Litigation is on the Rise: Have You Got D&O Cover?

Just a few years back, the directors’ and officers’ (D&O) insurance space was a buyers’ market. Soft market conditions meant lower premiums, broad coverage, and plenty of insurer capacity. In the wake of the Covid pandemic, the landscape is looking quite different.

“D&O is a really tough area to underwrite because you are always having to think ahead to the next emerging risk that could face insureds,” says Kate Lyes, head of specialty lines at CFC Underwriting. “And it's not always immediately obvious.”

The unprecedented past few years proved particularly challenging for insurers and contributed to hardening market conditions. Covid-related litigation, rising environmental, social and governance (ESG) pressures, and the increasing use of financial vehicles, such as Special Purpose Acquisition Companies (SPACs), have all added to a changed risk environment.

The top 20 D&O insurance underwriters saw their direct written premiums increase in the first half of 2021, according to analysis by S&P Global Market Intelligence, with AXIS Capital Holdings recording premium growth as high as 493% on the same period the previous year.

Nowhere are D&O market changes more apparent than in the US. Its more litigious culture, even pre-pandemic, places the country at the upper end of the risk spectrum for professional lines; so much so, that US risks are often excluded by international insurance providers on global schedules. But things are changing now.

“It used to be the case that, if you were talking about D&O claims, you were almost exclusively talking about activity in the US,” says Kevin LaCroix, executive vice president at US insurance solution provider, RT Specialty. “But in the last few years, there’s been increasing numbers of very large, collective investor action lawsuits that you would have only expected to see in the US in the past.”

Perhaps unsurprisingly, the US is often seen as a bellwether for emerging trends in the D&O space. But US-style lawsuits have now rippled out to Australia, Canada, the UK, the Netherlands, and Germany. They are even occurring in countries that were previously not thought of as litigious, such as South Africa, and could be on the cards in other territories too.

“New laws have been enacted in places like Thailand and India that are similar to the US,” says LaCroix. “Procedural vehicles for aggrieved investors to use to pursue claims against company management.”

Covid has been a key driver of new exposures under D&O policies, triggering event-driven litigation, securities claims, and regulatory actions. In fact, it accounted for around 10% of securities class-action lawsuits filed in 2020 in the US, according to broker Woodruff Sawyer.

According to a paper by RT Specialty, these roughly fall into the following categories:

• Claims against companies that suffered Covid outbreaks on their premises, such as private prisons, cruise liners, and companies in the meat-packing industry.

• Claims against companies that reaped financial benefits from the pandemic, such as vaccine development and diagnostic testing companies, as well as video conferencing and virtual education platforms.

• Claims against companies that overpromised to investors when they saw sales hike early in the pandemic, later to under-deliver in the medium-term — companies such as fitness bike manufacturer, Peleton.

RT Specialty also cites a fourth category — one for which the full extent remains unclear and potentially undiscovered. Knock-on exposures from Covid, such as supply chain disruptions, labour shortages, and inflation, as well as other pandemic-related economic ramifications.

A few companies have already fallen foul of this latter category already. ATI Physical Therapy was sued in 2021 for problems including labour shortages and operational disruptions. Romeo Power was also faced with a lawsuit in 2021 when supply chain issues stalled the import of high-quality battery cells, triggering investors to accuse the company of having misled them over its operational resilience.

The increasing use of SPACs — often called “blank check” shell companies created to float on the stock market, with a view to later acquiring a privately-owned company so the latter can circumvent traditional initial public offering (IPO) processes — are also bringing about new challenges for D&O underwriters on a scale yet unknown.

“Over 2020 and 2021, there were almost 900 SPAC IPOs in the United States,” says LaCroix. “In a litigious society you aren’t going to get that much financial activity concentrated in one area and not also have litigation.”

According to LaCroix, the rise in SPAC IPOs is attributable to the perception of the process as more straightforward, faster, less costly, and involving less legal and regulatory process than a traditional IPO.

There’s also some evidence in recent months that the target companies’ owners have benefitted from higher valuations in the private market – making it attractive for both the SPAC sponsors and the targets.

While litigation overall was down in the US in 2021, SPAC-related litigation rose substantially. Once again, this is likely to ripple out to the rest of the world.

“Securities regulators in a number of countries, specifically Singapore and Germany, have authorized SPACs in their countries,” continues LaCroix. “So, what had been just a US phenomenon, could now spread to other countries.”

ESG rises

Scrutiny on diversity at board level has also ramped-up in the past few years, particularly since the Black Lives Matter (BLM) movement captured global attention in 2020. Allegations of “idleness” have been directed at some Fortune 500 companies for failing to address the matter, according to Lyes.

High-profile derivative lawsuits were brought against Facebook, Oracle, and Gap in 2020 — to name a few — alleging shortcomings in board diversity. Though these claims were ultimately unsuccessful, Eric Scheiner, partner at Kennedy’s Law in Chicago, says that may not be the point.

“It makes one question the true motivation for bringing [the lawsuits],” he says. “Was it actually to get damages, or rather to highlight that companies sometimes make representations about board diversity and don’t always follow through on them?”

According to Kennedy’s Law, using shareholder derivative action to steer social change is nothing new. More unique is intervention by stock exchange groups to get behind the change.

In 2021, the Nasdaq introduced new rules around diversity listing standards, mandating that all companies must have at least one diverse director within two years, with higher requirements for larger companies. The stock exchange both formulated the requirement and provided services to Nasdaq-listed companies to help them recruit qualified board members.

This, along with increasing transparency requirements, has proved largely effective in kickstarting progress in the States, contributing to “relatively rapid change in board composition in America” according to LaCroix.

Though not yet seen at the same scale in other countries, the high-profile nature of the US cases has brought diversity and inclusion onto the board agendas of companies across the globe.

“Claims that come out of the US have a knock-on effect on the rest of the world,” adds Lyes. “If it starts off in the US, it’s undoubtedly going to end up going elsewhere as well. So, we are now seeing companies being far more proactive than they would have been in the past.”

As for the coming months, industry practitioners believe that the influx of new players —enticed by healthy premiums and high demand — could lead to a greater availability of capacity, particularly at the excess level.

But some risks will not be going away any time soon, according to LaCroix.

“I think we will see a lot of new litigation in the US in relation to SPAC IPOs and their targets in the coming year,” he says; as well as “exogenous factors such as the Ukraine war, supply chain issues and inflation, could affect underwriting and pricing by adding uncertainty to the market."