Australia is second only to the USA as the most litigious jurisdiction for companies facing a securities class action. Traditionally, cover for companies’ exposures to such class actions has been included as part of insurers’ D&O products, known as ‘Side C’ cover.
But the outlook for this type of cover is now very challenging. Growth in the number and size of Side C claims is driving significant remediation in the D&O liability market.
When Side C cover was introduced in Australia in the ’90s, it was offered as a new insuring clause or extension to the D&O policy, generally at no additional premium or minimal additional premium. Then, insurers were prepared to offer large amounts of Side C capacity, encouraging companies to transfer this exposure for a competitive price.
But the proliferation of class actions here, due in no small way to the advent and success of litigation funders, has changed the landscape. Since 2010, securities class action settlements have exceeded $925m from 17 separate actions
i. The largest shareholder class action settlement to date in Australia was the Centro settlement for $200m in 2012. The average settlement of a shareholder class action is approximately $62m.
This substantial deterioration in the claims environment, particularly in the last five years, is occurring in an Australian D&O marketplace that only has a premium pool of an estimated $250m.
Despite the losses, years of global and local soft market conditions prevailed and D&O insurers have previously been unable to properly adjust their premiums to reflect the D&O risk profile of listed entities in Australia. Market analysts now suggest, on the basis of D&O loss ratios, that D&O premium rates would need to increase by 70% for D&O if target returns on capital are to be achieved
ii.
Growth in the number and size of Side C claims is driving significant remediation in the D&O liability market
And there’s more in the pipeline
The frequency of class actions persists, with 35 new class actions filed in the 2015/16 period that follow 40 class actions filed the previous year. Also, 2017 has seen a number of new filings, and, more recently, the threat of Australia’s largest shareholder class action as law firm Maurice Blackburn, in conjunction with litigation funder IMF Bentham, investigates a potential action against the Commonwealth Bank.
These new class actions send a strong signal to D&O insurers that the trend of filing a class action as a financial remedy is showing no signs of abating. Indeed, the rising number of litigation funders is creating competition between funders and lawyers and resulting in a race to file.
Even more concerning is the emerging trend where secondary actions are being launched, arising from the same or similar allegations as referenced in the original filing but from a separate class of litigants. A recent example of this is the competing class actions filed against Bellamy’s Australia by plaintiff lawyers on behalf of different classes of shareholders in the Federal Court of Australia. Central to the claims made are alleged breaches of the continuous disclosure obligations relating to lower than anticipated revenue and regulatory changes in China.
How are insurers responding?
The pressures underlying the D&O market conditions are amplified by the broader difficulties facing the insurance industry with low levels of growth and lower returns on equity than that enjoyed in previous years.
Soft market forces had contained pressures on D&O premiums for years, with insurers focusing instead on reducing their Side C capacity. The abundance of local capacity meant that this capacity management had minor impact on companies until relatively recently despite some industry consolidation.
The tide has now turned. Over the past 12 months, the major D&O insurers in Australia that have appetite for underwriting public-listed companies with Side C exposures have announced significant portfolio remediation strategies.
The most immediate effect of this was a more highly disciplined capacity management strategy, with most insurers no longer offering more than $10m of D&O limit where Side C cover was included, irrespective of size, industry sector, profi tability or wider relationship. Following recent changes to underwriting guidelines, some insurers will not offer any Side C capacity below a $50m attachment point.
Further, the major D&O insurers have now implemented more discipline and rigour to their underwriting process, and are regularly seeking substantial premium and deductible increases.
As a result, a number of larger Australian D&O risks have transferred, or are considering transferring, to international D&O marketplaces, including London. However, these marketplaces are also being cautious in underwriting Australian Side C risks, as they do not wish to replicate the untenable situation that has developed here.
What types of allegations are being claimed?
Securities class actions in Australia
iii commonly include allegations of misleading, deceptive or unconscionable conduct, breach of fiduciary duty, breach of continuous disclosure obligations and failing to disclose a material fact. Such claims also typically allege a company’s financial position/profi t guidance was misstated.
In this jurisdiction, it is only necessary for claimants to prove the company delayed the release of information to the market or that it was materially incorrect or misleading. Under ASX Listing Rules specific to the disclosure of market sensitive information, there is no requirement for the act to be deliberate or negligent for an action to be successful.
Directors face similar scrutiny where it is suspected they were knowingly involved in the company’s conduct.
What is the role of brokers?
In a hardening D&O market, brokers will need to leverage their networks and relationships to obtain the best possible outcome for their clients but it’s equally important that they have a full understanding of a company’s risk exposures as well as knowledge of stressed industry sectors and changes to insurers’ underwriting guidelines in those areas.
i King & Wood Mallesons, The Review, Class Actions in Australia 2015/2016
ii Finity Consulting/Deutsche Bank, Industry Pendulum, GI Review 2016
iii Wotton + Kearney white paper series on securities class actions and the Australian D&O market
Tanya Stevenson is an account director and Tracy Grant is NSW state manager in the FINEX team at Willis Towers Watson.
