Examining the D&O Insurance Market for Non-Public Companies from the Luckin Coffee Massive Compensation Case

"Luckin Coffee D&O Insurance Claim Highlights a Much-Discussed Issue: Can D&O Insurance Provide Protection When Listed Companies are Involved in Financial 'Fraud' or Fraud?"

After four years of long waiting, there has been a new development in the massive D&O insurance claim case of Luckin Coffee involving a 2.2 billion yuan financial fraud.

Luckin Coffee had purchased a D&O insurance policy with a total limit of up to 25 million USD before its listing, with the coverage of the primary layer policy set at 10 million USD. Due to the complex nature of the financial fraud case involving Luckin Coffee, the issue of claims under this D&O insurance policy has been closely watched by the industry.

According to Securities Times, after thorough investigation and negotiations, the primary layer policy has finally entered the arbitration stage and a clear arbitral award has been made. According to the arbitration result, the co-insurers will pay out 7 million USD, with a deductible of 3 million USD.

The Luckin Coffee D&O insurance claim case highlights a much-discussed issue: Can D&O insurance provide protection when listed companies are involved in financial "fraud" or fraud?

D&O Insurance is Not a "Panacea" for Companies

D&O insurance, short for Directors and Officers Liability Insurance, mainly protects listed companies when directors, supervisors, and senior management are held responsible for negligence or misconduct in the performance of their duties, with the insurance company compensating for legal fees and assuming other corresponding civil liability.

It is worth noting that as an insurance product designed for directors and senior management, D&O insurance is not a "panacea" for companies. Its focus is on providing compensation protection for losses incurred by senior executives due to professional negligence.

Usually, D&O insurance will set some exclusions to reduce the risks brought by moral hazards or adverse selection, including fraud, false acts, known litigation and claims, etc. In simple terms, if directors and senior management engage in these behaviors, they are not covered by the insurance.

However, in determining exclusions such as fraud or false acts, formal recognition or judgments from regulatory agencies or courts are required to prove that the insured actually knew or participated in the false acts, rather than unilateral subjective judgments by the insurance company.

Some experts have indicated that when dealing with cases involving fraud, insurance companies will not adopt a "one-size-fits-all" approach, but will comprehensively consider factors such as the proportion of fraud and its impact on overall punitive actions and investor losses, whether all defendants were involved in the fraud, and the leading role of these actions and defendants in the overall case, and will fairly and appropriately allocate responsibilities based on relevant laws and regulations.

For losses not caused by false acts, or for directors and senior management who did not actually know or participate in false acts, the D&O insurance will remain effective and provide corresponding insurance protection.

Continued Rise in Popularity of D&O Insurance

It is worth noting that the popularity of D&O insurance has been steadily increasing recently and has been favored by more and more listed companies.

Since 2024, the number of A-share listed companies planning to purchase D&O insurance has shown a significant growth trend. According to incomplete statistics, as of now, nearly 300 A-share listed companies have announced their plans to purchase D&O insurance, a number that has grown by more than 60% compared to the same period last year Specifically, the premiums planned to be paid by these A-share listed companies vary depending on the sum insured, generally ranging from 50,000 to 2 million RMB; the sum insured for the planned D&O insurance generally ranges from 50 million to 100 million RMB.

Looking at a longer timeline, the enthusiasm for D&O insurance in recent years has been increasing year by year. According to data from Ping An Property Insurance, before the implementation of the new "Securities Law" (in 2019), the proportion of A-share listed companies that had purchased D&O insurance was about 8% (based on the 3,760 A-share companies that year), which is roughly 300 companies. By the end of 2023, the number of A-share companies that had purchased D&O insurance had reached 1,107, showing a significant increase.

The upcoming full implementation of the new "Company Law" will bring great potential to the D&O insurance market

At the same time, with the full implementation of the new "Company Law" on July 1, 2024, D&O insurance is expected to usher in new development opportunities. In the new law, the standards of loyalty and diligence for directors and executives have been more clearly defined, and combined with past judicial practices, their responsibilities in various aspects such as shareholder contributions, capital reduction, dividends, and liquidation have been concretized, further strengthening individual liability.

This also means that not only listed companies, but more non-listed companies will also begin to realize the importance of D&O insurance protection. Article 193 of the new "Company Law" specifically stipulates the insurance of D&O insurance, stating, "A company may purchase liability insurance for directors for the compensation liability assumed by directors during their term of office. After the company purchases or renews liability insurance for directors, the board of directors shall report to the shareholders' meeting the insured amount, coverage scope, and premium rate of the liability insurance." This will undoubtedly have a profound impact on the D&O insurance market.

Overall, the popularity of D&O insurance in China is still at a relatively low level, indicating significant growth potential in the future. As of the end of 2023, there were a total of 5,346 listed companies in China, while the number of companies with D&O insurance was only 304, accounting for only 5.68%, a ratio that is quite low compared to developed countries.

Furthermore, according to a research report from Guotai Junan Securities, we can see a significant contrast: the D&O insurance coverage rate for U.S. listed companies is as high as 97%, and the coverage rate for U.S.-listed Chinese companies exceeds 90%. In addition, 85% of listed companies in Europe and the United States, as well as 60% of listed companies in Hong Kong, have already arranged for D&O insurance