The issue of personal liability protection for directors has been steadily climbing up boardroom agendas over the last year. It even made the front page of the Financial Times in February 2021 under the heading ‘Cost of liability insurance for directors soars.’ And it is certainly the case that the directors’ and officers’(D&O) liability insurance market has hardened to a point at which a few companies in certain industry sectors are unable to renew their D&O programmes at any price, while many others are experiencing price increases steep enough to call into question the value of the product. There are a variety of reasons for this, but perhaps the most significant is that the insurance market had for many years not adequately reflected in its pricing its true exposure to losses from a large number of claims and regulatory investigations, which were slow to crystallise.
As Churchill once put it: ‘Never let a good crisis go to waste.’ We think this is once in a decade opportunity to re-think and if necessary, re-set priorities regarding personal liability protection at the board level. And with premiums running into millions of pounds for many larger companies and directors understandably regarding this as a non-discretionary spend, you can be confident you will have the board’s attention on this issue. We think there are four separate areas that merit scrutiny.
Firstly, ask yourself: how well do we understand the relationship between this class of insurance and other means of protecting directors from personal liability – principally but not exclusively company indemnities - and what balance of these means and measures work best for our company and its directors. Our combined experience of the last 12 months has been that the connection between the strength of a company’s commitment to indemnify its directors and the insurance has never been more important. There are restrictions on what companies can indemnify directors for under UK companies law (in a nutshell, liabilities of directors to the company cannot be covered; and if defence costs of claims/investigations against directors are funded by the company, repayment is required by the director if he/she is not exonerated except in relation to third party civil action or regulatory matters). Subject to those restrictions, approaches vary significantly as to the extent to which companies will indemnify their D&Os. But here is the critical point: the vast majority of D&O policies operate on the basis either that the company must bear some (known as a ‘Side B’ retention) or all (if cover is only bought for the benefit of individuals) of the loss to the extent it is legally indemnifiable by the company. Quite what the company must bear depends on what kind of cover is purchased and on what terms have been negotiated. It is important to have that in mind to avoid unexpected surprises when designing the company’s approach to insurance and corporate indemnities.
Secondly, how well does the board itself understand what the insurance protection actually provides, how it works, what it covers and importantly, what it does not cover? There is certainly anecdotal evidence to suggest that board members do not know the answers to such basic but important questions as what happens to the D&O policy if the company became insolvent or what happens to their protection when they leave the company. We think this matters and that unless there is a stronger connection between the product and its intended end-users, there is the very real risk of serious expectation gaps or, worse, gaps in the protection itself emerging in the event of the claim. With appropriate professional input, this is relatively easy to achieve through a practical workshop or training module.
Thirdly, plan and prepare carefully with your professional advisers for your engagement with the insurance market. Our experience has been that provided companies have a credible story to tell both in terms of solvency and business strategy over the next 12 to 24 months, that they know clearly what it is they want, and they are prepared to invest the time and effort necessary to engage with insurers at appropriately senior levels (on both sides), acceptable terms can be obtained in the market even for companies operating in so-called distressed sectors. The key here is allowing enough preparation time. Whereas 2- 3 months used to be the norm, now we would advise 6- 9 months lead time for the larger programmes. This should allow adequate opportunity to put in place and/or adjust other means of personal liability protection for directors if and to the extent the insurance market cannot deliver the whole answer (as to which see the fourth point below). As part of preparing to go to market, it is important to understand the evolving risk faced by the D&Os in your business. These risks continue to develop due to new regulation and technological, societal, regulatory and environmental change. In parallel, the legal landscape is developing with trends in certain types of claims, including regulatory action and shareholder actions. Particular areas of focus for regulators and shareholders alike may include operational resilience, environmental, social and governance issues (known as ESG) and non-financial misconduct (including behaviour such as bullying, harassment, sexual misconduct and discrimination). This will vary from business to business, and if you do not know the current risk, you will not be able to gauge the impact of coverage changes proposed by insurers (e.g. reducing regulatory cover to imposing cyber or securities exclusions).
Fourthly, consider what supplements or alternatives there may be to traditional D&O insurance structures if it transpires that the insurance market cannot deliver the whole answer. These options may range from restructuring the programme to buy Side A cover only, setting up captives to provide insurance cover for the company within the programme (or to provide reinsurance cover for external market fronting insurers), or setting up offshore protected cell companies or offshore trusts. Similar challenges arise in each case, including capitalising these vehicles, complying with company law restrictions on indemnifying directors, ensuring that the assets are ring-fenced in the event the company goes insolvent and ensuring that claims payment decisions cannot be influenced by the company. Getting this right legally will be key to ensure that any protection is fit for purpose.
McGill and Partners
The expert Financial Lines team at McGill and Partners provides market-defining solutions for risks across Financial Institutions, Directors & Officers, Professional Indemnity, Cyber, and Mergers and Acquisitions. It works with a broad range of clients including Banks, Insurance Companies, Investment managers, Fintech, Hedge funds, and Law firms. If you have any questions about this webinar, or would like to get in touch with the Financial Lines team at McGill and Partners, please email firstname.lastname@example.org.
Herbert Smith Freehills
The market-leading Insurance Team at Herbert Smith Freehills has a proven track record assisting policyholders on all classes of policy advising on coverage, claims project management and claims advocacy. Our approach is to work collaboratively with our clients and their brokers to achieve the best available outcome. If you have any questions about this webinar or would like to discuss how the HSF team may be able to assist you, please email email@example.com.