Insurance lawyer on Elon Musk and Tesla's unconventional D&O decision

Expert sees "more potential negatives than positives"

Insurance lawyer on Elon Musk and Tesla's unconventional D&O decision

Professional Risks

By Bethan Moorcraft

Billionaire technology entrepreneur Elon Musk has made plenty of headlines in the past few weeks. On Friday, April 01, the Tesla Inc. CEO shared a stream of controversial tweets suggesting the stock price for the electric car company “is too high,” thus prompting a 10% plunge in the carmaker’s shares. This rather risqué move, which Bloomberg analysts describe as reminiscent of Musk’s 2018 posts that securities regulators sued him over in 2018, came just days after Tesla announced it is foregoing directors & officers (D&O) insurance for the 2019 to 2020 year.

In a securities filing on Tuesday, April 28, Tesla announced its intention to forego D&O insurance rather than pay the “disproportionately high premiums quoted by insurance companies”. Instead CEO Musk has agreed to personally provide coverage for any legal defense and settlement costs. The exact statement in the securities filing reads: “Elon Musk agreed with Tesla to personally provide coverage substantially equivalent to such a policy for a one-year period, and the other members of the board are third-party beneficiaries thereof.”

It’s not unusual for Tesla to go against the grain in insurance matters. In past securities filings, the firm disclosed that it doesn’t typically insure all actions and conduct to the full limits. Tesla has also revealed that it doesn’t maintain as much insurance coverage as other companies of a similar size, and in some areas, it doesn’t maintain any coverage at all. One thing is clear, which is that Musk’s electric car company seems to have a different attitude towards insurance than most other multi-national firms.

The move that Tesla has made is “not unprecedented, but it’s certainly rare,” according to Marc Ladd, a partner in the Insurance Recovery Group at McKool Smith. “It’s a little less of a surprise coming from Tesla and Musk than it would be from other companies. I don’t recall seeing something like this from another company of Tesla’s size.”

While Tesla will save significant costs on D&O insurance premiums, which have gone up dramatically across the board over the last few years, Ladd said he sees “more potential negatives than positives” from the unconventional decision.

“I can easily envisage several scenarios where this could create some difficulties,” he told Insurance Business. “I’m not aware personally of the diversification of Elon Musk’s wealth, but if most of his wealth is tied up in the company, that could be problematic. If there were another economic recession, and then securities lawsuits which tend to follow, the other executives and board members might be left wondering whether or not they’ll actually be able to obtain coverage because Musk’s wealth would be tied up in the company which is struggling in the recession. That’s why companies typically place that responsibility in the hands of a third-party insurer.  

“Musk’s recent tweets about the share price for Tesla being ‘too high’ have already been reacted to by the market. If there’s a situation where, as a board member, your financial liability for lawsuits is tied up to a specific person, then is that going to affect how that individual is handled when these claims are made? [In a worst-case scenario], would there be difficulty in removing him as CEO if he’s personally responsible for your defense costs and your settlement costs for class action lawsuits? There are a whole host of issues that could arise.”

There are other actions that companies can take to reduce the financial burden of the hardening D&O insurance market, Ladd explained. For example, they may set up a captive insurance company, which still has the hallmarks of a third-party that’s separate, but avoids a lot of the red tape that comes with working with a traditional insurance provider. Firms can also raise their risk retention and self-insure a larger amount, which in turn would lower their insurance premiums.

“It’s just an interesting choice right now for a company that seems to find itself more and more in the news. Tesla and Musk are not seemingly shying away from exposure and liability,” Ladd added. “People will always pay attention to what Elon Musk is doing; he’s a thought provoker. But there are too many too potential pitfalls that companies can quite easily walk into by placing all the responsibility for D&O coverage on to one single individual.

“With a company of Tesla’s size and potential exposure, I don’t think they’re going to want to make one person individually liable for the insurance coverage of the entire company. What if a lawsuit is brought and Elon Musk wants to take it to trial, but all the other board members want to settle it and protect the company? There’s just so many inherent conflicts of interest. It will be interesting to see how this will play out given Tesla’s propensity for controversy, and I think it will play out sooner rather than later.”

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