After a tumultuous period of skyrocketing prices, changing legislation and reduced availability, stability is on the horizon for D&O liability insurance. It’s a good time to consider the recent evolution of D&O, what directors can expect in the year ahead and how to make sure you have appropriate protection.
Emerging from a hard market
In a 2020 Market Recap article, insurance broker Marsh reported that average premiums for directors and officers (D&O) liability insurance had risen in excess of 200 per cent.
“The international D&O insurance market has been in a hard phase since 2018 with reduced capacity and insurer appetite resulting in substantial premium increases for Australian D&O insureds,” says Nick Chubb, head of financial lines at Howden Insurance Brokers (Australia). “These ‘hard market’ conditions were driven by successive years of unprofitable insurer portfolios resulting from both underpriced capacity and a high level of global D&O claims activity.”
Australia was hit particularly hard. “Australia was perceived as a high-risk jurisdiction by international D&O insurers, due primarily to the class action and associated litigation funding environment,” says Chubb. “The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry added a further element of risk.”
It seems the tide has finally turned. “By the first quarter of 2022, most insurers had the view that they had attained pricing adequacy,” says Eden Fletcher, head of specialty solutions at Aon. “New market entrants have emerged, particularly in London, driving competition and improved pricing, although this is still significantly higher than historical rates. Finity Consulting have estimated that the D&O premium pool is now over $1.3b, which is up from $522m in the 2019 financial year.”
Marsh MD and head of FINPRO — Pacific Craig Claughton has also seen insurers adopt a more flexible attitude. “There’s definitely a move away from the ‘take it or leave it’ attitude of the past couple of years, and it’s been quite a sudden change,” he says. “It appears insurers are starting to look for growth as they get back into the black with better- performing portfolios.”
Michael Herron, Gallagher’s national head of professional and financial risks, says, “D&O insurers are piling back in, competitively quoting risks they previously declined or had quoted at uncommercial terms. Directors have options again to increase limits or negotiate coverage with insurers eager to deploy their reinvigorated appetite.”
In response to increasing competition, some insurers are differentiating themselves by offering bespoke endorsements. “Directors need to review these with care to ensure the insurers are not undermining the ‘all risks’ nature of the cover under the veil of ‘coverage certainty’,” says Fletcher.
For the moment, the good news is stability. It could be a while before premium costs actually fall. “Insurers are continuing to exercise some caution when they look at business risks, particularly in the wake of post-government economic support during COVID-19,” says Dawn James GAICD, account manager of D&O insurance at specialist insurance brokerage KBI. “They’re flagging insolvency as a significant risk to business and some are applying insolvency exclusions. We can also expect insurers to take a wait-and-see approach as D&O is what we call ‘long-tail’ insurance — claims can materialise over a long period of time.”
Many companies are looking to cut costs. “Some boards consider reducing the limits of their cover,” says James. “Although, as legal defence costs and settlement quantums are rising all the time and pushing up the cost of claims, there’s a danger that reducing a limit will leave the board vulnerable in the event of a large claim. The decision on limit adequacy must take a number of factors into consideration, including the overall risk appetite of the board on behalf of the company, the size of the company’s balance sheet and the number of directors and officers to be covered by the policy as well as the historic share price performance and where the market is now compared with a year ago. This is a discussion boards that need to have with their broker.”
Company securities (Side C) cover is the component of D&O insurance that protects the company itself if it is named in a securities claim.
“For many years, the vast majority of listed companies included this as part of their D&O insurance program without much consideration to the cover itself or its impact on the other sections of their D&O cover,” says Chubb. “Now we’re seeing a growing number of companies reducing or ceasing to take out Side C cover. In some cases, this has been a conscious decision in response to rising costs, in others it has been imposed on individual insureds by reduced availability in the market. All directors need to familiarise themselves with the composition and structure of their D&O cover, and balance the available risk transfer with cost and its impact on the rest of the D&O insurance program.”
Increasing focus on ESG and cyber risk
Along with governance, environmental and social behaviour are intrinsically linked to all directors’ liabilities. As Claughton points out, this is nothing new. “Good insurers have been asking about these things for some time,” he says. “The difference now is that they’re getting more attention.”
Companies should expect insurers to ask more probing questions about their ESG exposure. “Obviously, each business has its own particular ESG requirements,” says Claughton. “A company drilling for oil in the North Sea is going to have a very different exposure from, say, a law firm or a bank. Insurers are interested in the specifics, and they want to know how the board and executive are analysing and monitoring their exposures. Some insurers are also changing their strategies — for example, indicating they won’t insure certain industries such as the mining of fossil fuels. We could see more of that in the future, although hopefully with a realistic lens.”
Overseas, shareholders, regulatory authorities and insurers are scrutinising company statements and claims around ESG as a matter of course. It is inevitable Australia will follow suit. “Insurers are closely monitoring legislative and case law developments in relation to these emerging risks,” says Fletcher. “A number of jurisdictions have compulsory climate disclosure, while in Australia, ASIC encourages voluntary reporting under the Task Force on Climate-related Disclosures.”
On 12 December, the federal government commenced a consultation on a new mandatory climate disclosure regime, which is expected to closely follow the global sustainability standards being developed by the International Sustainability Standards Board (ISSB).
ASIC has also prioritised the exposure of greenwashing, which it defines as the practice of misrepresenting the extent to which a financial product or investment strategy is environmentally friendly, sustainable or ethical. In October 2022, the regulator took its first action in this area against listed company Tlou Energy Ltd, which was required to pay a total of $53,280 to comply with four infringement notices issued by ASIC over concerns about alleged false or misleading sustainability- related statements made to the Australian Securities Exchange (ASX) in October the previous year. Since then, ASIC has issued greenwashing infringement notices against Vanguard Investments Australia, Diversa Trustees and Black Mountain Energy.
“As the energy transition gains pace, disclosure of the risks involved in the transition itself will become equally pressing,” says Dr Michael Duffy, director of the Corporate Law, Organisation and Litigation Research Group at Monash University. “On present trends, these appear to include short- and possibly medium-term higher energy costs, heightened by the international geopolitical situation. Also, as the practice of generating energy from fossil fuels is wound down, possible energy reliability issues should be disclosed if they are likely to disrupt business and production processes. All of these could conceivably be material to share prices.”
Meanwhile, cyberattacks remain a concern for both cyber and D&O insurers. “Current distress in the cyber market reflects this,” says Chubb. “Ransomware and denial-of-service incidents may not be considered direct D&O risks, but can lead to board exposure, either due to issues associated with data breaches or failure to implement adequate protections against attack, as well as the impact on the business if access is denied.”
Recent breaches, including Optus and Medibank, have exposed the personal data of millions on Australians. However, as Claughton notes, cyberattacks are not a new phenomenon, notwithstanding the scale of recent incidents. “The amount of publicity these high-profile cases received gave the impression that attacks are suddenly on the rise, which isn’t the case. However, they are encouraging D&O insurers to dig more deeply when they’re questioning companies and boards about how they’re mitigating cyber risk. Insurance is just one aspect of the process — effectively the last step, as a company won’t be offered insurance unless appropriate controls and procedures are in place.”
Fletcher believes the recent data breaches have energised the push for legislative reform. “A number of class actions have been filed or mooted on behalf of affected Australians and these are being closely monitored by insurers,” he says. “However, to date, insurers haven’t moved to limit the cover available for these risks under D&O insurance, so boards should strongly resist policies with wording that suggests they might.”
Many companies collect more customer information than strictly necessary in order to improve their marketing strategies or build stronger customer relationships. Duffy recommends boards consider the risks associated with the practice. “Once companies have data, various laws can require them to hold on to it for a certain period of time, which increases their vulnerability if they are attacked,” he says. “If they don’t ask for the information in the first place, this problem doesn’t arise.”
In May 2020, the federal government introduced temporary changes to continuous disclosure obligations. “These were designed to give boards a little more comfort around the statements they were making to the ASX and their shareholders in a very uncertain environment,” says James. “They were due to expire in March 2021, but have now been incorporated into the Corporations Act 2001, bringing Australia more in line with the UK and US. As a result, companies will only attract civil liability if they knew that undisclosed information would have a material effect on the price or value of the securities, or acted in a reckless or negligent way with regard to the information. As an optimist, I like to think this will have a direct impact by discouraging class actions, although that would inevitably take time to come into effect.”
In the meantime, the securities class action landscape continues to evolve in response to judicial decisions and legislative interventions. “King & Wood Mallesons recently reported 13 new securities class actions filings for the 2021–22 financial year,” says Fletcher. “Up from eight in the prior year, but substantially below a high of 22 in 2017–18.”
Protection going forward
A deed of indemnity requires a company to indemnify its directors against potential claims, liabilities, penalties, legal costs and expenses, unless they’re related to fraudulent, dishonest or criminal behaviour. Fletcher recommends directors ensure they have a deed of indemnity in place, providing them with indemnification to the full extent permitted by law. “Directors should also be actively involved in key decisions relating to their insurance program and expect a detailed briefing on both coverage and their obligations under the insurance arrangements,” he says. “If the D&O insurance includes Side C cover, the limit of liability is shared between competing interests. Directors should be satisfied that an adequate limit of liability has been ring-fenced for their interests.”
Boards also need to understand the kinds of information insurers want when they’re considering whether to provide a quotation.
“They will always be interested in fundamental risk profile features such as financial performance, management of continuous disclosure obligations, stability of the board and senior management, and the shareholder profile,” says Chubb. “Specific issues relating to a company’s risk profile will also arise at different times and directors need to be aware of these. They should also consider any changes to their policy cover, satisfy themselves that their insurers have appropriate experience and expertise in claims management, and make sure they understand the terms and conditions of the policy cover, especially as they relate to changes in risk and notification of claims and circumstances during the policy period.”
Meetings between the client and the insurer are now integral to renewal negotiations.
“These provide an opportunity for organisations to engage directly with insurers and convey their risk maturity,” says Fletcher.
“Access to the best available D&O coverage is a priority,” says Herron “Improving market conditions will allow a focus on the quality of the insurer — and the terms and conditions.”
James sees little change in the foundations of protection. “Directors still need to be well aware of their fiduciary duties, to keep up to date with the rapidly changing regulatory and risk environment, and maintain risk management as a priority item on every agenda,” he says. “Good directors understand they are in a position of privilege. They know that educating themselves and ensuring they have trusted and well-informed advisers to fill in any knowledge gaps are essential for everyone sitting on a board in a challenging environment.”
Claughton advises directors to document every decision they make, along with their reasoning and supporting evidence. “Good people can find themselves being sued, and detailed documentation will be your best form of defence if it should happen to you,” he says. “Directors’ roles are becoming more complex and challenging, and they need to take care, but I’m concerned we are reaching a point where the good people we need on boards might decide the rewards of the job just aren’t worth the level of personal risk.”
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