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The range of exposures facing directors and officers (D&Os) – as well as subsequent claims scenarios – have increased significantly in recent years in the midst of a prolonged soft market. With corporate management increasingly under the spotlight, how will the 2020 D&O insurance market impact risk managers, their D&Os and their broker partners.


Although around $15bn of premiums are collected annually for D&O insurance, the profitability of the sector has been challenged in recent years due to several factors including increasing competition, growth in the number of lawsuits and rising claims frequency and severity.


The D&O insurance loss ratio has variously been estimated to be in excess of 100% in numerous markets including the UK, US 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. AGCS has seen double digit growth in the number of claims it has received over the past five years.


Increased claims activity combined with years of new capital and soft D&O pricing has resulted in some capacity reductions, while the increasing number, size and tail of claims (combined with older claims developing much later) mean smaller carriers aren’t able to compete. For example, AGCS has seen many claims notified between 2012 and 2015 only in the last 12 months develop to a point in which either a realistic reserve assessment or a payment could be made, creating a double-impact of prior year claims being more severe than anticipated and notifications more numerous in recent years. AGCS has seen more new filings overall, as well as a much higher frequency of claims at the upper bands of severity.


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.


Market reports estimate that the D&O insurance industry has under-reserved for losses by somewhere between $3bn to $5bn in recent years – a significant portion of premiums earned even as loss ratios are among the highest since the financial crisis. Publicly-disclosed data suggests D&O pricing turned modestly positive in 2018, for the first time since 2003 – at the end of 2018 it was still around 20% to 25% below even 2010 levels and a fraction of the level from the prior market top in the early 2000s. However, accounts suggest rate momentum has accelerated further in 2019, while D&O rates per million of limit covered were up 17.1% in Q2 2019, compared to the same period in 2018, with the overall price change for primary policies renewing with the same limit and deductible up almost 7%.


Risk mitigation and insurance guidance


Insurers are facing more legal costs as increasing attorney activity from plaintiffs requires more claims handling and settlements. Another issues is that event-driven litigation can result in aggregation issues where multiple policies may be triggered by an event. For example, one event could trigger both D&O and either aviation, environmental, construction, product recall or cyber claims.


From an insurance-purchasing perspective, AGCS 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.


There are a number of ways businesses can protect themselves in the D&O space. They may consider taking more entity risk on the company balance sheet via higher Side-C and Side-B retentions, as well as consider vertical co-insurance, reduce their Side-C limit and purchase more Side-A cover for individual officers.


They may also coordinate and tie-in international insurance solution limits, if appropriate, or remove sub-limited extensions which may be easily self-insured, as well as consider alternative risk solutions – for example, multi-year solutions can be structured allowing companies to retain more D&O exposures while effectively reducing earnings volatility. Businesses should meet with their brokers for detailed advice on options, as well as open dialogue with underwriters in order to better understand their risk culture and governance.


Underwriters need clarity from customers about cyber and privacy risk exposures, corporate governance set-up, intangible asset protections, reputation and brand protections, crisis management plans, and how risks are monitored and managed at the board level.


Five trends to watch out for in 2020


More “bad news” litigation -  AGCS continues to see more D&O claims emanating from “bad news” not necessarily related to financial reports, including product problems, man-made disasters, environmental disasters, corruption and cyber-attacks – “event-driven litigation” claims which often result in securities or derivative claims. AGCS has recently seen a number of cyber-related securities class actions, derivative actions and regulatory investigations and fines, including from the EU’s General Data Protection Regulation (GDPR), and expects an acceleration of this tends in 2020.


ESG and climate change in the boardroom spotlight - Environmental, social and governance (ESG) failings can cause brand values to plummet. Investors, regulators, governments and customers increasingly expect companies and boards to focus on ESG issues such as climate change – litigation cases have already been brought in at least 28 countries to date (three-quarters in the US) for perceived failings to adjust business practices in line with changing conditions.


Securities class actions accelerating globally - Securities class actions, most prevalent in the US, Canada and Australia, are growing globally as legal environments evolve as governments grow more receptive to class actions. Significantly, the EU has proposed enacting a collective redress model to allow for class actions, while states, such as Germany, the Netherlands and the UK, have established collective redress procedures. The pace of US 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, and the highest since 2001.


Economic and political challenges loom - AGCS expects to see increased insolvencies with the potential to result in D&O claims. Business insolvencies rose in 2018 by more than 10% year-on-year, owing to a sharp surge of over 60% in China. 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.


Litigation funding now has a wide appeal – Litigation is now a global investment class, attracting investors hurt by years of low interest rates searching for higher returns. Although the US accounts for roughly 40% of the market, followed by Australia and the UK, 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 about the size of the litigation funding industry vary widely from around $10bn globally to as much as $50bn to $100bn.

Source: Allianz Global Corporate & Specialty South Africa Ltd
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