Last week, I talked about Enron and what has happened to it.

This week I will briefly describe how the Directors and Officers (D&O) policy will compensate the directors and officers of Enron.

What is Directors and Officers Liability?

Directors of all companies can now be held personally responsible for any actions and decisions they make on behalf of the company. This means they are putting their personal assets at risk if they chose to sit on a board.

From a legal perspective, the directors of the company and the company are treated as two separate entities. Therefore, they can be sued individually or jointly.

If board members want to protect their personal assets and to be compensated for defending themselves as a result of their association with a company, they should make sure the company purchases D&O Insurance. They should also consider purchasing additional D&O coverage above and beyond that purchased by the company if they truly want the maximum protection they can get.

How does a D&O policy work?

The policy is a claims made policy, written on a 12-month basis. By that I mean the claim has to actually take place during the policy period for the loss to be paid. As an example, Enron has a policy period of January 1, 2001 to January 1, 2002. The fact that it filed for bankruptcy in December 2, 2001 would fall within the policy period and as long as Enron notified its insurers, which it did, it would have coverage for the D&O suits.

The policy is also an indemnification policy which means the claims must be paid first then Enron's directors and officers would be reimbursed for their costs.

The coverage of the policy is broken down into two sides: 1. Side A Coverage - the insurer agrees to indemnify (reimburse), including defence costs, directors and officers for their liability for any wrongful act. Side A applies where the corporation can not indemnify its directors and officers. A corporation may not indemnify its directors and officers because it (1) is prohibited to do so by law, (2) is permitted to do so by law or by company bylaws but chooses not to do so, or (3) is financially incapable of doing so due to bankruptcy, liquidation, or lack of funds. This coverage is essential coverage to have in the event of bankruptcy because this side of the policy will respond if the company does not have the financial assets to reimburse the directors and officers.

2.Side B Coverage - the insurer will indemnify the company where it has reimbursed directors and officers for such liability. Side B does not cover the company for its own liability. D&O insurance typically does not provide coverage for the company itself unless the company purchases "Entity Coverage".

What is a Wrongful Act? A wrongful act has a fairly broad definition under a D&O policy but in general will pick up losses resulting from any actual or alleged breach of duty or trust, neglect, error, misstatement, omission or breach of authority committed by a director or an officer. Therefore based on this definition of a wrongful act, Enron's board of directors would be covered for suits arising out of the company filing for bankruptcy.

There are several exclusions under the D&O policy but the principle exclusion that could apply to the Enron debacle is the exclusion for fraudulent, dishonest acts, or wilful violation of laws or statutes committed by directors and officers. The dishonesty exclusion may also include a personal profit exclusion, which would exclude coverage in connection with a director's illicit gain.

If the Securities and Exchange Commission (SEC) can prove that Enron wilfully jeopardised its shareholders by financing off-balance sheet deals with companies owned by its former executives it could bring criminal charges against Enron. If the SEC proves this allegation, the D&O policy may exclude coverage as per the illicit gain exclusion.

Because Enron has admitted fudging its profits for four years, it is very likely that the dishonesty exclusion will apply. However, the D&O policy will only be able to exclude coverage for those directors and officers who were privy to the off balance sheet deals. It is rumoured that Enron purchased $350 million of D&O Insurance. Some reports suggest that the insurance industry could be on the hook for more than $3billion in losses from the Enron bankruptcy.

Much of that estimated $3billion will fall in the financial credit side where several insurers and reinsurers financed some of Enron's deals. Only time will tell if Enron purchased enough coverage to protect its officers and directors. If the $350 million is not enough to cover the directors and officers, shareholders do have the right to collect from Enron's directors and officers' personal assets.

Enron's bankruptcy filing is the largest case in history. It will redefine the way companies purchase directors and officers liability because many directors will now know just how exposed their personal assets are should their company file for bankruptcy.

Many will insist that companies purchase Side A coverage so they can be reimbursed in the event the company is financially unable to indemnify them due to bankruptcy proceedings. Many directors will also think twice about joining boards without first checking to make sure all transactions are legitimate.

Enron's bankruptcy will also change the way companies handle their 401K plans so they don't face the class action suits from employees who have lost their retirement nest eggs. And lastly, it will change the way D&O underwriters look at companies' balance sheets on a go forward basis.

There are rumours that insurers have already written in terms that state, should any allegations of fraudulent balance sheets arise, insurers reserve the right to void D&O policies immediately. Some are even excluding bankruptcy proceedings in fear of what the Enron debacle may reveal for other companies. The effect of Enron's bankruptcy to the insurance industry and for that matter the economy will take some time to unfold but it will definitely bring significant changes to the financial world, hopefully for the better.

Correction of last

week's column

As one reader duly pointed out, by omitting the word "alleged" in paragraph nine when I wrote about Enron breaking several responsibilities to its shareholders, it reads as if I have convicted Enron before it is tried in a court of law. It was clearly not my intention to do so but an oversight on my behalf. Enron still has to go before a court of law to determine who was aware of the off balance sheet deals as I point out in this column.

Cathy Duffy is a Chartered Property Casualty Underwriter (CPCU) and is now a freelance writer. She is a former executive of Zurich Global Energy and has 15 years experience in the insurance industry.

She writes on insurance issues in The Royal Gazette every Monday. Feedback crduffy@wbda.bm.