U.K. Directors’ and Officers’ Programs Should Be Reviewed

With legal and economic risks increasing for businesses in 2009, many in the U.K. are expected to look at their insurance programs in more detail.

It’s set to be a tough year for anyone running a business. As well as the difficulties created by the economic slowdown, the introduction of more legislation will heighten the risk of legal action and financial penalties.

For those involved in insuring those risks, 2009 will bring a mixture of challenges and opportunities.

One insurer, Zurich Insurance, says that there’s going to be increased demand for directors’ and officers’ cover this year as more people think about their responsibilities. Yet after seeing prices fall, often substantially, over the last three years, there will be pressure on price as claims start to come through.

Certainly, claims are on the up. At the end of 2008, insurance research firm Advisen revised its forecast for D&O losses, taking it up to $5.9bn from the $3.6bn it had forecast in February. Its revision resulted from “the mushrooming of the credit crisis into a global financial calamity”. It also reflected an increase in securities class-action lawsuits, securities fraud lawsuits brought by regulators and law enforcement agencies, bankruptcies, and shareholder derivative lawsuits.

The number of securities lawsuit filings in the U.S. reportedly has increased sharply in the last two years. There were 119 filings in 2006, 176 in 2007 and 210 in 2008. It is widely held that the statistical average is 200, so we have moved to a position where filings are above that number. Additional concern for some insurers is that it takes three to five years for a lawsuit to reach the filing stage.

See you in court

With new legislation coming into force this year, directors have additional rules to observe. Most recently, the Health & Safety Offences Act came into force on 16 January and will increase the penalties for companies that break health and safety law.

It is not just domestic U.K. regulation that directors need to be mindful of, either. A company can also face legal action from the U.S., regardless of where it is domiciled. A prime example is the German engineering company Siemens, which paid $800m to the US Justice Department and stock market regulator, Securities and Exchange Commission, in December to settle corruption charges. This was on top of the EUR395m it had already paid to German regulators.

There has also been an increase in regulatory risk. The Financial Services Authority and the Serious Fraud Office have become more aggressive in their approach to fraud over the last 12 months. The FSA has beefed up its criminal prosecutor and enforcement teams and sent out a clear message about its intentions by carrying out a series of dawn raids to combat insider dealing.

As well as action from the regulatory bodies, it is believed that there will be more claims brought against former directors this year. There’s been a lot of change in boardrooms and as the new directors settle into their roles, it’s not inconceivable that there will be claims brought against former board members.

And there has been a steep rise in the number of firms going into liquidation, which will also result in an increase in claims. Figures from the Insolvency Service show that 4001 companies went into liquidation in the third quarter of 2008, an increase of 10.5% on the previous quarter and a rise of 26.3% on the same quarter in 2007.

It is not uncommon to see more claims being brought against directors in a recession. If a company goes out of business, people, including the administrator, look to the directors for potential redress.

Colleagues of mine in the U.K. tell me these factors are starting to influence the market, with rates hardening and terms and conditions getting tougher on some cover.

The market is also very divided, with financial institutions facing very different conditions to companies in the commercial market. Rates are reportedly hardening for financial institution business because of the problems in this sector, whether it’s the credit crunch or the alleged Madoff fraud.

The extent to which premiums are rising does vary, with sectors like hedge funds and U.S. banks hit hardest. But while recent press reports have put a figure as high as 50% on the increases, this level of premium hike is still unusual.

But while the financial market may be having a tough time, it’s pretty much business as usual for the commercial market, with the 1 January renewal date passing relatively smoothly.

Insurers are fighting for market share and there’s plenty of competition for commercial D&O business. The loss ratios are low and profits are good. That market hasn’t really been affected by what’s happening in the financial market yet, in large part driven by segments like private companies being largely unaffected.

However, this is expected to change. As many insurers have exposure to both the financial and commercial markets, the problems facing financial customers are likely to have a knock-on effect for commercial customers. No longer is pricing falling, but rather many renewals are reported flat. Some are gradually moving up and it is expected that this will accelerate.

Additionally, Clients are paying more attention to the cover they purchase. Rather than buying purely on price, directors are giving more thought to their purchase and analyzing coverage as part of a broader risk management and corporate governance approach.

With a higher level of claims anticipated, capacity could come under pressure this year. It is likely that, although there will still be plenty of cover to go round, it will not necessarily be as easy to obtain. This will require insurers to adjust their pricing strategies.

Underwriters are still basing their pricing on financial stability and other financial factors, but that this does not give sufficient insight into the business which is why risk management can become an even more critical factor. Claims and bankruptcies can come from anywhere but it is more likely to be those companies that have poor controls in place as well as those with weak balance sheets.

In spite of the greater risks present in the market, new players may also be attracted to the market over the next 12 months. With rates hardening and demand for the product. An underwriter coming into the market now wouldn’t have a history of claims and, with a good risk management strategy, could maintain a clean and profitable book of business. It could be a very good time to be writing D&O cover.

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