While 2020 will be remembered as a difficult year for many people and organizations, the year ahead is not likely to be much easier for public company directors and officers. As companies and senior leaders plan for 2021, managing directors and officers liability (D&O) insurance programs and related risks will be crucial. Here are five D&O trends that risk professionals should watch closely.
As 2020 draws to a close, the global commercial insurance market remains difficult, especially for US buyers of D&O insurance: In the third quarter of 2020, D&O pricing for public companies rose more than 50%, with more than 90% of Marsh clients renewing with rate increases. In addition to higher pricing, public companies also face narrowing coverage, with underwriters no longer willing to provide some coverage enhancements that were previously available. This is especially true for harder-to-place risks, including life sciences and technology companies, cryptocurrency market players, and companies that are preparing to go public. D&O capacity challenges are not limited to the US. While the London market has traditionally provided a supplement to domestic capacity for US companies, underwriting interest in US risks has waned. Meanwhile, non-US companies that have historically secured D&O coverage from London insurers are now hoping other markets, such as the US, can help provide capacity. Amid these challenges, companies are often being forced to make difficult choices, including reducing their limits and retaining more risk. Companies are also more focused on potential alternative risk transfer solutions where either capacity is lacking or pricing is deemed too egregious. Although some recent new market entrants should help increase supply and temper pricing increases in the long run, it will take some time before their influence is apparent. Difficult conditions for D&O buyers are expected to continue into 2021.
While the pandemic has had some effect on the D&O insurance market, there are several reasons why D&O prices are increasing, one of which is the ever-increasing cost of securities litigation. Public companies were targeted in more than 400 securities suits in each of the last three calendar years, and are on pace to see another 350 this year, according to data from NERA Economic Consulting.
An increasingly large share of these suits are derivative actions. Unlike traditional shareholder suits, which allege that companies and their senior leaders have violated their duty to shareholders, a derivative action is filed on behalf of a company against individual directors and officers, who are alleged to have violated their duty to the company. Many recent derivative actions are so-called “event-driven” suits, alleging that senior company leaders have failed to adequately respond to high-profile events and trends, including cyber-attacks, climate change, and allegations of sexual harassment.
In addition to growing in frequency, derivative suits are becoming more costly. While plaintiffs in derivative suits have historically settled for attorneys’ fees and changes in corporate governance — for example, a commitment to improving cybersecurity — they are now looking for compensatory damages as well.
As derivative settlements are nonindemnifiable in most states, protection against them is found in Side-A D&O coverage only. The Side-A portion of a D&O policy provides personal asset protection for directors and officers; without adequate limits for this portion of a policy, directors and officers could be responsible for paying large settlement costs out of pocket. Unfortunately, while Side-A coverage has historically been readily available and affordable, the cost is now increasing as a result of the increase in derivative action frequency and severity.
Shareholder activism remains a significant concern for public companies and their directors and officers — and continues to succeed in altering corporate behavior and the balance of power between shareholders and boards. While activists have often made a variety of demands, including that companies be sold or broken up or directors of their choice be appointed, they are increasingly focusing their energies on environmental, social, and governance (ESG) issues. Notably, activists are demanding that companies prioritize diversity — across workforces and at the board level — and climate change.
Climate change, in particular, appears to be a topic that activists will continue to focus on in 2021. Shareholder activists are seeking greater climate-related disclosures in financial statements and that companies enact environmentally friendly policies, including taking steps to reduce their carbon footprints.
As activists pursue action on ESG issues, a worry for public companies is whether and how D&O policies will respond. Coverage for activism has traditionally been limited and varied by insurer and based on the nature of specific activities. There has been, however, a push among policyholders in recent years to clarify coverage. Insurers, meanwhile, have considered developing specific activist defense coverage grants; without such grants, however, insurers have generally determined whether to provide coverage on a case-by-case basis.
Achieving greater diversity and inclusion within boards has become an important objective for many stakeholders.
A number of public companies have been targeted in securities suits demanding that boards become more diverse. To date, these have generally taken the form of shareholder derivative actions alleging that directors and officers have breached their fiduciary duties by making false assertions about their commitment to diversity and the inclusion of women and people of color.
State governments — led by California — have also started to take action. In 2018, California passed SB 826, which required that public companies based in the state have at least one woman on their boards by the end of 2019 and ensure greater representation by the end of 2021. For companies with at five directors, at least two would need to be women; for companies with six or more directors, at least three would need to be women.
Earlier this year, California passed AB 979, which requires companies to have at least one director from an underrepresented community on their boards by the end of 2021. Similar to SB 826, AB 979 requires greater representation going forward: By the end of 2021, companies with five to eight directors must have at least two from underrepresented communities, and those with nine or more directors must have at least three from these communities. The bill defines directors from “underrepresented communities” as being those who self-identify as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, Alaska Native, or LGBT.
A first-time violation of each of the California laws carries a penalty of $100,000; subsequent fines are $300,000 for each violation. Beyond California, other states — including Illinois, Maryland, New York, and Washington — have passed laws requiring greater diversity on boards, more detailed reporting on board makeup in financial statements, or that governments conduct studies on board representation.
Securities exchange operators are likewise concentrating on diversity. On December 1, Nasdaq filed a proposal with the Securities and Exchange Commission to require most Nasdaq-listed companies to have a least one female director and one director who self-identifies as either an underrepresented minority or LGBTQ; compliance would be required within two to five years of the SEC’s approval of the new listing rule. The New York Stock Exchange, meanwhile, formed an advisory council in 2019 to promote diversity and inclusion “by connecting diverse candidates with companies seeking new directors.”
As shareholders, states, and exchanges press this issue, insurers are taking notice. Underwriters are asking detailed questions about board composition during renewal discussions, a trend that is likely to continue. And given the potential for costly legal decisions and settlements or regulatory actions, companies that do not demonstrate their commitment to diversity could see their standing with underwriters weaken.
2021 will likely be a year of significant change for many companies, including in how they are structured. Consider the following:
Despite a lull in corporate restructurings at the start of the pandemic, activity has significantly picked up and is expected to continue in 2021.
The growing number and intensity of risks for public companies highlights the need for them to ensure they have robust insurance coverage in place. And with directors’ and officers’ personal assets potentially at stake, ensuring sufficient Side-A coverage is especially important.
While many companies already purchase Side-A coverage as part of their D&O insuring agreements, they often share limits with Side-B and Side-C coverage for claims against the company, which means that Side-A coverage can be quickly exhausted. As personal risks for directors and officers grow, companies should consider purchasing dedicated Side-A coverage that sits above the traditional ABC coverage tower.
It’s important that Side-A coverage be a difference in conditions (DIC) policy, which is generally broader than traditional Side-A coverage and will drop down if a traditional ABC policy does not respond. And, although it may be difficult given current conditions, risk professionals should work with their advisors to negotiate as few exclusions as possible.
As public companies ready themselves for potentially more difficult D&O insurance renewals in 2021, it’s important to remember some best practices. Starting early is crucial, especially if you intend to market your program. It’s also important to focus on building personal relationships with insurers — if underwriters see you as people rather than a company, it may be more difficult for them to say no to you.
Risk professionals should also: