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D&O Liability: What Directors Need to Know in an Evolving Market

The directors & officers liability insurance market continues to work its way through multiple years of increasing prices, higher retentions and restricted capacity. However, there are early signs that a turn may be occurring.

For more than two years, a variety of factors have challenged the D&O market, leading to a 67% cumulative increase in market premiums since 2019.[1] There may be good news on the horizon. As upward pricing pressures continue through mid-2021, new capacity has begun to enter the scene, signaling that the D&O market may be at a crossroads.[2] D&O price increases continued in the second quarter 2021, but at a slower pace than prior quarters.[3]

New market entries will ultimately accelerate competition and rate deceleration, although it may be a year before we see considerable rate improvement. Further, with more companies starting to return to the office, they are able to provide a better narrative to underwriters at renewal time, which is resonating with insurers and resulting in glimpses of better pricing, retention and capacity.

There are also signs of less class underwriting and more risk-differentiating underwriting among insurers, which will benefit good D&O risks that have weathered COVID-19. That said, underwriters remain focused on financial strength, claim history, industry and resilience to COVID-19.

However, until pricing pressure, increased retention and capacity limitations fully abate, it continues to be important for organizations to evaluate their risk portfolio and truly take control of their risk appetite.

To maximize D&O coverage, risk managers should not only prepare for today’s risks but should also consider risk identification over the next few years -- and if your D&O program is sustainable with the pressures of the continued hard market.

 

Current D&O Exposure Trends

The following are some of the evolving trends in liability for directors and officers:

Supply chain: One of the impacts of COVID-19 has been around supply chain disruptions and the significant financial and economic turmoil they bring. D&O litigation against companies and their boards for the way they respond to supply chain disruptions may continue for years after the COVID-19 crisis wanes.

SPACs: Special purpose acquisition companies (SPACs) are public investment vehicles created by a group of investors that look to merge with a private company to bring that company public. In recent years SPAC structures have evolved in ways that make them more attractive to private companies looking to go public. In the first half of 2021 alone there have been 14 new securities class action lawsuits involving SPACs, with more than half of those alleging that potential targets defrauded investors by misrepresenting their product’s viability.[4] There is little litigation history around SPACs and de-SPACs, leading to uncertainty that makes D&O underwriters hesitant to take on SPAC risks. Some markets are unwilling to even quote SPAC or de-SPAC D&O coverage.

ESG: As the expectation of companies focusing on Environmental, Social and Governance (ESG) continues to grow in prominence globally, so does scrutiny from stakeholders, which is being felt in corporate boardrooms, including a variety of D&O risks. How organizations approach ESG is becoming of interest to underwriters as well. It is essential to have a clear understanding of how your D&O program will respond to ESG exposures and that the program provides the breath and scope of coverage for shareholder and regulatory claims that involve ESG claims. Here are several key current ESG D&O issues:

  • Board Diversity: Lack of focus on ESG issues can give rise to increased litigation, including shareholder derivative lawsuits, alleging that boards’ failure to live up to their diversity commitment is a breach of their fiduciary duty.
  • Climate Change: Global climate change continues to drive the frequency and severity of severe weather events. Companies are being held accountable for their role in causing these types of events.[5]
  • Employee Wellness: How companies deal with employee wellness, especially returning to work after COVID-19 falls under the “S,”—Social – in ESG, which also include diversity & inclusion, fair pay and human rights.[6]

Restructuring/Bankruptcy/Insolvency: D&O insurers remain focused on heightened liquidity/bankruptcy risk, disclosure risk to stakeholders, and employee exposure due to layoffs and wellbeing.

Securities Class Actions: Securities class action settlements stayed on pace with courts approving 77 settlements totaling $4.2 billion in 2020, compared to 74 settlements and $2.1 billion in 2019. Median settlement value, however, declined 13% in 2020 from 2018-2019 levels.[7]

 

How Are Limits of Insurance Established?

Litigation frequency and claim severity continue to rise in the US and for Canadian companies. In the current D&O market, many insurers are managing overall capacity deployment and some clients are facing capacity constraints at renewal. Other clients are facing material increases in premium for their current limit of liability, as well as, increased retention thresholds.

To determine appropriate policy limits, companies should seek benchmarking information that measures their exposure against similarly situated corporations and against current litigation and regulatory conditions. But beyond benchmarking and a historical view of class action settlements in specific jurisdictions, companies should look to data and analytics to assess risk. Determining an appropriate limit to purchase coupled with a policy structure that fits your risk appetite and ultimately will satisfy your board, is critical to managing the total cost of risk.

Side A DIC/Excess

Personal asset protection for directors and officers

 

 

 

Additional aggregate limit

 

Excess limits available when:
Underlying limits are eroded/exhausted

DIC limits available when:
Underlying insurer

  • Wrongfully refuses to cover
  • Is financially unable to cover
  • Rescinds
  • Is not liable

Bankruptcy

  • Proceeds of underlying insurance are frozen

Side A

Personal asset protection for directors and officers

Insurance for covered non-indemnifiable claims

  • Statute
  • Bankruptcy
  • Company’s refusal

 

Side B

Corporate asset protection

Insurance reimbursement for covered indemnifiable claims

 

Side C

Corporate asset protection

Insurance for corporate liability when company is a defendant in covered securities claims

 

Single aggregate limit
Nil retention $50,000 $50,000

 

Market Management

The opportunity is now to customize your contract to address these trends and prepare for continued volatility. Contract customization would include but certainly not be limited to obtaining best in class terms relating to bankruptcy (i.e. priority of payments, pre-agreed runoff terms, bankruptcy centric carve-backs to the entity versus insured exclusion), particularly when a company is not in a state of distress. Also, a broad definition of claim and securities claim, including pre-claim inquiry, derivative demands and books and records coverage are fundamental to a broad-based D&O contract. Narrow exclusions and severability language are also trademarks of a best-in-class D&O contract.

D&O program structure has evolved with the changing market. A total cost of risk analysis will require an evaluation of your company’s D&O program structure to determine if it represents an efficient and effective approach to shifting your D&O risk exposures. Defining risk appetite and considering alternative structures will help companies and executives leverage the market. Companies may want to consider both conventional and innovative approaches to a D&O structure to fully evaluate the total cost of risk. Companies can consider, among a multitude of structures, alternatives such as: forgoing balance sheet protection and only insuring non-indemnifiable loss (side A only); ventilating retentions; utilizing a captive to spread risk and leverage market conditions; or creating an indemnification trust (where legally viable) to transfer certain risk.

The fundamental shift in considering the total cost of risk and loss will help organizations prepare for risk today and those unknown risks that will be identified over the next few years. Given the complexities of coverage and an insurance market that historically supported enhanced coverage at a lower cost, the D&O issues presented here should be discussed with an insurance professional skilled in management liability to achieve appropriate and adequate coverage for you and your organization.


 

[1] D&O rate hikes expected to continue: Fitch

[2] New capacity enters D&O sector as prices, exposures increase

[3] Quarterly D&O Pricing Index Second Quarter 2021

[4] Cornerstone Research Securities Class Action Filings 2021 Midyear Assessment

[5] D&O Price Increases Sting in a Hardening Market. Adopting ESG Best Practices Can Reduce the Pain.

[6] 5 ESG Myths that can Hinder its True Impact

[7] Stanford Law School Securities Class Action Clearinghouse