Here’s what you need to know about D&O insurance in 2021 and looking forward.
Companies entered 2021 facing an already-hard D&O insurance market. While businesses hope for relief, it’s unlikely to emerge fully during this year’s renewal, due to continuing pressures that are shaping the directors & officers liability market.
A record 402 federal court securities class action lawsuits were filed in 2019. 2020 ended with fewer, at 324, but that number is still far above historical national averages. (The 1997-2018 annual average was 215.) And while the number of lawsuits has gone up over recent years, the number of listed companies has decreased, thus increasing the rate of D&O litigation and driving insurance coverage costs up as a result.
However, risk managers must further consider the wide range of pressures that contribute to the hard market, besides litigation alone. As the hard market continues there are a variety of best practice strategies, as well as alternative coverage strategies to consider to lessen the burden a hard market can bring.
Factors affecting the D&O landscape
Here’s what risk managers need to know as they navigate unpredictable, compounding risks and a hard market that is becoming increasingly burdensome for buyers.
Environment, Social and Governance (ESG)
ESG risk and reporting is taking on greater importance across all industries and geographies, and increasingly showing up on boardroom and investor agendas. Sectors such as oil, gas and mining are facing increased scrutiny. Some insurers are responding to investor pressure by reducing or eliminating capacity in certain risk areas, such as oil sands.
While ESG positions are historically more common from European insurers, they’re now starting to show up in North America. When capacity exits a sector, it impacts the overall cost of insurance. It also remains to be seen how the new Biden administration influences this movement.
COVID-19 and return to work
The COVID-19 pandemic didn’t create the hard insurance market, but it continues to contribute. The past year’s public health crisis and economic volatility have pushed insurers to include new exclusionary language in their policies. And as companies contemplate the post-pandemic return to work, they’re faced with many unknown D&O risks, especially surrounding vaccinations and who will come back to work on-site.
Diversity, Equity and Inclusion (DE&I)
Like ESG, DE&I initiatives are becoming a major business consideration. Companies are facing scrutiny from shareholders, the media and the public on issues of diversity, inclusion and equity within their leadership and board, which creates greater risk. It’s no longer enough to have a DE&I statement; companies must be able to prove that they have strategies and metrics to back them up.
While cyber risks are nothing new to organizations, they’re getting worse as threat actors grow more sophisticated and attacks become more frequent. Ransomware attacks, in particular, have grown significantly and are one of the most prominent issues facing cyber insurers today. They have responded by tightening underwriting criteria, increasing rates and reducing capacity. Risk managers should have a clear grasp of how their D&O policies respond in the event of a cyber incident.
The transition to a new US presidential administration can increase risk for businesses as they adjust to new policies and regulations, and respond to changes and emerging risks in the market.
Where the market is headed
Many companies are asking when they might see a more predictable risk cycle, but today’s market conditions are expected to remain for the foreseeable future. Pressure on pricing, retention and capacity will continue in the US and Canada at least through the end of the year.
Claim costs have risen, further putting pressure on buyers. Companies need to start making difficult decisions about what to cover, how much coverage to buy, and potential alternative market solutions.
There are some market changes that have positive implications for buyers, though.
For one thing, the number of coronavirus-related lawsuits has decreased in recent months. That’s not to say that the aftershocks of the pandemic won’t create new waves of litigation, but the number of cases related to employee exposure has gone down.
D&O insurance capacity is also starting to increase as new insurers, unencumbered by prior losses, are starting to enter the market. That is typically the first sign of a more competitive marketplace.
Best practices to enhance better outcomes
These market conditions put companies in a difficult position when it’s time to renew their D&O insurance. A best practice for risk managers is to be innovative and proactive, and know what to expect—for instance, staying on top of the expected range of price increases will help mitigate the likelihood of surprises come renewal time.
Best practices include:
- Begin conversations with insurers early in the renewal process and be prepared for your underwriting meeting. Ideally, companies won’t have to make these decisions under time pressure. Companies that build in renewal lead time gain an advantage by giving their broker the necessary time to explore all market options to deliver comprehensive and competitive coverage and cost outcomes. Preparation and a strategic approach to highlighting the key risk differentiators at the underwriting meeting and addressing headwind with candor and proactive problem solving will display to the underwriters why your company’s risk is a more attractive risk profile.
- Have an effective and impactful organizational structure. Risk management, finance, legal, and the board all need to work together. Acknowledge that each group has an individual agenda, but there's also a collective agenda that everyone can get behind. Ideally, risk management will communicate and gain consensus with the C-suite and the board.
- Have powerful data and analytics that empower good decision-making. Invest in technology that gives you more sophisticated capabilities, such as predictive modeling and benchmarking. Build the internal operational capabilities to use data and analytics to their full potential. You’ll gain valuable insights into loss experience and risk characteristics that will facilitate discussions with your insurer and C-suite.
- Communicate with leadership early and often. It's critical for risk managers to keep leaders apprised of the renewal process. Share market trends and the findings of your data analysis with the C-suite and board, as well as any factors they should be watching more closely. And don’t allow any surprises: Expectations around coverage are changing and, for the most challenged industries, prepare your board to potentially review a lower overall limit of liability than on the expiring policy. Proposed solutions also need to be shared and discussed with all internal stakeholders to ensure they understand the objectives and implications and ultimately support the direction. The less conventional the product structures, the more time an organization will have to devote to communication and consensus building.
- Think about insurance as part of the overall financial portfolio. Insurance is no longer a line item that remains static and gets approved automatically, year after year. Considering insurance in a new, holistic way requires a philosophical change for most companies. Along with the philosophical change comes the need for a greater commitment of time and resources, and companies should be prepared for that.
- Develop a more innovative program structure. Entertain the idea of covering your risks with alternative strategies, if you haven’t already. Companies must be ready to explore all options and how innovative approaches or combinations of strategies—such as captive insurance or risk retention groups—could meet their needs. This process will help prevent companies from being caught flat-footed or in the position where the market dictates terms.
- Take a long-term view. Depending on the risk tolerance within the company, one option is to define a clear path and then make minor course corrections based on market trends and the organization’s evolving needs. Examples include taking a higher retention or amending the allocation between Side ABC and Side A coverage. However, if the company has a higher risk tolerance, it can quickly pivot to a new aggressive D&O strategy, provided all stakeholders are aligned. Examples include Side A and use of a captive.
Sound alternative strategies for pricing in the hard market
If risk managers haven’t seriously considered the alternative strategies available to them, they should start exploring them with plenty of time to make a decision before the renewal.
Alternative coverage strategies might include:
- Lower limits
When insurance is less expensive to buy, it’s easy for companies to buy more. It’s possible that some companies have even been over-insured in the past. But in a hard market, even risk-averse companies need to consider reducing their insurance limits. Risk managers should take a thorough look at the company’s total risk profile and identify areas where they can consider lower limits.
- Quota shares
A quota share approach involves multiple insurers that share the risk proportionally across one layer. The benefit of this strategy is that it can facilitate harder to place attachment points versus a traditional layered structure.
- Higher retentions
In a hard market, companies may be required to retain more risk than they’d ideally like to. When considering higher retentions, look at factors such as the exposure and the potential reduction in premium, but also the balance sheet and earnings. When the latter are strong, companies can take on greater risks.
With co-insurance, after the company has paid its retention, they and the insurer will each pay a fixed percentage of the next dollars for as long as co-insurance applies. Carriers typically prefer limit-reducing co-insurance, where their maximum obligation is the agreed-upon percentage of the limit. Loss-reducing co-insurance may be preferable to companies, where the insurer’s maximum obligation is the full limit (though the company will still pay a percentage of every dollar).
Captives—insurance companies owned by the parent company—can make risk financing more cost-effective and offer other benefits such as appropriate funding of risk retention and an additional revenue stream. But before establishing a captive, companies need to carefully consider the commitment and weigh the true costs of investment to decide if it’s the right strategy.
- More Side A coverage, less B and C
Side A insurance is helpful when a claim is insurable but indemnification of the directors and officers is not being advanced by the company. Typically, it’s less expensive than Side B and C, allowing companies to purchase more. As with higher retentions, if the company’s cash flow is strong, they may not need as much balance sheet protection. In that case, they can reduce the amount of Side B and C purchased and potentially save money.
Companies in 2021 can no longer think about D&O insurance the way they have in the past. While the hard market won’t last forever, it will exist for the time being. Risk managers will need to pivot in response and bring their stakeholders along with them.
All descriptions, summaries or highlights of coverage are for general informational purposes only and do not amend, alter or modify the actual terms or conditions of any insurance policy. Coverage is governed only by the terms and conditions of the relevant policy.