The range of risks facing company executives or directors and officers (D&Os) – as well as resulting insurance claims scenarios – has increased significantly in recent years. With corporate management under the spotlight like never before, Allianz Global Corporate & Specialty has identified, in its latest risk report, Directors and Officers Insurance Insights 2020, five mega trends that will have significant risk implications for senior management in 2020 and beyond.
1. More litigation is coming from “bad news” events
Allianz continues to see more D&O claims emanating from “bad news” not necessarily related to financial results, including product problems, man-made disasters, environmental disasters, corruption and cyber-attacks – “event-driven litigation” cases that often result in significant securities or derivative claims from shareholders after a share price fall or regulatory investigation related to the “bad news” event.
Plaintiffs seek to relate the “event” to prior company or board statements of reassurance to shareholders and regulators of no known issues. Of the top 100 US securities fraud settlements ever, 59% are event-driven.
One of the most prevalent types of these events is cyber incidents. Allianz has seen a number of securities class actions, derivative actions and regulatory investigations and fines, including from the E.U.’s General Data Protection Regulation (GDPR), in the last year, and expects an acceleration in 2020.
Companies and boards increasingly will be held responsible for data breaches and network security issues that cause loss of personal information or significant impairment to the company’s performance and reputation. Companies suffering major cyber or security breaches increasingly are targeted by shareholders in derivative litigations alleging failure to institute timely protective measures for the company and its customers.
The Marriott case – where the hotel chain announced that one of its reservation systems had been compromised, with hundreds of millions of customer records left exposed – is a recent example of a cyber breach resulting in D&O claims – one $12.5 billion lawsuit among several filings alleges that a “digital infestation” of the company, unnoticed by management, caused customer personal data to be compromised for over four years.
2. ESG and climate change litigation on the rise
Environmental, social and governance (ESG) failings can cause brand values to plummet. And investors, regulators, governments and customers increasingly expect companies and boards to focus on ESG issues, such as climate change, for example. Climate change litigation cases have been brought in at least 28 countries to date (three-quarters in the U.S.). In the U.S., there are an increasing number of cases alleging that companies have failed to adjust business practices in line with changing climate conditions.
Human exploitation in the supply chain is another disrupter and illustrates how ethical topics can cause D&O claims. Such topics can also be a major focus for activist investors whose campaigns continue to increase year-on-year.
Appropriate company culture can be a strong defense risk-mechanism. Many studies show board diversity helps reduce and foresee risk. Regulators are keen to investigate and punish individual officers rather than the entity, forcing directors into increased personal scrutiny to provide assurance that they did due diligence to prevent such cases from occurring.
See also: How to Deliver Tough Message on D&O
3. Growth of securities class actions globally
Securities class actions, most prevalent in the U.S., Canada and Australia, are growing globally as legal environments evolve and in response to growing receptivity of governments to collective redress and class actions. Significantly, the E.U. has proposed enacting a collective redress model to allow for class actions, while states, such as Germany, the Netherlands and the U.K., have established collective redress procedures. The pace of U.S. filing activity in 2019 has been only marginally slower than record highs of 2017 and 2018, when there were over 400 filings, almost double the average number of the preceding two decades.
Shareholder activism has increased. Approximately 82% of public company merger transactions valued over $100 million gave rise to litigation by shareholders of the target company threatening that the target company’s board will have breached its duties by underpricing the company, should the merger succeed.
4. Bankruptcies and political challenges
With most experts predicting a slowdown in economic growth, Allianz expects to see increased insolvencies, which may potentially translate into D&O claims. Business insolvencies rose in 2018 by more than 10% year-on-year, owing to a surge of over 60% in China, according to Euler Hermes. In 2019, business failures are set to rise for the third consecutive year by more than 6% year-on-year, with two out of three countries poised to post higher numbers of insolvencies than in 2018.
Political challenges, including significant elections, Brexit and trade wars, could create the need for risk planning for boards, including revisiting currency strategy, merger and acquisition (M&A) planning and supply chain and sourcing decisions based on tariffs. Poor decision- making may also result in claims from stakeholders.
5. Litigation funding is now a global investment class
These mega trends are further fueled by litigation funding now becoming a global investment class, attracting investors hurt by years of low interest rates searching for higher returns. Litigation finance reduces many of the entrance cost barriers for individuals wanting to seek compensation, although there is much debate around the remuneration model of this business.
Recently, many of the largest litigation funders have set up in Europe. Although the U.S. accounts for roughly 40% of the market, followed by Australia and the U.K., other areas are opening up, such as recent authorizations for litigation funding for arbitration cases in Singapore and Hong Kong. Next hotspots are predicted to be India and parts of the Middle East. Estimates are that the litigation funding industry has grown to around $10 billion globally, although some put the figure much higher, in the $50 billion to $100 billion range, based on billings of the largest law firms.
The state of the market
Although around $15 billion of D&O insurance premiums are collected annually, the sector’s profitability is challenged due to increased competition, growth in the number of lawsuits and rising claims frequency and severity. Loss ratios have been variously estimated to be in excess of 100% in numerous markets, including the U.K., U.S. and Germany in recent years due to drivers such as event-driven litigation, collective redress developments, regulatory investigations, pollution, higher defense costs and a general cultural shift, even in civil law countries, to bring more D&O claims both against individuals and the company in relation to securities.
The increased claims activity, combined with many years of new capital and soft pricing in the D&O market has resulted in some reductions in capacity. In addition, there has also been an increase in the tail of claims. Hence, there is a double impact of prior-year claims being more severe than anticipated and a higher frequency of notifications in recent years. As for claims severity, marketplace data suggests that the aggregate amount of alleged investor losses underlying U.S. securities class action claims filed last year was a multiple of any year preceding it.
See also: Why Private Firms Should Buy D&O
Despite rising claim frequency and severity, the industry has labored under a persistent and deepening soft market for well over a decade before seeing some recent hardening. Publicly disclosed data suggests D&O market pricing turned modestly positive in 2018 for the first time since 2003. However, D&O rates per million of limit covered were up by around 17% in Q2 2019, compared with the same period in 2018, with the overall price change for primary policies renewing with the same limit and deductible up almost 7%.
From an insurance-purchasing perspective, Allianz sees customers unable to purchase the same limits at expiration also looking to purchase additional Side A-only limits and also to use captives or alternative risk transfer (ART) solutions for the entity portion of D&O Insurance (Side C). Higher retentions, co-insurance and captive-use indicate a clear trend of customers considering retaining more risk in current conditions.