Risk Magazine : D&O insurance under strain post-GFC

by Greg Skehan
8 December 2010
Directors and officers (D&O) insurance policies are coming under strain as mounting class actions and ASIC enforcement activity severely test the adequacy of current policies, according to recent research.

It found that 6 out of every 10 D&O insurance providers saw the number of claims and notifications against their D&O policies at least double following the global financial crisis.

A further 60 per cent predicted that in the coming year, class actions would be the main challenge for D&O policies, followed by greater enforcement action from regulators such as ASIC (20 per cent) and the rise in liquidator actions (8 per cent).

"The corporate collapses from the GFC created a perfect storm of shareholder, creditor and regulator outrage," said Greg Skehan, senior partner in the insurance group at law firm Colin Biggers & Paisley, which conducted the research.

"We’ve seen a big upsurge in legal actions against companies and directors as investors and liquidators galvanise to recover their losses and ASIC mobilises to crack down on ‘so-called’ corporate crooks.

"D&O insurance is consequently being called upon to cover a greater number of claims involving higher aggregate payouts so it’s no wonder many policies are being squeezed, particularly in the area of payout limits".

To illustrate, 20 per cent of D&O insurance providers revealed that the insured’s D&O policy did not fully cover their costs in up to 25 per cent of claims, while 10 per cent indicated the policy was not sufficient to cover costs in 25 to 50 per cent of cases.

While the system was not yet at breaking point, Skehan cautioned that there were clear signs cracks were developing, given 70 per cent of respondents reported that an insured’s claim costs were generally fully covered.

Another significant area where directors were being left out of pocket was investigation costs – a bi-product of ASIC significantly ‘upping the ante’ on enforcement action in recent times, according to Skehan.

The survey found that 80 per cent of respondents had observed an increase in claims for investigation costs, while 50 per cent reported that current sub-limits for this category of costs were not sufficient to fully cover claimants’ needs.

"ASIC has not held back in using its powers to compel corporates to produce information and attend extensive interviews in recent years. Summonses often go out to multiple directors and executives which only increases the time and costs, as every individual called up needs to have capable legal representation," said Skehan.

"The regulator’s more active investigative role has meant that limits for representation costs are being eroded at a very early stage so there’s often little left in reserve for when proceedings develop into serious litigation later down the track."

Skehan added that companies at risk of incurring substantial investigation and representation costs should consider negotiating more accommodating policy limits with their insurers and be prepared to pay a higher premium for those benefits.

Similarly, Paul Smyth, national D&O manager at Aon Risk Services Australia, also noted that there was an immediate impact on D&O insurance following the GFC.

"Availability and coverage retracted very quickly while prices went up very significantly – pretty much overnight – but as we’ve gone on, that’s leveled out," he said.

"Insurers are very much risk selective and I think that’s one of the key issues at the moment. Insurers are still trying to work through the 10 per cent [of clients] that are quite ugly, the 80 per cent that are somewhere in the middle and the 10 per cent that sits at the very top end of the attractive range for them."

Smyth said that insurers are paying close attention to the "ugly 10 per cent" which have short-term debt problems, inadequate cash flows, financing issues to deal with in a very short timeframe and poor corporate governance.

For companies that might find it difficult in planning appropriate D&O insurance, Smyth said the best approach is to build a relationship with insurers, insurance advisors and/or lawyers.

"It’s a much easier conversation to have with an insurer when they have seen the white’s of the eyes of the client. In other words, the client’s just not a piece of paper," he said.

"I think it’s important that clients build a rapport in the relationship with their insurers in the easier times, not when you’ve got lawyers breathing down your neck and your business is under stress. The ideal position is to have that relationship established before you actually need to call upon that relationship."

This article has been published by Colin Biggers & Paisley for information and education purposes only and is a general summary of the topic(s) presented. This article is not specific legal advice. Please seek your own legal advice for any questions you may have. All information contained in this article is subject to change. Colin Biggers & Paisley cannot be held responsible for any liability whatsoever, or for any loss howsoever arising from any reliance upon the contents of this article.