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For the past decade, many companies approached renewing their directors and officers (D&O) insurance policy in a more routine manner. Capacity was abundant with broadening coverage, so companies typically found their renewal to be a straightforward process with a predictable premium spend as well as choice around the amount to retain before the policy would respond. Market conditions did not create the need for a major re-examination of strategy, broad internal stakeholder communication or deep analysis of needs from year to year.
More recently, however, many companies have been taken by surprise by increased rates and retention levels for coverage, less capacity, and a much more cumbersome renewal process. Several factors have shaped today’s D&O market:
- The frequency of US Securities litigation for public companies hit a high of 403 in 2019 and is forecasted to come in close to 400 for 2020.
- In 2019, the likelihood of litigation involving a core filing for U.S. exchange-listed companies increased for a seventh consecutive year.
- Insurers have had to cover large settlements, some at record highs.
- There is an increased frequency and severity of claims against non-US traded companies & foreign US-listed companies.
Across North America, the prevalence of event-driven litigation (for example, from cyber attacks) has placed many companies at added risk. The onset of the pandemic has magnified these factors while introducing pervasive uncertainty into the business climate. Since the pandemic started, there have been several examples of D&O litigation directly related to its impact on companies, including a large cruise line and technology company.
Some insurers have sought to add COVID-19 exclusions or other restrictions, such as bankruptcy or cyber exclusions, to policies or strip back coverage protecting directors and officers. However, the business challenges related to the pandemic are unpredictable — meaning that companies have to stay vigilant not only about the risks but about their coverage.
Amid this disruption, the social unrest in the US and Canada has elevated diversity and inclusion (D&I) to a board-level priority. Many organizations have had to contend with the lack of women and minorities in leadership positions, including Board level seats. Plaintiff firms have brought several derivative suits against US companies alleging breach of their fiduciary duties in failing to address Board diversity and inclusion. Such incidents have demonstrated that companies must address D&I at the highest level with measurable accountability for change. This translates into the need to communicate proactively on this issue through the D&O renewal process.
Heading into 2021, how can companies regain control of the D&O buying process? In our experience, several actions can help:
Managing the renewal process properly takes a significant amount of time. So that companies have the time explore the full range of options and understand the trade-offs and implications, they should begin six to nine months before the renewal date. While this schedule might be a dramatic change from previous years, that time will help the organization assume a proactive posture and tie their coverage strategy to the overall business strategy. 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. Here’s an example:
Quota share solution leads to lower premium
- A large publicly traded mining company had secured its primary D&O capacity but had capacity and cost challenges with its low excess layers after the incumbent excess market cut capacity in half.
- With the additional lead time, the broker explored a variety of options, and ultimately utilized an excess quota share structure instead of the traditional straight layer approach. That unlocked capacity at a lower comparable cost. Given the perceived burn layer due to market capitalization, claim activity would have eroded the attachment -- the group of carriers saw the benefit of sharing a loss up the layer versus being fully at risk on a layer approach.
Takeaways: Start early to explore all options to find strategic partner markets -- not all insurers view this as a preferred structure. It is important to consider and negotiate claims approach as well as wording.
Since D&O coverage has gotten much more complex, organizations can benefit from the input of specialists with industry knowledge. Establishing such partnerships can help to differentiate risk across markets and define coverage requirements. Being more informed can not only change the dynamic with underwriters but also support conversations with internal stakeholders. In this example, the company and broker worked collaboratively on a co-insurance approach to unlock primary layer capacity:
Co-insurance approach shares the risk
- A large publicly traded financial institution was challenged to secure primary layer renewal capacity due to the company’s size and scope.
- In addition to a retention, the company was open to a co-insurance approach where it would take a portion of the claim (for example, 20%) on the layers where co-insurance was added. Through further sharing of the risk beyond the retention, this unlocked needed capacity.
Takeaways: Delivering a co-insurance approach takes time. The concept must be explained to a variety of internal company stakeholders. Further, insurers require a strong balance sheet to be comfortable with the approach. Co-insurance may be used on primary and excess layers, or only on select excess layers.
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 is once again dictating terms. Incorporating creative thinking into these types of processes can also have broader organizational impact and elevate the organization’s problem-solving approach. This example illustrates how creative thinking led to utilization of a captive to solve capacity issues:
Wholly owned captive provides capacity solution
- A large publicly traded pharmaceutical with a strong financial balance sheet had secured its primary Side ABC D&O capacity, however, no retail market was available for the first excess Side ABC layer. The incumbent carrier’s pricing was prohibitive, and no other options could be sourced. The broker creatively worked with the client to deliver a solution for the capacity issue.
- The broker placed the BC D&O coverage into a captive at market rate of underlying, and then secured Side A coverage from the retail market. The pharma’s D&O program was ultimately placed at a contained premium increase.
Takeaways: Don’t wait to start the renewal process. A strong marketing exercise is required for the retail market as well as ample lead time and data to place Side BC insurance into a captive. A seasoned captive with liquidity was key to securing retail market excess capacity above the captive layer. In fact, several insurers requested to review the captive financial statements to underwrite its ability to pay a claim.
Obtaining D&O coverage that adequately mitigates the organization’s risk is just one facet of the renewal process. 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.
Takeaways: Focus on clear and concise communication to help garner support from stakeholders, especially when considering nontraditional D&O structures.
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 captives. Nevertheless, leading D&O strategies shouldn’t change dramatically each year, in part because many of the options require time to develop and implement or could have separate cost implications.
Takeaways: Companies’ foundational D&O strategies shouldn’t change from year to year. With an effective long-term strategy in place, and an understanding of risk tolerance, companies will be able to make the right shifts in response to the market and organizational changes.
Getting started: A checklist
As a first step, companies need to develop an understanding of how the events of the previous year have altered their risk profile. Executives can use the following checklist to begin to get a sense of how their D&O risk may have changed and ensure they prioritize their needs accordingly. Sample checklist items:
- Is your company part of an at-risk industry—for example, hospitality, airlines, cruise lines—that have been significantly affected by the pandemic?
- Is your company part of an adjacent industry that might be affected by a significant decline in business for at-risk industries?
- How transparent has your company’s communication during COVID-19 been, particularly the financial impact? Potential guidance revisions, business continuity, liquidity management, and debt restructuring are some of the key related topics.
- Has your company been preparing to make major strategic moves such as M&A or an IPO in the coming year?
- Does your company operate in countries or regions that have experienced geopolitical incidents or rising tension over the past year?
- Is your company in an industry (such as retail or financial services) that represents a high-profile target for cyberattacks?
- Are women and minorities adequately represented on your board?
- How has your company addressed the heightened workplace exposures during the pandemic (layoffs, remote working, return to work concerns, safe keeping of employees)?
- Have you taken action over the past year to enhance your corporate governance function?
- When do you typically start the renewal process for D&O coverage?
- Have you developed a comprehensive risk profile and conducted benchmarking against industry peers?
This checklist can support more effective preliminary discussions and educate senior leaders on the shifting risk landscape.
 Stanford Law School's Securities Class Action
 Side A is D&O for non-indemnifiable loss, direct protection for directors and officers for defense costs and liability; Side B covers indemnification of directors and officers for defense costs and legal liability; and Side C is entity coverage. For publicly traded companies, Side C coverage is limited to securities claims.