D&O Liability: What Directors Need to Know in an Evolving Market – How to Obtain Best Terms and Pricing
The Directors & Officers liability insurance market is stabilizing and improving as new carriers unencumbered by prior-year loss development enter the market. That new capacity has led to increased competition and a moderating of rates yielding expected decreases in overall premium in today’s market.
Higher competition levels throughout 2021 factored significantly in the tapering of renewal pricing increases, particularly for businesses that were proactive and strategic with their placement approach. In 2022 as new insurer capital competition and decreased claim frequency trends returning to more historical norms and the solution-oriented mindset of established insurers are encouraging.
Let’s dive into what underwriters look for — both in initial and ongoing assessment of ESG performance metrics — and what risk managers can do to help mitigate ESG-related risks.
New market entries will ultimately accelerate competition and rate deceleration, and we are already seeing considerable rate improvement. Further, as more companies begin to finally 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 beyond COVID-19 impact.
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.
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.
SPAC-related Litigation: Overall D&O litigation filing trends are subsiding, but SPAC-related filings doubled in the first half of 2021 compared to all of 2020 and remained accelerated in the second half of 2021. The amount of SPAC formations seeking a merger target and the scrutiny experienced from investors, the SEC and other stakeholders expect SPAC-related litigation rates to continue to be elevated in 2022.
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.1
- 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.2
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 reached a 10-year high, but the dollar amount of all settlements and the median settlement fell to their lowest levels since 2017. Courts approved 87 settlements totaling $1.8 billion in 2021, compared to 77 settlements and $4.4 billion in 2020. Median settlement value, however, declined 13 percent in 2020 from 2018-2019 levels.3
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.
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.