New laws, financial scandals and recessionary strategies are all playing their part in creating a volatile climate for D&O insurers. Insurance Times finds out how the market is reacting
With little sign of imminent economic recovery, directors’ and officers’ (D&O) insurers are bracing themselves for an increase in claims activity as the Serious Fraud Office and Office of Fair Trading (OFT) investigate possible recession-related wrongdoing by company directors.
In addition, legislation such as the Companies Act, the Corporate Manslaughter Act and the Bribery Act could provide aggrieved parties with the tools to hold directors to account.
Chartis’ London manager of commercial D&O, Alexandra Grant, says regulatory investigations in both the USA and UK are a “genuine cause for concern”. She says: “In the USA, they are coming from the Department of Justice, while in the UK it is the Serious Fraud Office and the OFT that are increasingly active.”
Grant says that as such bodies step up their activities, they are pursuing “individuals as well as their companies” and raising the possibility of fines and even imprisonment. “The cost of defending regulatory claims cannot be underestimated,” she says.
Grant expresses surprise at the results of a recent survey by Chartis, which showed that a significant proportion of companies had failed to respond to the potential threat to their businesses posed by the Corporate Manslaughter Act.
“At our recent corporate governance seminar, we asked companies how they were reacting in light of the first company having been charged under the Corporate Manslaughter Act, and what actions they were taking. Only 18% said they were taking specific actions,” she says.
“It is surprising that half of those who responded to the questionnaire are still either taking no action or keeping a watching brief. That raises the spectre of possible future D&O claims if companies do not already have robust corporate governance processes in place.”
Partner at law firm Clyde & Co Neil Beresford believes that the recently enacted Bribery Act could trigger D&O claims. “The act cuts through to individual directors and there might be test cases.
“For example, if you are the UK arm of a big multinational that pays bribes in the Ivory Coast, to what extent are you responsible as a UK office or as a director?”
Markel UK underwriting manager Simon Fell says more run of the mill issues drive claims in the D&O market. “There has been significant publicity within the D&O market as to potential claims arising from the Companies Act 2006, extradition proceedings and the Corporate Manslaughter Act,” he says.
“And while this will inevitably lead to a greater number of potential claims in the future, the present driver is regulatory investigations from the likes of HM Revenue & Customs for unpaid tax or OFT probes relating to construction industry price-fixing.”
Angel Underwriting D&O regional business development executive Gary Green believes the spotlight will be most firmly trained on financial services companies. He says: “After the recent scandals regarding Bernie Madoff and Allen Stanford, the market in general seems to have returned to focus on the D&O exposures associated mostly with financial institutions, particularly those with US exposures. Therefore, capacity in these sectors remains tight.”
Grant argues that it is increasingly difficult to ascertain which industries will be most likely to prompt D&O claims.
“Historically, telecoms, software and pharmaceutical companies have fallen into this category,” she says. “Now, concerns extend to businesses that have been hit by the recession or are highly exposed to currency fluctuations – this by definition is virtually all companies”.
Green says that the tough economic conditions have led to D&O claims relating to “insolvency and creditor actions, internal disputes between directors, and employment disputes”.
He cites the example of employers sacking staff for alleged misconduct without going through the correct procedures as they are anxious to get people off the payroll in an era of belt-tightening.
“Where additional coverage is included, such as employment practices liability,” he says, “we are seeing insurers looking more carefully into a firm’s recent employment history for redundancies or involuntary terminations before releasing terms.”
Green does not believe the recession has had much impact on rates. “Apart from D&O risks for financial lines businesses, we have seen premiums remain pretty constant over the past 12 months for D&O,” he says.
Fell says there has been pressure on rates during the past 12 months, with falls of 20% in some cases.
He adds that D&O cover has, in general, become cheaper to buy over the past decade. “Ten years ago, D&O cover for a small business would cost £1,000 to £2,000, but now you can get it for £150. The reasonable price means there has been great take-up of the product.”
Despite these falls, says Fell, more operators are entering the market. “Insurers have seen D&O as profitable and there has been a standardisation of the product. In the past, our regional offices may have had competition from just two other players, but now it might be 10 different players competing.”
Miller professional lines broker Simon Tyndall anticipates that more insurers will begin offering D&O cover, partly due to the “positive claims experience” in the market.
“There is no shortage of new commercial D&O capacity entering the market, with a number of underwriters on the move to new vehicles or existing markets,” he says. “There has been a significant increase in primary D&O underwriting appetite in recent years. There are also plenty of rumours suggesting that more are set to join.”
Green also acknowledges that during the past 12 months, there have been new entrants in the SME D&O market. But – like many aspects of the sector – it is too early to tell what impact this will have yet. IT
Top tips for success in the D&O market
• Underwriters should choose risks carefully
“It’s about understanding the business of the insured,” Lockton executive director Chris Hewitt says. “It means drilling deeper into the business – how is their balance sheet structured? What debt do they have? Can they service the debt? If you don’t ask these questions, those accounts will give you grief.”
• Brokers should keep underwriters informed of changes to risks
“[An insured] maybe had five locations, now they have two. If one of those burns down, you have a major logistical issue,” Hewitt says. Such changes need to be relayed to the underwriter, he says, because underwriters will be “looking for opportunities to deny cover as investment returns have collapsed”.
• Brokers need to educate clients about the importance of D&O cover
“A high proportion of businesses don’t insure [against D&O claims],” Markel UK underwriting manager Simon Fell says. “Underwriters need to explain the benefits to brokers in everyday language that can be passed on to the client. It should involve looking at what could potentially happen within the client’s trade.”
Broker focus: Lockton
Global D&O business brokered by Lockton totals about £340m in gross written premium, £150m of it placed in the UK. Executive director Chris Hewitt says D&O is expanding because insurers see it as attractive business.
“Carriers are hungry for income to be generated. The loss ratio and the revenues mean it’s a profitable business for underwriters and has been for years,” he says.
Hewitt says the appeal of the D&O market is reflected in the entry of new operators such as Argo and Taurus in the past year. “There is great demand for cover – directors realise that they do need it.”
The Companies Act 2006 is a key reason for the increased take-up in D&O cover, he says. “[The Act] means directors have more onerous risk liabilities, and it gives the law teeth to challenge what directors are doing,” he says. The Corporate Manslaughter Act has also played its part because, while the Act does not impose direct liability on directors, it will result in directors being subject to greater scrutiny. So the associated legal costs – and the need for D&O cover – will be greater.
Hewitt says the total D&O capacity in the UK market has increased by 25%-30% in the past 18 months. The recession has not had a big impact. “We’ve not seen a huge amount of bankruptcies, though they are there,” he says. He argues there has not been a surge in D&O claims because people have taken the view that companies have folded because of the recession, not necessarily due to “decisions made by the management team”.
But Hewitt believes the situation could change. “If we don’t see recovery in the next 12 months, directors could face cases where they are accused of trading insolvently.”
Rates have gone down by as much as 25% in the past year, says Hewitt. “In the commercial arena, it’s a free for all.” But he points to an uplift in financial institutions rates as banks and investment managers have come under fire.
Policies in the spotlight
Directors’ and officers’ policies have played a part in two recent high-profile financial scandals involving Ponzi schemes.
Travelers and Bernard Madoff
Travelers succeeded in dismissing a lawsuit relating to the fallout from the collapse of Bernard Madoff’s fraudulent Ponzi scheme earlier this year.
In April, the district court for Connecticut judged in favour of Travelers and its subsidiary, the St Paul Mercury Insurance Company, against a string of banks that had been involved in administering Madoff’s scheme.
The banks had accused Travelers of breach of contract after the insurer refused to pay out on their D&O policy for legal fees relating to a law suit by investors in the scheme.
The district judge ruled that the policy’s insolvency exclusion barred coverage under the policy.
Lloyd’s and Allen Stanford
Lloyd’s has declared it is no longer willing to pay out for different lawyers defending the alleged Ponzi scheme operator Allen Stanford, after indemnifying more than $6m (£4m) costs on lawyers from 10 firms. Stanford is charged with defrauding investors out of $7bn.
In May, Lloyd’s told US district judge Nancy Atlas, who is presiding over the case, that it was refusing to pay for Stanford’s most recent – and fourth – criminal defence team.
In March, Lloyd’s was told by the court that it had to pay for Stanford’s legal representation, following a court order to pay legal costs, citing a money-laundering exclusion on Stanford Financial Group’s D&O policy.