Five D&O risks to watch for in 2021

The claims landscape for Directors & Officers insurance is shifting. The cost of claims is rising, driven primarily by a combination of an increase in bribery and corruption investigations, US securities litigation against foreign-domiciled firms reaching an all-time high, and greater number of regulatory investigations.

In the last decade or so defence costs have doubled – total claim pay-outs of $10m to $15m for defence costs are now not uncommon. These trends will continue into 2021 but in addition, we have identified five D&O risks to watch in the coming year from our new special report - Board Directors’ Guide to D&O Liability Insurance - produced by Board Agenda in partnership with AIG.

Insolvency claims

As the near-term economic and political outlook grows ever more uncertain, D&O liabilities linked to company insolvency are likely to increase.

D&O claims resulting from insolvency – traditionally one of the biggest sources of losses by frequency – typically rise in times of economic uncertainty. Even before the pandemic, insolvency rates had been increasing in Western Europe and North America due to slowing global trade, political threats such as Brexit and trade wars between the US and China.

A number of sectors – including automotive and retail – are also under pressure from technology disruption, changing consumer behaviour, climate change concerns and competition. When companies fail, questions are asked about the actions and decisions of directors. Recent high-profile insolvencies have seen directors come under scrutiny from regulators, while directors are aggressively targeted by administrators and creditors seeking to recoup losses.

Even before the pandemic, insolvency rates had been increasing in Western Europe and North America due to slowing global trade, political threats such as Brexit and trade wars between the US and China

Cyber incidents

Cyber incidents and data breaches have already triggered D&O claims in the US where investors have pursued directors in a bid to recoup losses following a cyber incident, such as a data breach or service outage. As data and IT infrastructure becomes even more vital, and cyber and privacy liability increases, investigations and lawsuits are likely to increase.

Typically, directors can face shareholder class actions (there was a notable increase in US cyber class actions in 2019, according to NERA) following a cyber incident and where they are thought to have failed in their duty to manage the risk, such as ensure proper security controls or backups were in place and up to date. There have also been a number of cases where companies and directors have been sued for their failure to disclose cyber risks, such as GDPR exposures. So-called "fake president and CEO impersonation fraud" is another related threat that has led to D&O claims, whereby employees and executives have been tricked into transferring funds to criminals’ accounts.

Climate change and environmental claims

Environmental issues are behind a number of D&O claims, a trend that is likely to accelerate.

Interest in climate change risk is rising, from investors, regulators and various interested parties, and directors will be increasingly expected to have considered climate and other environment-related risks and taken steps to mitigate them. There have already been a number of cases in the US where claimants have sought damages from energy companies accused of contributing to global warming, while environmental disasters, including mining dam failures in Brazil and wildfires in California, have resulted in large D&O claims.

Investors may also seek compensation for a company’s failure to adapt to climate change or to adequately disclose environmental risks. Activist groups in the UK and Australia have already filed complaints against financial services firms alleging they had failed to comply with climate change reporting requirements. In 2019, the UK’s Prudential Regulation Authority applied new rules that require certain financial services firms to nominate a senior manager responsible for identifying and managing financial risks from climate change.

Allegations of sexual misconduct, bullying and discrimination have led to a spike in the number of employment practices liability claims in the US

#MeToo and societal risks

With increased personal accountability, changing attitudes and the rise of social media, directors are increasingly exposed to claims related to employment related risks, ethics and culture.

Directors may face prosecution or civil litigation where they fail in their duty of care to employees or where they preside over a toxic corporate culture that permits abuses. Allegations of sexual misconduct, bullying and discrimination have led to a spike in the number of employment practices liability claims in the US, while a number of derivative class actions have been filed against boards of corporations that have allegedly turned a blind eye to misconduct or inappropriate workplace relationships.

The potential for employment liability-related D&O claims is not limited to the US. In France, for example, a group of former senior executives at a major telecommunications company went on trial in 2019 accused of "moral harassment", after a wave of suicides following company restructuring and job cuts in 2006. In the UK, the introduction of gender pay gap reporting creates a potential liability for directors that fail to take action to address any disparities.

Merger objection litigation

Mergers and acquisitions have become a notable source of D&O claims as plaintiff attorneys and investors use the courts to object to mergers and acquisitions or recoup associated losses.

Merger objection litigation has increased in recent years, to the point that the majority of M&A transactions involve a lawsuit, often filed within days of the deal being announced. According to Cornerstone, eight in ten mergers resulted in shareholder litigation in 2017 and 2018. Some 39% of all US federal court securities suit filings in 2019 were merger objection lawsuits, while 7% involved initial public offerings.

Plaintiff lawyers and investors are much more aggressive in pursuing claims against directors alleging they were misled by the prospectus or because they want changes in governance. Many M&A claims are “nuisance lawsuits” that are dismissed or do not result in large awards or settlements. However, they are relatively expensive to defend and D&O insurers often foot the bill for what has been described as this “tax” on M&A transactions.

Against this backdrop of new and evolving threats, as well as the on-going shift in the cost and availability of cover, board engagement with D&O risk and insurance has never been so important. Directors need to stay informed of the risks that lead to claims, and work with their risk managers and brokers to understand the scope of D&O cover and how they should respond in the event of a claim.

By Chris Magee, Head of Commercial D&O

This article first appeared in Insurance Day.