Clawbacks Can’t Touch This: Executives, Protect Your Pay with Clawback Insurance

No Fault: Compensation clawback is on a “no-fault” basis. That is, it doesn’t matter if the executive officer was involved in the actions leading to the misstated financial statements.

Triggering Event: An accounting restatement due to material noncompliance with any financial reporting requirement under the securities laws can trigger this rule. This includes both “Big R restatements” and “Little r restatements.” 

Compensation Subject to Clawback: Compensation that could be subject to a clawback includes the executive officers’ incentive-based compensation received during the three completed fiscal years preceding the date a restatement is required. The amount to be clawed back is generally the compensation the executive received in excess of what they would have been entitled to absent the restatement. Incentive-based compensation includes any compensation that is granted, earned, or vested, based wholly or in part upon the attainment of any financial reporting measure. 

No Indemnification: Companies are prohibited from insuring or indemnifying any current or former executive officer against the loss of erroneously awarded compensation. 

Third-Party Insurance: The SEC’s discussion of the final rules recognized that although “an executive officer may be able to purchase a third-party insurance policy to fund potential recovery obligations, the indemnification provision prohibits an issuer from paying or reimbursing the executive officer for premiums for such an insurance policy.”  

Before diving into the elements of compensation clawback insurance, it’s worth spending a moment on the current state of clawback policies at public companies.

Expanding the Scope of Clawback Policies 

The SEC’s compensation clawback rules effectively set a new minimum requirement for what public companies must include in their compensation clawback policies. Most public companies, however, have adopted more expansive policies. Companies typically include more than just accounting restatements as event triggers that can lead to clawbacks. For a discussion of this trend among large market-cap companies, see this article from FW Cook. 

According to that article, a few of the more common clawback policy event triggers—other than those related to the SEC’s clawback rules—include fraud or misconduct; reputational, financial, and other harm to the company; and violation of the company’s code of conduct or other policies.

This trend signals a continued shift toward more rigorous governance practices that align with broader investor and regulatory expectations for increased executive officer accountability. It also increases the personal financial risk for executive officers. For example, imagine you are an executive officer (e.g., the head of a business unit) and a financial restatement triggers a clawback of some incentive-based compensation you received two years earlier. You weren’t at fault for the issues that led to the financial restatement, yet you must dig into your own pocket to repay $X million back to the company. Clawback insurance, if you have it, should dampen the impact.

Compensation Clawback Insurance

With the onset of the SEC’s compensation clawback rules and the rules prohibiting companies from being able to insure or indemnify executive officers for clawbacks, a few insurers have begun to offer tailored products that specifically address the personal financial exposure of these executive officers. What follows are some key features of the current forms of compensation clawback insurance.

Limits: As of this writing, primary insurers are offering relatively low limits, ranging from $500,000 to $1 million for each individual executive at a company. Higher limits will require additional carriers to participate on an excess basis. The amount of excess limit available will depend, in part, on interest in this type of insurance over time. We should also expect carriers to impose a per-company cap, at least in the near or medium term, depending on how many executives at any one company decide to purchase this insurance. 

Purchased and Funded by Individual Executives: This insurance must be purchased and funded by the individual executive, not the company. Executives must pay premiums out of pocket, making it a personal investment in protecting their own assets. 

Simplified Application Process: The application process for this insurance should generally be streamlined. Insurers will review the company’s public filings and disclosures. This will often include evaluating the company’s compensation clawback policy, governance practices, any recent material weaknesses in internal controls over financial reporting, and any existing legal or regulatory disputes that might impact the company’s risk profile. Because the underwriting process relies heavily on publicly available information, there should be minimal administrative burden placed on the executive during the application phase. 

Evolving Coverage for Clawback Triggers: The coverage generally offered under this insurance may address a wide range of scenarios that could trigger a clawback. For instance, insurers may offer protection not just for financial restatements, but also for non-financial triggers—aligning closely with the trends highlighted in the FW Cook article. This comprehensive coverage structure may help ensure that executives are safeguarded against most event triggers included in their company’s clawback policies. 

This coverage shouldn’t be confused with a free pass. For instance, these policies will not respond if an executive is found guilty of fraud or if reimbursement under the policy is prohibited by law.  

Coverage for Compensation Repayment and Defense Costs: This insurance can cover both the compensation amounts an executive must repay and the defense costs associated with compensation clawback claims. As previously mentioned, compensation repayment can range from cash bonuses to equity awards based on the company hitting several metrics. This makes the insurance attractive not just for executives whose compensation is performance-based, but for all executives. 

While compensation clawback actions under Dodd-Frank’s new rules are still in the early stages, prior experience with the SEC suggests it will expect companies to take a heavy-handed approach. The SEC will likely encourage companies to claw back all incentive compensation when there has been either a Big R or Little r restatement. It won’t be just that portion of the compensation impacted by the error resulting in the R(r)estatement.  

The defense cost provided by this insurance allows executives to challenge the SEC/company on the amount of the compensation subject to the clawback. Defense costs could be substantial, especially if the executive opts for legal counsel with expertise in corporate governance, compensation, and/or securities disputes. The compensation clawback insurance specific policy would be excess of any loss, including defense costs, covered by the underlying insurance purchased by the company. When considering coverage and limits, it's important to remember that defense costs typically erode the policy limits of the company’s insurance and clawback specific insurance. 

No Duty to Defend: One distinct feature of current forms of this insurance is they are not “duty-to-defend” policies. This means the policyholder (i.e., the executive) retains the right to select their own counsel rather than being constrained to the insurer’s panel of attorneys. This is important for executives who value autonomy and wish to retain counsel familiar with their individual circumstances in addition to having deep industry expertise.

Strategic Considerations for Executives  

The introduction of compensation clawback insurance presents a new tool for executives looking to protect their personal finances. However, successfully leveraging this insurance requires a nuanced approach that includes thoughtful coordination with experienced insurance brokers. Two important considerations include: 

Ensure Tailored Coverage: An experienced insurance broker can help executives navigate the complex landscape of compensation clawback insurance and ensure coverage aligns with the company’s clawback triggers. This exercise should include an evaluation of the executive’s compensation package and the potential exposure under the company’s compensation clawback policy. 

Engaging a Broker Who Will Serve as an Advocate: Brokers play a crucial role in ensuring  the application process is straightforward. As noted above, the application process for this insurance should be relatively streamlined. That said, given the reliance on public filings and corporate governance practices for underwriting, a broker with experience in reviewing these documents and explaining them to insurers can help to further streamline the application and underwriting processes, saving the executive time and potential headaches. 

More importantly, you will want a sophisticated broker to help advocate for you should you need to use the compensation clawback insurance. Along those lines, when choosing a broker to help secure this type of insurance, confirm who within the brokerage firm would be your primary point of contact(s) should a claim need to be made, as well as their level of expertise and comfort with managing and advising on matters that impact executive compensation.

The key takeaway here is that by engaging a specialized broker, executives can better navigate the complexities of clawback insurance and obtain coverage that provides meaningful financial protection.

Looking Ahead: Evolving Insurance Solutions and Policy Trends 

As compensation clawback insurance gains traction, we will likely see further developments in insurance solutions. Additionally, as companies continue to adapt their compensation clawback policies to new regulatory requirements and investor expectations, we may see a shift in the demand and pricing for this insurance. 

For now, the availability of this coverage will lean more favorably in the direction of executives at mid- to large-market cap companies without a history of recent financial restatements. However, this may change in the near term and is something we will continue to monitor.

Parting Thoughts 

As companies evolve their compensation clawback policies and adopt provisions that go beyond the SEC’s clawback rules, the personal financial stakes for executives are increasing. Compensation clawback insurance provides a novel solution to mitigate some of these risks.

For executives, understanding the nuances of both their company’s compensation clawback policies and related insurance options is crucial to navigating this complex landscape. By working closely with an experienced insurance broker and staying attuned to regulatory developments, executives can better protect themselves from what in some cases may equate to an individual financial calamity.