ESG risks are increasing and are likely to result in a spike of claims against directors as well as drive further increases to insurance costs.
A director’s role can be a perilous one should they be faced with a lawsuit. There is the prospect of financial wipeout since personal assets are at risk, as well as someone’s reputation. Directors’ and Officers’ (D&O) insurance provides valuable protection and what is more, the sector has attracted a healthy number of insurers with cover available at competitive rates, at least until relatively recently where it was hit hard at the beginning of the current hard market in 2020/21 but with some flattening since which some brokers have commented as coming out the other side of a difficult period.
However, Mactavish believes the current situation with D&O is poised to change with rates set to further increase and with cover likely to become more restrictive based on yet more headwinds increasing perception of risk. As a result, now is a good time to review D&O cover and ensure it is fit for purpose.
ESG should be high on the board’s agenda
So, what is likely to drive an increase in claims? Environmental, Social and Governance (ESG) are to the fore, with tighter regulation and sometimes scattergun investor activism meaning more directors face being branded ‘climate criminals’ if they are sued because of alleged wrongdoing or even just inaction.
LSE research in 2022 found the number of climate change-related litigation cases has more than doubled since 2015 – there were some 800 cases filed throughout the period between 1986 and 2014, while more than 1,200 cases were filed in the last eight years alone.
Although three quarters of cases occurred in the US, numbers are rising elsewhere, including in Europe. Given the macro picture, though, we remain in the foothills of litigation potential.
Companies must also ensure their ESG commitments can be evidenced or risk being accused of greenwashing. In May 2022, BNY Mellon’s investment adviser division was fined $1.5 million for misleading statements about its ESG investment work, while in June, the group CEO of DWS stepped down after a police raid and accusations of greenwashing. A few months later in November, Goldman Sachs Asset Management agreed to pay a $4 million penalty for failing to comply with ESG policies.
In a further example, the Dutch subsidiary of Air France KLM is being sued by environmental groups, which claim the airline has misled the public about its sustainability programme.
Most recently, Shell is in the firing line as its board of 11 directors are all being sued by environmental law charity ClientEarth over the company’s climate strategy. This is a first of its kind legislation, where the board is personally being sued for alleged failures connected to climate crisis risks and not aligning these with the Paris Agreement. And with a large increase in D&O legal defence costs in recent years, with individuals sometimes each needing independent representation, the costs of defending such claims can be eye-watering.
UK focuses on ESG disclosure
The UK has tightened up its requirements in terms of disclosure requirements via amendments to the Companies Act 2006, which apply to businesses where there are over 500 employees or have turnovers in excess of £500 million. Firms with either £36 million annual turnover, £18 million balance sheet total, or 250 employees are impacted by the Streamlined Energy and Carbon Reporting, which requires disclosure on carbon and energy use. Meanwhile starting in 2023, ESG reporting in the UK will be further boosted by the Sustainable Disclosure Regime from the FCA, designed to combat greenwashing within the investment market.
More risks on the horizon
But, ESG risks are not the only influence on D&O. The UK’s ongoing economic uncertainties are also increasing directors’ exposure. The financial support that came about because of the pandemic are now a distant memory as businesses are forced to deal with high inflation, supply chain issues and for some, operational problems stemming from Brexit and political instability. Directors may put their company on a riskier course to achieve growth or even just survive. More insolvencies always mean more D&O claims.
Then there are cyber security risks and our cyber report has shown how these are spiralling – businesses are 85% more likely to be a victim of a cyber attack compared to four years ago. Whilst more businesses buy cyber insurance today, if individuals are accused of mismanagement or inadequate preparation then the focus immediately turns to D&O insurance.
In the UK, there is a further reputational element to this, as last year, the Information Commissioner’s Office began ‘naming and shaming’ businesses that had notified them of a data breach or cyber incident.
A further threat on the horizon for directors is diversity and inclusion and employment practices, with a number of changes announced for this year, including possible rushed removal of longstanding EU laws, a new duty on employers to protect against harassment and a right to request flexible working.
At Mactavish, we are also reminding clients that the quality and breadth of cover in D&O polices vary considerably. In addition, most insurers are tightening up on their policy wordings and adding in new exclusions meaning that in the event of a claim, directors are likely to face stringent checks to ensure eligibility and whether costs qualify for reimbursement.
Mactavish’s Claim Insurance Litigation Index showed that over the last 10 years, the number of insurance claims which end up being litigated in pursuit of a pay-out has tripled. A claim may be refuted if it is felt the director has overstepped the boundaries of their role, for example, or if they failed to make the notification quickly enough. Disclosure matters when taking out cover and advice should be taken to ensure that cover is as watertight as possible, as well as on the insurer’s track record in handling claims.
A swathe of litigation against directors could well be in the offing and when it comes to D&O cover, this is not the time for directors to be lulled into a false sense of security.
Hard market report 2023
The insurance market is currently going through the longest ‘hard’ phase in history, with prices spiking, cover being withdrawn and dispute rates soaring.
In this report, you will understand the market conditions and main challenges, the role of brokers in helping businesses navigate the hard market and get best practice advice to tackle a hard market.
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