Courts to play crucial role as D&O insurers brace for pandemic claims storm

When Covid-19 has been defeated and the world returns to a new version of normality, there will be recriminations for companies and senior executives that were ill prepared or responded poorly to the crisis. For management liability insurers, the resulting claims will run into the millions.

“London underwriters that write directors’ and officers’ [D&O] risks were already grappling with a record year of class action securities claims and now they face the biggest event-driven loss they have ever seen,” Oliver Wheeler, D&O practice leader at Aon, says.

There are several ways in which boards may find themselves on the hook for their handling of the crisis, from failing to put adequate business continuity planning in place to endangering lives or hurting the pockets of investors. The scale of losses facing insurers is, as yet, unknowable.

There have already been a handful of class action suits launched against boards as a direct result of Covid-19. Among them, cruise line Celebrity Cruises faces a class action for allegedly failing to protect its crew from the virus, while pharmaceutical company Inovio is being sued by shareholders for misleading them over its ability to develop a vaccine.

D&O policies may pay out for reputational or crisis management and possibly a raft of the third-party liability claims that seem inevitable, given the high number of contracts that will be breached due to the economic shutdown. Remote working may also expose boards to cyber security and fraud-related claims if they have not put adequate controls and procedures in place.

The biggest threat to the insurance industry, however, is from shareholder derivative actions as a result of poor financial performance and the raft of company insolvencies that lies ahead.

“Typically, stock market losses can lead to a wave of D&O claims, so we expect more to come,” Nicky Stokes, head of management liability and financial institutions at New Dawn Risk, says. Claims are already coming through in the worst-affected industries such as cruise, aviation and retail, she adds.

Lawyers are also issuing warnings. “Given the inevitable bankruptcies and cashflow issues that public and private companies will face, Side-A D&O insurers should be on high alert,” Kennedys partner John Bruce says in a recent blog post.

Last resort

Side-A D&O insurance is a last-resort coverage that protects directors against non-indemnifiable losses; in other words, it covers directors when their company will not or cannot foot the bill. Given many companies may no longer have the means to indemnify their directors, insurers may be exposed to more Side-A risk than they may have knowingly agreed to.

This comes at a time when D&O books are already under pressure from social inflation and rising claim volumes. Last year saw a record 428 class action filings – up 13% on 2018 – while damages payouts continue to rise, forcing drastic hardening of D&O coverages.

“Insurers’ concerns over the impact of Covid-19-related claims across their entire portfolios are fuelling an increasingly difficult D&O market, which has already seen significant rate rises over the past few years,” Tracy-Lee Kus, managing director of financial and professional services at Aon, says.

Even before the crisis, it was difficult for insureds to obtain sufficient limits for C-side coverage, which protects companies, as well as directors, in the event of a drop in share price or class action. “Covid-19 will only add to that situation,” Kus says.

According to Wheeler, clients are being asked to take higher retentions than he has seen before, and there has been a significant reduction in limits and capacity. But insurers may have little choice but to cut capacity and hike prices even further at the next renewal for heavily exposed sectors such as airlines, restaurants, events, tourism and leisure.

Indeed, John Orr, director of financial, executive and professional risks at Willis Towers Watson, believes there will be some “challenging” renewals ahead, with insurers already sharpening their focus on the pandemic impact, plans and disclosures, as well as company liquidity and industry sector.

“For some companies, insurers may attempt to modify terms that were, several weeks back, formally or informally quoted or conveyed,” Orr warns, while Wheeler reports underwriters are reviewing coverage terms “almost weekly”.

“At least one insurer has ceased to consider new business while it reviews its book and its longer-term strategy,” John Lea, head of management liability at Lockton, says.

Lea says he is advising clients to bind cover layer by layer as terms are confirmed to lock in quotes as soon as possible.

D&O buyers must now contend with questionnaires grilling them on a range of factors including their exposure to and preparedness for Covid-19 and how they are communicating with employees. “In the event the questions are not addressed to the satisfaction of D&O insurers, we are seeing Covid-19 exclusions imposed on renewals,” Lea says.

Employment practices

In addition to D&O, employment practices liability (EPL) coverage – more popular with businesses in the US than the UK – may also be triggered by the pandemic. “The impact of Covid-19 on EPL lines is still uncertain,” Stokes says, although she raises several potential areas of exposure for insureds and their insurers.

“Any perceived lack of or delay in responding to the outbreak could result in reputational harm to businesses. There is also the question of employee wellbeing under occupational health and safety regulations. Are those who are still going to work – in supermarkets, for example – doing so in a safe environment?” she says.

Management may also be exposed to risks related to the way they have handled putting staff on furlough, laying them off or reducing salaries and working hours. This could include allegations of discrimination if certain teams have been treated differently from others, as well as privacy infringement claims if employees have been quizzed over their personal health.

“There is also the threat of actions from employees who lost their jobs at the outset of the outbreak, before government backstop measures were introduced,” Stokes adds.

“Suppliers and creditors are also going to be affected. It’s likely we’ll see a number of speculative and opportunistic claims, especially in the more litigious environments. Although these may not succeed, the costs incurred in defending these claims have the potential to be substantial.”

With management liability insurers set to field claims from all angles, and loss adjusters having to handle claims remotely, the claims process could be subject to delays. Insureds will also be holding their breath to see if underwriters use exclusions to limit their exposure.

While few, if any, D&O policies would have had a specific pandemic exclusion before the crisis, some standard exclusions such as bodily injury, property and errors and omissions could, in specific situations, become points of contention. However, these are usually narrowly drafted and their interpretation during the unique situation posed by Covid-19 will be for the courts to decide.

Industry consensus, so far, appears to be that D&O policies will most likely respond. As D&O cover, typically, has broad triggers that do not expressly address pandemic perils but may nevertheless respond to them, insurers may face a significant “silent Covid-19” exposure, Orr says.

Management liability

Management liability best practices will need to be amended and preparedness for “black swan” events such as Covid-19 will be of greater importance to underwriting decisions. It will be up to insureds and their brokers to demonstrate they are doing all they can to limit risk and to ensure robust crisis management, communication and investor relations plans are in place.

Brokers will also have to fight tooth and nail to ensure their clients continue to have access to adequate, affordable cover with fair wordings. “The longer this crisis goes on and the more difficult it becomes for underwriters, the more they will attempt to put exclusions into policies. It is, of course, difficult for insurers to take on what is almost an unknown event, but our job is to fight those exclusions on behalf of clients or at least amend them to ensure they are appropriate,” Kus says.

One big unknown is the extent to which management will be deemed liable for the impacts of Covid-19 by the courts, given the unprecedented nature of the crisis facing the economy and the fact very few disaster plans have, to date, focused on a pandemic as a major threat.

“We have not seen a pandemic on this scale for more than a century. This raises a question of how mismanagement is defined,” Stokes says, arguing even the most profitable and cautious companies cannot completely avoid being affected by the Covid-19 lockdown.

“They may have prepared for two or three months with no trading but is it realistic or reasonable to expect them to have anticipated that set of circumstances to endure for an unknown period of time? These decisions will play out in the courts and the industry will be watching developments with interest.”

The extent to which blame is laid at the door of company directors will not only have a huge financial impact on the companies in question, but also determine the scale of losses facing insurers.

In the meantime, management liability insurance rates will continue to rise and, in this time of great uncertainty, the coverage these policies provide may never have been more valuable.