Emerging risks and competitive pressure testing D&O market

The Head of London Market Management Liability at Sompo International has warned directors and officers in the UK will face new threats as the market grapples with the changing risk picture and competitive pressures.

Jeremy Isaacs said macroeconomic risks stemming from the worldwide economic downturn and increased inflationary pressures will likely lead to some insolvencies and potential litigation.

He added: “Evolving cyber risks and increased regulation for many businesses will also shine a light on exposures for directors and officers whose companies might be implicated.

“While the worst of the COVID-19-related business disruption is – we all hope – behind us, there is a continued impact on labour and supply chains, which could lead to lengthy delays in the distribution of goods and products and thereby could potentially have an impact on their quality when they reach the market,” he explained. “Renewed attention from both stakeholders and regulators on the Environmental, Social and Governance (ESG) pledges made by companies will mean that these concerns, which have been on the radar for some time now, will come into sharper focus for directors and officers.”

Against this backdrop, the insurance market for D&O has been softening quickly since Q2 of 2022, following a few years of rate correction, Issacs added. While some carriers are reducing the amount of business they underwrite – where rates are deemed inadequate – or reducing the line sizes they are willing to offer, other carriers seeking market share are continuing to expand their books of business, doubling line sizes and pressing for new business in new sectors.

“For companies across many industry sectors, increased costs can have a significant impact on the balance sheet,” he continued. “We are likely to see some bankruptcies in 2023, which could result in insurance claims being brought by insolvency practitioners if they believe that decisions made by directors and officers contributed to a company’s failure.

“Companies that experience severe negative impacts on property valuations, for example, could be at risk of covenants being triggered. If companies cut corners on health and safety or reduce the quality of their product because of cost-inflation pressures, they could leave themselves at risk of shareholder actions if products are faulty, unsafe or of a lower-than-expected standard.”

While inflation is likely to cause serious problems for a number of companies, perhaps particularly smaller ones, the fact that many businesses have weathered the challenges of the pandemic, and in some cases are leaner than they were before COVID-19, puts them on a stronger footing to withstand what is likely to be a challenging year for us all.

“While ESG concerns have been on the radar of companies, their directors and officers and their shareholders for some time now, these issues are likely to come into even sharper focus in 2023,” he continued. “This year, companies in the UK will have to report their ESG performance and environmental impact in line with Sustainability Disclosure Requirements.”

Later in the year, the US Securities & Exchange Commission (SEC) will publish its climate-disclosure guidelines, which will require registered companies to make specific climate-related disclosures in SEC filings.

Many companies already publish ESG goals, targets and progress on a voluntary basis, but these official reporting requirements may give greater visibility of these commitments and provide more fuel for shareholders and activists to launch claims, for example when targets have not been met or important information accidentally omitted, Issacs warned.

“Ironically, we have seen claims hit the companies that have been more forthcoming with their disclosures. But despite the increased focus on ESG, we have not seen – and do not expect to see in the near future – a huge uptick in speculative or opportunistic shareholder derivative actions or other group action claims.

“Typically, the ‘loser-pays’ principle of UK courts means litigation funders are reluctant to pursue claims that do not stand a realistic chance of success. And despite some significant stock drops in recent months and years there has not been a flood of D&O claims in the UK.”

In terms of new exposures Issacs said the recent $500 million child abuse suit brought by former teen actors against Paramount studios relating to a 1960s production of Romeo & Juliet, once again highlights the vulnerability of companies – in all sectors – to allegations of sexual misconduct and discrimination, both recent and historic.

“While this case is somewhat unusual, because it was filed during a temporary suspension of the statute of limitations for child abuse claims in California, and because the film director is dead, D&Os will follow the case with interest as it highlights the potential for a new raft of #MeToo-style claims,” Issacs explained. “Several other film directors currently are embroiled in controversy for allegedly not making child performers aware of the nature of the content of films in which they were involved. It’s too early to tell how significant this issue could turn out to be, but directors and officers and their insurers will be keeping a close eye on how it develops.”

The UK market for D&O insurance has undergone a dramatic softening in the last three quarters. The market is extremely competitive, with several new entrants seeking to build market share, creating more competition and driving rates downward.

This has led to incumbent markets being more defensive with their approach and reducing rate further than what they may have planned for. Some established carriers are standing their ground and are willing to walk away from accounts that they feel do not pay the premium that reflects the exposure.

The average line size in the market for high-risk business – typically stock which is publicly traded in the United States or Australia – is approximately $5 million currently compared with around $20 million a few years ago.
“While many carriers are tentatively increasing their line sizes for lower risk – usually privately owned businesses, there is still a degree of caution in the market about increasing line sizes on big-ticket risks,” Issacs said. “The current risk environment, however, coupled with fears that there might be a race-to-the-bottom on rate in some areas, could mean that the next market hardening might be just around the corner.”

Looking to the future Issacs said the current economic climate, the increased focus on ESG, and newer and emerging risks mean this will be a challenging year for the directors and officers of UK companies and will highlight the need for good levels of D&O insurance coverage.

“It will be important for directors and officers to communicate effectively to shareholders about potential issues and performance targets in a timely fashion, to minimise any surprises or shocks,” he added. “As a result of reduced premiums, we expect to see many clients seeking to increase the amount of D&O they purchase in order to protect themselves against risks stemming from inflationary pressures, increased ESG scrutiny, cyber threats and so on.

“Insurance market dynamics may move swiftly as economic conditions bite and losses begin to trickle through. A continuing dialogue between buyers, brokers and insurers will, therefore, become increasingly important to make sure that coverage is adequate.”

Later in the year, the US Securities & Exchange Commission (SEC) will publish its climate-disclosure guidelines, which will require registered companies to make specific climate-related disclosures in SEC filings.