Directors & Officers Risk Landscape Shaped by Insolvencies, COVID, Activism: Allianz

December 16, 2020

While the COVID-19 pandemic presents risks for directors and officers (D&O), it is far from the only force these insureds and their insurers will be dealing with in the year ahead.

Rising insolvency exposures, growing cyber security threats and persistent securities class action activity are among the other key risks where executives of companies could be held liable, according to a new report, Directors and Officers Insurance Insights 2021, from Allianz Global Corporate & Specialty (AGCS).

In 2021, companies will also need to be on guard against “event-driven litigation” caused by inaction on diversity, poor sustainability performance or for underestimating or misrepresenting COVID-19 related risks.

The report contends these factors will exacerbate an already-strained D&O insurance market.

Growth in the number of lawsuits as well as rising claims frequency and severity has already resulted in a difficult environment for the D&O insurance sector in recent years. Underwriting results have been negative in many markets around the world, including Australia, the UK, the U.S. and parts of Europe. While the market was correcting itself at the beginning of 2020, it was then hit by the current pandemic and economic crisis.

“Many insurers are still digesting the effect of previous pricing inadequacy and exposure and loss trend increases from prior-year policies,” says Shanil Williams, global head of Financial Lines at AGCS. “This is also at a time of great uncertainty around forward-looking exposure assessments, in particular the impact of COVID-19 on the economy in general and on specific industries.”

Williams said these conditions, when combined with climate change, cyber risks or ESG (environmental, social or governance) factors, create a” lot of nervousness” in this sector.

Top Concerns

The sector will also be watching insolvencies, which are a key cause of D&O claims as insolvency administrators usually look to recoup losses from directors.

According to Euler Hermes, the bulk of insolvencies is still to come through the first half of 2021, with its global insolvency index likely to hit a record high for bankruptcies, up 35% by end of 2021, and with top increases expected in the U.S., Brazil, China and core European countries such as UK, Italy, Belgium and France.

“We expect markets to remain fragile in view of the recent extreme bullish reaction to positive COVID-19 vaccine news,” said David Van den Berghe, global head of Financial Institutions at AGCS. “Further, the tech war between the U.S. and China, and the end of the Brexit transition period, will remain top of mind as well, and adds to an overall high level of economic uncertainty.”

Companies also face a constantly evolving landscape of cyber security threats as ransomware attacks and data breaches continue to be on the rise, while the shift to remote working due to COVID-19 is believed to have generally increased security vulnerabilities. Investors view cyber risk management and adequate security standards as a critical component of a board’s oversight responsibilities, the authors note.

Class Actions and COVID Cases

New U.S. securities class actions filings were pacing about 18% behind rates seen in 2019 during the first half of 2020, according to Cornerstone Research, largely due to the disruption of business and court activity caused by the pandemic. Nonetheless, the report says, the frequency of court filings is on track to match rates in 2017 and 2018 and will be well in excess of every year prior to those.

The percentage of new filings in 2020 targeting foreign-domiciled U.S.-listed companies has been nearly twice the average in recent years, with around half of these against Asia-domiciled companies. Outside the U.S., securities class actions are being filed in record numbers and the threat of facing an action has increased in many jurisdictions, as highlighted in a recent AGCS and Clyde & Co report.

New initial public offerings (IPO) dramatically increased as 2020 was coming to a close, suggesting the potential for a wave of new IPO-related securities litigation. Approximately 20% of U.S. IPOs launched between 2009 and 2018 gave rise to securities class action suits within four years of the offering.

Shareholders have filed the first class action lawsuits directly related to COVID-19. These include suits against cruise ship lines that suffered COVID-19 outbreaks, as well as litigation regarding the business impact of the pandemic on companies’ financial performance or operations and misrepresentations about coronavirus-related therapies.

Another threat looming on the horizon comes from the return-to-office steps taken by businesses. “Such decisions are fraught with peril, with regard to shareholder derivative actions, but also in relation to other forms of litigation stemming from employees or customers,” warns Williams.

The report adds that companies that are slower to recover from the pandemic compared to their competitors could face litigation from shareholders and consumers claiming underperformance.

ESG and Private Company Issues

Beyond financial performance and shareholder value, so-called “soft” management topics are increasingly triggering what is known as “event-driven litigation” against boards: diversity, climate change or ESG concerns are increasingly seen as opportunities to bring class actions or to force settlements.

For example, Oracle, Facebook and Qualcomm are among the technology companies that have been subjected to diversity derivative lawsuits. In such cases, shareholders typically allege that directors violated their fiduciary duties by their inaction on diversity issues including remuneration or nomination of new black board directors.

While the financial impact of such lawsuits remains to be seen, there will be legal defense costs involved in their settlement and this growing threat may further drive U.S. securities class actions, warn the authors.

Also in the area of ESG, climate change, water management, biodiversity degradation, exploitation in supply chains and corporate governance are some of the topics companies and boards will be expected to focus on in 2021 with regards to disclosure and internal risk management, according to the report.

Corporates – particularly in Europe – and boards are increasingly being challenged by investors and stakeholders with climate change concerns and allegations that companies have failed to adjust business practices in line with changing climate conditions.

“Current and future D&O underwriters need to be aware of ongoing global ESG matters – from activist investor campaigns to social justice protests or money laundering schemes – in order to adequately assess potential perils,” notes Joana Moniz, global head of Commercial Financial Lines at AGCS, in the report. “Ultimately, underwriters must assess how these matters may develop into a litigation trend and/ or impact a company’s risk management practices.”

While publicly-listed companies are generally more highly exposed to D&O risks, the situation of private companies also is aggravating and, the report contends, often understated.

While the majority of private company lawsuits are employee-related matters, a private company’s officers can also be sued over the sale of a company, anti-trust claims or regulatory actions, including securities regulations for alleged misrepresentations to prospective investors and others.

The report further notes that the COVID-19 pandemic is currently placing private companies and their executives under considerably higher litigation risk. D&Os of privately-held companies are typically closely involved in business decisions, which can become even more challenging than usual in a crisis environment such as COVID-19. The business decisions will also have a long-term impact on these organizations, according to the report.

Source: Directors and Officers Insurance Insights 2021

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