepresentation during due diligence or in the case of a lawsuit brought against GPs by the limited partners (LPs), as investors in PE funds are known, or any other third party.

Product Recall

The demand for this product comes from sectors such as auto ancillary, food and beverages, pharma, telecom and electronics. As more Indian manufacturers export goods to overseas markets, they opt for the product recall insurance plan.In recent times, carmaker Maruti Suzuki and Honda faced a similar situation when they had to recall cars for faulty parts. Earlier, even global biggies such as Honda and Nokia had to recall their products owing to defective parts.

Claims

The claim activities against liability segments have significantly increased in the last two years, more in frequency than severity. A rough estimate by industry players shows that Indian general insurers have faced claims worth Rs 1,000 crore from overseas companies dealing with Indian IT companies in the last two years.Accordingly, Directors' & Officers' Liability Insurance claims have seen a three-fold increase in the past one year. Most of the other claims in the country are related to employment practice issues, employee fraud and conflict of interest situations, compliance of corporate governance norms across the world, deficiency in products and its subsequent recall. Most affected industry segments are pharma, FIs and IT.

Pricing

The pricing of any liability insurance product is a function of various underwriting considerations like the industry type, products territory where products are being sold, turnover of a company, and limits of liability being purchased. Insurers typically charge about 1-1.5% as premium of the size of the cover provided.GIC Re's Lohiya says, Claim notifications that various lines of liability insurance business have seen recently have helped increase rate of liability covers.

Class Action

The pending amendment in the Companies Act, which will also focus on Class Action will usher in a new era of liability risks in India. The enactment of the Indian Companies Bill 2009 will change a company's future risk scenario drastically The new Companies Bill, which seeks to fix more responsibility on independent directors, comes in the backdrop of the multi-crore accounting fraud in Satyam Computer Services that exposed gaping holes in the existing corporate governance norms in the country and highlighted the need for stricter norms. It could become a game changer as more and more regulators and investors press for transparency and accountability, say insurers.Recession globally had a wide impact on the awareness of liability insurance. The financial meltdown has led to increase in shareholder activism and also claims against financial institutions, banks and corporates. With empowerment of consumers and regulatory thrust on competition and transparency, such trends are bound to catch up in India.

Check list

Mandatory Covers

* Motor Third Party Liability

* Public Liability Act Policy

* Stock Brokers Indemnity Policy

* Errors and Omission for Insurance Brokers

* Mutual Fund Asset Management / Investment Management Insurance

Sources of Director & Officer Liability Insurance

* Companies Act

* Listing agreements with stock exchanges

* Statutory liabilities legal statutes

* Common Law - corporate governance issues

* Worldwide trends and the litigious environment prevailing in jurisdictions like US, EU

Directors/ Officers Liability under other laws

* Directors and officers may also be held under the provisions of a broad set of laws. These contraventions are punishable with imprisonment or fines and penalties:

* Corporate and commercial laws

* Environment and pollution laws

* Consumer welfare laws

* Direct and indirect taxation laws

* Labour and employment laws

* Laws relating to intellectual property rights

General rule under Common Law

The general formulation is that the company and every person in charge of and responsible for the conduct of its business at the time shall be deemed guilty and be proceeded against, unless they can prove:

* They were unaware of the breach/offence committed

* They exercised all due diligence needed in order to prevent such breach/ offence

* They can prove that they acted innocently and in good faith

Civil and criminal liabilities of directors and important officers

Sec 5 of the Companies Act clearly defines an officer in default for certain contraventions committed by a company. These are:

* MD, executive or whole time director, company secretary, managers

* Any person in accordance with whose instructions the board is accustomed to act

* Any person who has been entrusted or charged by the board to be an officer in default

* When none of these hold, the board in totality is considered liable as the officer in default

Liability for damages for misstatement in prospectus

* Every, director, promoter or person authorising issue of prospectus liable to pay compensation for untrue statements

* Right of contribution every person liable to pay compensation under Sec 62 may recover contribution from other guilty persons

* Measure of damages as per general law (Sec 73 of the Indian Contract Act), the difference between what the shareholder paid for the shares and what the shares were worth when they were allotted to him

Liability under the Common Law

A shareholder can hold all or any of the persons responsible for the issue of a prospectus liable for any misstatement or fraud, if he was actually deceived by reason for his having acted on the faith of the misstatement or fraud in the prospectus.