Role and Responsibility of the Board

Corporate Governance

Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the board, managers … and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance.1

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The Role of the Board of Directors

The Model Business Corporation Act succinctly states, “All corporate powers shall be exercised by or under authority of, and the business and affairs of the corporation managed by or under the direction of, its board of directors.”2

A board’s basic responsibilities consist of:

Approving a corporate philosophy and mission.
Selecting, monitoring, evaluating, compensating, and – if necessary – replacing the CEO and other senior executives, and ensuring management succession.
Reviewing and approving management’s strategic and business plans.
Advising management on significant issues facing the corporation.
Reviewing and approving the corporation’s financial objectives, plans, and actions, including significant capital allocations and expenditures.
Reviewing and approving material transactions not in the ordinary course of business.
Monitoring corporate performance against the strategic and business plans, including overseeing the operating results on a regular basis to evaluate whether the business is being properly managed.
Ensuring ethical behavior and compliance with laws and regulations, auditing and accounting principles, and the corporation’s own governing documents.
Nominating directors and committee members and overseeing effective corporate governance.
Focusing on the integrity and clarity of the corporation’s financial statements and financial reporting, engaging outside auditors and considering auditor independence issues.
Performing such other functions as are prescribed by law, or assigned to the board in the corporation’s governing documents.3

As they perform these responsibilities, however, boards can tend to exhibit specific styles of behavior or roles. Board roles can be grouped as follows:

Legitimizing role: Generally passive and simply fulfills the legal requirements for the corporate charter.
Auditing Role: Tries to ensure the accuracy of information going to the public and to the government and the adequacy of financial reporting systems.
Directing Role: Becomes more important as the board gets involved in focusing on the company’s future goals and derivation of the strategies by which they will be reached.4

Board Legal Duties

All board members have individual board duties of a legal and fiduciary nature.

Duty of care: The duty of care translates into a practice of concern, attention and diligence in discharging the tasks of a director.
Duty of loyalty: The duty of loyalty is an obligation of a director to place the interests of the company above his/her self-interest.
Duty of disclosure: Mutual boards that are engaged in any activity requiring policyholder approval will need to consider their responsibilities under this duty. Policyholders, like shareholders of stock companies, may be entitled to all relevant and material information necessary for them to make any governance decision they are called upon to make as a policyholder.

These duties are very real and are very important to the exercise of sound governance practice on the part of mutual company board members. They are also critical in minimizing the risk of legal liability on the part of a board member. At a minimum, each board member should be familiar with the general requirements of the duties.

Board Charter

All boards and their management allocate decision-making authority between themselves. Often, the only documents that provide any specific guidelines on this issue are the bylaws of the company and the CEO’s job description. A board charter can supply much needed additional detail in this important board-management working relationship. Anything that is intended to provide general guidance to board decision-making should be clearly identified and explained in a charter document. Potential topics for a board charter include the following: board responsibilities; board composition; director selection; board leadership; board meeting procedures; board performance expectations; committees; and board-management relationships.

Strategic Planning

The degree to which a board is involved in the strategic planning process will reflect a board’s governance philosophy perhaps more than any other board activity or decision. Several factors often influence a board’s involvement in strategic planning – the size of the organization, the ongoing challenges within the industry, and the relative capabilities and styles of the board and CEO. Board involvement in strategic planning runs from an acknowledged micro-management of the process to a hands-off non-involvement.

Micro-management: The board or a committee dominates the planning effort, which may be necessary during periods of transition, start-up or turnarounds, but is otherwise not considered a normal or advisable practice.
Participative: The board or a committee is very active and engaged in the process, contributing expertise or experience in key areas, providing advice or perspective throughout the process.1
Review and approve: There is no designated committee or special board activity related to the development of the strategy and the review and approval process is a part of a normal board meeting.
Non-involvement: The board does not require or does not approve a formal plan (manages simply by numbers).5

Board Policies

Every board sets policy for the company and these policies help the organization by providing clear expectations and guidance for individual and corporate behavior. Some of the most common corporate governance policies address the following subjects:

Conflict of Interests: Conflicts of interest generally arise in one or more of the following situations: conducting business with the company itself; competing with the company; taking personal advantage of a corporate business opportunity; receiving something of value that gives the appearance of being influenced in a decision.

Conduct/Ethics: A conduct/ethics policy addresses standards for business behavior or conduct in the workplace and/or industry. Conduct/ethics policies can include a number of topic/subjects: employee and customer privacy; fair competition/antitrust; dealing with the media; vendor relationships; agent/customer relationships; protecting company assets; advertising and marketing practices; confidential information; policyholder communications.6

Executive Session: Executive sessions of the board occur when boards meet without inside directors or staff present. The principal argument supporting executive sessions is the ability of independent directors to speak more openly about issues, including management proposals and performance.

Board Member Expectations: These policies can cover a variety of behaviors that are expected of board members including: meeting attendance, preparation, and participation; costs/expense reimbursement; director compensation; etc.

CEO Evaluation

Since boards delegate day-to-day management of the company to the CEO and staff, ongoing performance evaluation is a meaningful way of exercising the board’s oversight function. The advantages of such a review include:

Setting clear expectations of performance.
Fostering clear accountability and rewarding success.
Improving communication between the board and the CEO on key corporate issues.
Mentoring the CEO in areas requiring improvement or development.
Providing a pre-arranged method to identify performance issues early.
Promoting teamwork between board and CEO.
Leading by example for the rest of the management staff.
Providing a clear signal that the board is serious about its oversight responsibilities.
Understanding when CEO replacement might be required.7

Most CEO performance reviews include at least some of the following areas of accountability:

Integrity/Values: Setting the tone for ethical awareness and honesty.
Vision: Clear, compelling, and consistent.
Leadership: Empowerment, motivation and development of staff.
Judgment/Decision-making: The process used and the results obtained.
Accomplishments: Meeting corporate and personal objectives and goals.
Succession planning: Quality of candidates and plan.
Policyholder relations: Meeting member’s interests.
Board relations: Respect for and candor with the board.
Strategic Planning: The quality of plans and process.8

CEO Succession

Boards understand that a successor to the CEO will be needed at some point, and it seems they are increasingly aware that it may occur in advance of current expectations.9 For succession planning to become a meaningful and effective governance practice the following characteristics should apply to the process:10

The board must take the responsibility seriously, making sure a process is in place now.
The definition of “leadership” must be known and agreed upon.
There must be a reasonable opportunity to make a good decision, with sufficient access to potential candidates before a vacancy occurs or a decision is needed.
The process must be a part of leadership development.
Potential successors must be evaluated as leaders, with exposure to the board and conscious development opportunities.11

Executive Compensation

Management or executive compensation has become an increasingly complex and demanding task for boards. To address the matter of management compensation with confidence directors must deal with issues and trends in accounting, tax, insurance, and employee compensation and benefits. A good approach to addressing executive compensation includes the following steps:

Review your current plan/program. Times change and a program can lose its effectiveness.
Consider everything. Pay, benefits, qualified and non-qualified, long-term and short-term.
Get organized. Obtain the right legal, accounting or financial advice.
Think strategically. Link the compensation to criteria that are strategic.12

Policyholder Relations

Mutual policyholders do have the power to elect board members. Generally, each mutual policyholder receives a single vote regardless of the amount of insurance purchased (some states do provide for other allocations of policyholder voting rights).13

Policyholders’ exercise of governance rights varies dramatically among mutual insurers. Participation may be affected by a number of causes, including level of company communication, policyholder approval or disapproval of the insurer’s current performance, the nature of the insurer’s business or the mission of the mutual insurer, the lack of a personal stake (financial investment/stock) in the company, and the composition and specific interests of its members.14 State law may contain rules for mutual company board elections that are substantially different from those required for companies in other states.

Policyholder Status as “Owner”

From a governance standpoint, the most controversial label attached to the definition of a policyholder’s interest is that of owner. In actual legal fact, the ownership status of most mutual company policyholders has a very limited meaning. Generally, it means only governance/participation rights and includes no financial interest in the assets of the company (except perhaps in the relatively rare instance of corporate restructuring or the more common situation of a declaration of dividends).

Although it is commonly stated that policyholders own a mutual insurer, the membership interest of a mutual policyholder is not equivalent to ownership. In its most common sense, ownership usually implies a right of dominion and control over property, including the right to dispose of the property. In a mutual insurer, policyholders, or members, do not have the ability to sell or otherwise transfer individual ownership. The ownership interest arises out of the policy of insurance and does not survive the termination of the policy of insurance.15

Excess Reserves

State law (including statutes, regulations and court decisions) has repeatedly recognized that only the board of directors has the authority to determine the amount of reserves needed to operate a mutual company. As a consequence, only the board can determine whether any of the reserves are available for distribution to policyholders by declaring a dividend. The right to a dividend based on company reserves does not arise unless and until the board decides. The law has consistently refused to recognize a policyholder’s right to compel any dividend based on a mutual insurance policyholder’s ownership interest.16

Policyholder Communication

In this atmosphere of corporate governance interest and scrutiny, policyholder communications regarding governance is something companies should seriously consider. Enhanced policyholder communication may be one way the industry can proactively address any public concern regarding mutual company governance practices. In addition to the items mentioned previously, policyholder communication could also include the following items of governance practice:

Board mandate or charter (roles and responsibilities).
Board composition, size and proportion of outside or independent directors.
Existence, purpose and membership of board committees.
Existence of board evaluation process.
Numbers of board and committee meetings.17

Conclusion

There is tremendous opportunity in the insurance industry. Perhaps more than ever before the critical capability of the insurance industry to manage risk and enable a robust economy is understood by a number of consumers and policymakers. Just as in the past, the mutual insurance industry is more than capable of meeting these challenges and exceeding all expectations, and improved corporate governance can be a significant enabler in that effort.

Footnotes

1 OECD, Principles of Corporate Governance, April 1999.

2 Model Business Corporation Act, Section 8.01.

3 Report of the NACD Blue Ribbon Commission on Director Professionalism, 2001 Edition, National Association of Corporate Directors (Washington, D.C. 2001) p. 1.

4 Charles N. Waldo, Boards of Directors, Their Changing Roles, Structure and Information Needs, Quorum Books (Westport, CT, 1985) pp. 17, 18.

5 Richard M. Steinberg and Catherine L. Bromilow, Corporate Governance and the Board – What Works Best, The Institute of Internal Auditors Research Foundation, 2000, p. 2.

6 Richard M. Steinberg and Catherine L. Bromilow, Corporate Governance and the Board – What Works Best, The Institute of Internal Auditors Research Foundation, 2000, p. 23.

7 Report of the NACD Blue Ribbon Commission on Performance Evaluation of Chief Executive Officers, Boards and Directors, National Association of Corporate Directors (Washington, D.C. 1994, 1995) p. 8.

8 Report of the NACD Blue Ribbon Commission on Performance Evaluation of Chief Executive Officers, Boards and Directors, National Association of Corporate Directors (Washington, D.C. 1994, 1995) p. 10.

9 2001-2002 Public Company Governance Survey, National Association of Corporate Directors, 2001, p. 5.

10 Randall S. Cheloha, “The Board and Effective Succession Planning,” Corporate Board, Sept/Oct 2000, volume 21, issue 124, p. 7.

11 Randall S. Cheloha, “The Board and Effective Succession Planning,” Corporate Board, Sept/Oct 2000, volume 21, issue 124, p. 7.

12 Greg A. McDermott and Daniel F. Miller, Crain’s Cleveland Business, 9/23/2002, volume 23, issue 38, p. 28.

13 Douglas Long, “Governance of Mutual Insurance Companies, A Call for Reform,” 29 Drake Law Review, 693-742 (1980)

14 Focus on the Future: Options for the Mutual Insurance Company, Report of the National Association of Mutual Insurance Companies Structural Strategies Task Force (undated) p. 3.

15 Focus on the Future: Options for the Mutual Insurance Company, Report of the National Association of Mutual Insurance Companies Structural Strategies Task Force (undated) p. 2.

16 Focus on the Future: Options for the Mutual Insurance Company, Report of the National Association of Mutual Insurance Companies Structural Strategies Task Force (undated) p. 4.

17 Richard M. Steinberg and Catherine L. Bromilow, Corporate Governance the Board – What Works Best, The Institute of Internal Auditors Research Foundation, 2000, p. 63.

Posted: Monday, March 29, 2004 12:00:00 AM. Modified: Friday, September 23, 2005 4:05:25 PM.

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