D&O: A market in freefall

Insurance capacity continues to be only sporadically available for all the relevant D&O sectors in Australia, and at a very significant price. Insurers are declining to renew programs where they cannot achieve their required premium increases, and product line underwriters are under intense scrutiny from management to be unyielding on pricing improvement. Insurance placement has therefore become challenging, in particular for clients purchasing cover for Side C or security entity claims (shareholder class action).

The frequency of current claims and increased costs of defending regulatory investigations, such as the recent Royal Commission, are dwarfing the current financial institutions’ insurance premium pool, which is estimated at $250m. Many insurers claim to having not made a profit in the FI space for over 10 years.

Critically, there is now very limited insurer appetite for security entity cover (Side C) insurance locally or in international markets for Australian risks attaching under $100m, according to Marsh. Currently, premiums above $100m attachment remain stable, but with major global insurers now looking more closely at their cost of capital, that could be about to change. Conversely, insurance premiums below $100m are rising substantially, albeit not to levels forecast by insurers and actuaries.

DRIVING AWAY THE BEST

Former chief risk officer for Scentre, Eamonn Cunningham, says this slash in the availability of Side C coverage is adversely affecting corporate Australia. “It is having a major impact. Board members are keenly aware of what is happening and it impacts them in a number of ways. First, determining whether it is worthwhile to accept that board position in the first place. Not all potential board members will follow this course of action and corporate Australia will lose out.

“Assuming you actually get a quality board, you then face the dilemma that board members will constantly have one eye on potential legal action as they go about routine board business. What does this all mean? Well, a negative impact on the quality of good, impactful governance in Australian boardrooms,” he says.

“Why would people of calibre consider joining a board when a system ostensibly designed to protect shareholders actually acts as an inhibitor to director performance?” Risk management consultant, Eamonn Cunningham

Despite the significant, year-long pricing correction from the existing market leaders, management liability portfolios are only just beginning to stabilise, with loss ratios expected to break even some time in the second half of 2018. Local insurers have expressed the view that the pricing correction has not been sufficient to attract their participation, and thus competition, against the existing market leaders.

Cunningham says, critically, it is affecting Australian firms’ ability to attract quality directors. “Quality directors are a scarce commodity. Why would people of calibre consider joining a board when a system ostensibly designed to protect shareholders actually acts as an inhibitor to director performance and thus a brake on value creation?”

RIMS Australasia president and Lend Lease group head of risk and insurance Kevin Bates says: “More senior or experienced directors will, or indeed are, walking away from the position. They do not want their reputations pulled apart in a witness box – and their impressive careers left with a stigma. Junior or less experienced executives considering the move to a non- executive director position simply won’t. The reward does not outweigh the risk in the current environment.”

INVESTORS FEEL IT, TOO

Cunningham says investors are also being stung. “In additional to the pressures on good governance, the ordinary Mum and Dad shareholder will invariably get a minuscule portion, if any, of any class action award. This is just the immediate cash impact. The amount of executive time required to defend these actions is enormous. Every hour spent on these opportunistic claims is an hour less devoted to enhancing value for shareholders.”

Bates weighs in: “In addition, the immediate erosion of market cap for the entity will take years to recover from. Dividends are immediately impacted also – hitting Mums and Dads in the pocket directly and indirectly, with their superfunds underperforming as a result of their investment returns having diminished.”

“Keep in mind, there is not an example of the largest shareholder of any organisation having funded or underwritten the funding for a class action on behalf of a class. Why? They clearly have more money than the funders themselves. It is because they know that there is no arbitrage to be found. The value erosion resultant from a class action is never outweighed by the settlement sum percentage given to the class; and the organisation takes years to recover. It’s a lose-lose for the class.”

WHAT CAN YOU DO?

The obvious question for a risk manager is: ‘How can I protect my firm from this?’ Unfortunately, experts agree there is no obvious way. Bates says: “It is nigh-on impossible for a corporate to protect against an action. The rules of the day simply make raising the action too easy, and the lack of regulation supports this. A corporate can have done all within its power to act in the best interests of the shareholders, yet still find themselves on the receiving end of an action.”

“Act in the best interests of shareholders and question the structures in place that conspire to adversely impact value creation,” says Cunningham. “Ensure that all participants in legal processes are subject to the same set of rules.”

“Encourage legislators to enact laws to create an even playing field; limit or discourage excessive fees that are unrelated to actual time and e ort spent. Consider the laws relating to continuous disclosure. Are they delivering to the Mums and Dads of Australia what was originally intended? Or are they really of more value to those who back and mount spurious claims in order to essentially blackmail boards and their insurers to the settlement table?”

“The immediate erosion of market cap for the entity will take years to recover from. Dividends are immediately impacted also – hitting mums and dads in the pocket.” Group head of risk and insurance, Lend Lease Kevin Bates

Make no mistake - the future of Side C coverage in Australia is dire. Marsh predicts the market will to continue seeking price increases through the rest of 2018, even if the class action activity proves to have peaked. Indeed, in their most recent market assessment, Finity Consulting suggests that even after the most recent round of increases, another 35%–55% would be required to stabilise the local D&O market.

Cunningham says the Australian firms are running short on options. “The legislative environment that facilitates and enables class actions is eroding the marketplace that underpins D&O insurance cover. Limits will continue to reduce, the breadth of cover will suffer from more restrictive policy wording, and of course, pricing will constantly increase. And this is unfortunately the better of the options. The alternative and increasingly more likely one is the withdrawal of cover. Individual carriers have already signalled this as a clear likelihood.”

Bates puts it bluntly: “Carriers are retreating. Some from the primary layers and others from the class of insurance altogether. Without a change in legislation, or some regulatory framework being placed around class action funders, it is very difficult to see a future that has a D&O market as we know it presently.”