The changing insurance landscape means directors must ensure they carefully consider and review their directors and officers coverage on a regular basis, writes Domini Stuart.

    In six months’ time, the directors and officers (D&O) insurance market could look exactly as it does now, with plenty of capacity, low premiums and broad coverage. But there’s a chance it will look very different.

    “I believe we’ve reached a tipping point,” says John Kelly MAICD, senior partner at McDougall Kelly & Martinis Insurance Partners. “We have seen a string of class actions over the last few years which could bite and take premium out of the market. Competition between proliferating litigation funders appears to be pushing them towards the smaller listed companies that insurers currently consider safe. We’re seeing more overlapping class actions, where one client is targeted by multiple claimants. And shareholder activism is continuing to rise – we’ve seen shareholders targeting clients like gold prospectors in search of a profitable seam. It’s possible that all this could tip and harden the market.”

    There are already signs of change. Some insurers are reducing limits on renewal, and Allianz has said that, in many cases, it will be looking at a minimum of a 100 per cent increase in renewal pricing after its portfolio was burnt by Australian shareholder class actions.

    “This is the only statement of its kind so far – though we do know that other markets that had poor loss histories in the D&O product class are trying to find their way through,” says Craig Claughton, national practice leader, financial and professional services at Marsh.

    At the very least, insurers are likely to start asking for more detailed information before they put up a quote. “There is still significant capacity but boards may need to look further afield – at the London market, for example,” Claughton continues. “They should also allow more time for the renewal process.”

    The right cover

    Different types of cover are available for different sectors and organisations of different sizes. For example, an association’s liability policy can provide a good-value range of cover for a not-for-profit organisation. And most private companies are best served by management liability insurance, which is a package of directors insurance, employment practices liabilities and crime.

    “Companies with a turnover above $100 million are probably better off with more extensive protection of a full-blown D&O policy,” says Claughton. “If the entity is very large with specific exposures, a manuscript policy can be written to include particular coverage or conditions. And very large international companies might need to look for multinational placement. This takes account of the fact that there are many countries where it is compulsory to insure in-country when you have a business there.”

    The wording of D&O policies is critical. “A few minor amendments can make the difference between very good and unworkable,” says Kelly. “Most directors don’t know what they should be looking for, but neither do some generalist insurance practitioners. For example, a few years ago we were asked to review a $20 million D&O policy for a new client.

    The directors had identified the company’s three main risks as pollution, occupational health and safety (OH&S) and regulatory actions, but we found that they had a $500,000 sub-limit for OH&S and a $1 million dollar sub-limit for pollution. We managed to find an insurer who was prepared to give them the full $20 million for all three critical areas.”

    Before joining a board, directors should ask for confirmation of indemnity and any limitations the indemnity may contain. “If you’re joining the board of a listed entity or large business we also suggest you seek a specific deed of indemnity for you as an individual that includes legal access to company records,” says Claughton. “If you ever needed to defend yourself this access would be crucial. And you’d be surprised how many directors don’t think to ask for, and retain, a copy of the D&O policy. This could be a big problem if you need to lodge a claim after you’ve left the organisation.”

    Side A insurance should be a separate purchase. “Side A covers directors’ personal liability, but unless it is purchased separately, it could be eroded for the benefit of the company by a big shareholder class action,” says Claughton. “I also know of an instance where separate Side A cover bridged a worrying gap. After a company entered into voluntary administration a large institution made allegations against the directors and told them it was intending to sue. None of these allegations triggered the primary D&O policy so the primary insurer was unable to grant the directors indemnity. The administrator also left them high and dry, so they appeared to have no cover for their defence costs.

    Fortunately, their separate Side A cover was broad enough to be triggered by the threat of a claim and immediately provided funding for their defence. As a result, they will be much better prepared when the claim is eventually formalised.”

    Some directors have a professional indemnity exposure, though this is rarely discussed. “Many directors, in particular non-executive directors, are providing what is effectively a professional service,” says Kelly. “If a company should sue them for a breach of their professional services this obviously wouldn’t be covered by the company’s D&O.”

    The impact of cyber crime

    The consequences of cyber crime and climate change are two relatively new areas of concern for both directors and insurers.

    “By and large, Australian D&O policies have no form of cyber exclusion at present, though insurers might start to consider this now that the mandatory disclosure laws have passed through parliament,” says Claughton.

    It is vital that directors understand the nature of the risk as it applies to their organisation. They also need to know that appropriate controls and procedures are in place to prevent a data breach and to minimise the impact in the case of a cyber event.

    “Only then should they start thinking about cyber insurance,” says Claughton. “Some cyber policies include a suite of services such as public relations, forensic accountancy and specialist legal and technical advice. If you’re not big enough to have these in-house this could make the difference between managing the event and losing your business.”

    Taking climate change seriously

    Dean Carrigan, partner at Clyde & Co, sees parallels between cyber risk and those associated with climate change. “Although they’re technically very different issues, there is a commonality in terms of regulatory pronouncements and regulatory statements – and also in terms of the profound impact they are going to have on the way a business operates,” he says.

    In February, Geoff Summerhayes MAICD, an executive board member of the Australian Prudential Regulation Authority (APRA), said that climate risks could no longer be seen as a future or non-financial problem.

    “Some climate risks are distinctly financial in nature,” he told the Insurance Council of Australia. “Many of these risks are foreseeable, material and actionable now.” He also referred to legal opinion of barrister Noel Hutley SC that directors who fail properly to consider and disclose foreseeable climate-related risks to their business could be held personally liable for breaching their statutory duty of care and due diligence under the Corporations Act.

    “The associated risks are very broad, ranging from physical damage caused by a flood or bushfire or an extreme weather event to interruption of the supply chain,” says Carrigan. “We saw an example of this when floods in Thailand had an enormous impact on the global automotive industry because the majority of components were being manufactured in that area. All of these exposures and risks have the potential to flow through to actions, claims, demands and threats, both to the company and the board. This is where directors need the comfort of knowing that the company’s D&O insurance is sufficient and broad enough to cover off all of those liabilities.”

    Very large global reinsurers such as Swiss Re, Munich Re and Berkshire Hathaway have expressed concern about the impact that climate change might have on their balance sheets – though, as with cyber risk, we have yet to see wholesale adoption of climate change exclusions. However, it is standard for D&O insurance to exclude cover for pollution, and it is possible that these exclusions could be extrapolated into a broader, climate-related context.

    “I fear we are likely to see disputes as to whether climate change/pollution exclusions come into play for certain claims,” says Carrigan. “Australia is a jurisdiction where this needs to be looked at very closely given our economy’s reliance on the resources and energy sector. Other sectors are certainly not immune but, on any analysis, listed entities that are carbon polluters must be more exposed to these climate-related claims.”

    Projecting how climate change consequences are likely to affect earning patterns, investment patterns and profitability patterns is a huge challenge. “As we have a very active and sophisticated securities class action regime here, I think it’s inevitable that we will see more activity in that space,” Carrigan continues. “There have been a couple of cases in the US where these very issues are being agitated and we know from bitter experience that what happens in the United States almost inevitably filters through to Australia.”

    The first case of this kind was filed late last year against Exxon. It followed a rapid fall in value after the company disclosed that it had been over-valuing its oil and gas assets by about 20 per cent.

    “The allegation is that Exxon failed to disclose climate change risks – that, when they were made, the company’s public statements were materially false and misleading,” says Yvonne Lam, an associate at Clyde & Co. “According to the claim, Exxon repeatedly highlighted the strength of its business model and the integrity and transparency of its reporting while failing to disclose internal reports that recognised environmental risks from global warming and climate change.”

    Brand and reputation number one concern

    The 2015 Aon Global Risk Management Survey found that clients around the world were more concerned about damage to brand and reputation than any other risk.

    “Brand and reputation are two of an organisation’s most valuable assets,” says Karina Rodriguez-Diaz, placement manager, crisis management at Aon. “Warren Buffet once said: ‘It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.’ This sums up the realities of reputation – something carefully cultivated over the years that can be destroyed in a blink of an eye. But it’s important to bear in mind that a well-managed crisis event can actually strengthen brand and reputation.”

    Brand and reputational risk is ‘consequential’ – the consequence of a crisis such as a product recall or a cyber attack. Insurance can cover the cost of hiring public relations experts to help with crisis communication and other costs associated with minimising the impact of the event. Some policies also cover financial loss suffered by the organisation as a result of a crisis.

    “The best way to minimise the cost of the insurance is to demonstrate to the insurer that you have taken appropriate action to minimise risk and prepare for a crisis,” says Rodriguez-Diaz. “You may also find that some aspects of the insurance are covered by other policies. The wording of these policies can be complex – it’s important to ensure that coverage is tailored to the company’s specific needs.”

    The broker and insurer

    When buying any kind of insurance it’s natural to focus on whether, and how quickly, a claim will be paid. John Kelly MAICD believes that directors should also consider the personal impact.

    “A claim is a very isolating experience that can drag on for years,” he says. “Most eventually end up in settlement, so the parties on the other side of the litigation fence will endeavour to make you look as bad as possible. The worse you look, the more you will have to pay.

    “At the same time, you may be prohibited from talking to your fellow directors and, if you are identified by press or social media, the claim can impinge on your personal life. It is vital that the process is well managed but beyond that, having an insurance broker or insurer you can talk to, and who feels like an ally, can help to protect your wellbeing as well as your reputation.”

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