A new report from the Institute of Directors (IoD) and insurer Marsh NZ has found that the country’s insurers will avoid covering company liabilities if the directors do know the ins and outs of their businesses, especially emerging risks.
The report identified social disruption, climate change, and environmental, social, and governance (ESG) as emerging risks that leaders need to be on top of this year.
The potential impacts of these emerging risks and the likely severity of their consequences should drive a new level of inquiry by each director and officer, the report said. Key drivers of claims include allegations of wrongful acts by directors or officers, and as such having a deeper understanding of their causes as well as their likely consequences is essential.
According to a summation of the report, insurers were putting directors through their paces when assessing them for liability insurance, also known as the directors and officers (D&O) insurance. An increased emphasis on the risk profile of directors, officers, and overall governance of the respective entities were of higher note to insurers.
"There is more focus on these things,” said Guy Beatson, IoD governance leadership centre general manager. "Insurers are asking harder questions and if the insurers aren't getting good answers in terms of that good practice governance and all those dimensions, they will either refuse cover in some cases, or they'll narrow the scope of their cover or raise the price.”
According to Beatson, there is a good incentive for directors across all sorts of entities that have this sort of cover to “pay really strong attention to that culture, conduct, ESG, business continuity, risk management and all of those aspects of good governance."
Beatson noted his surprise at the tougher stance that insurers are taking, especially the sector’s efforts to promote good governance among directors. "I thought that when you look at some of this insurance, it would create a range of what economists call moral hazard – that is, people just getting the insurance and basically doing what they needed to do,” he said.
Insurers asking these questions means that they are doing part of the reinforcement of good practice governance that is welcome to see, Beatson said.
A 2022/23 report from the IoD tackling director’s fees found that 89.5% of organisations provided directors with liability insurance. Beatson said that as these directors start facing new and changing challenges, risks, legislation, and stakeholder expectations, the percentage of organisations with D&O insurance will increase. A corresponding decrease in percentage of directors wary of taking on governance roles due to increased personal liability was also noted.
The report also mentioned that the insurance market would be impacted by the incoming economic downturn. With emerging risks also identified, a surge of D&O claims was expected as the economy worsened. The biggest claims, Beatson said, would be around liquidations and receiverships, with liquidators often seeking compensation from directors they believed had breached their duties.
"But there are other things that occur through this, what we've seen through COVID is people being more litigious, in some sense, in various ways,” Beatson said. "You could see people looking to the performance of directors, say if their share price were to go down, there's something called Side C cover that's referenced in the document, as well as people thinking that the duties were breached, perhaps in terms of commitments made around climate change, for example, which is some some of the stuff that's happening overseas and to a lesser extent, in New Zealand."
A study conducted by Marsh UK between 2005 and 2015 found increased D&O claims by 75% during the global financial crisis, with the figure peaking in 2012. The study also recorded a steady increase over a two-year period (between 2005 and 2007). During that timeline, the average number of claims rose from 200 to 300. In 2012, a total of 1,685 claims were recorded.
"Directors should understand what their duties are, understand the difference that they make in terms of having good practice governance for the performance of their organisations and look at it through the positive lens and see the directors and officers insurance is a backstop, rather than trying to just mitigate risk,” Beatson said.
He also noted that directors need to “pay much, much more attention,” especially to the changing risk landscape for companies, including identifying these risks and successfully managing them. D&O cover would be critical as leaders start to face greater liabilities for decisions made at the table.
Marsh NZ commercial head Megan Warner recently spoke to Insurance Business about how the industry and workplace awareness have changed over the years, especially in terms of gender parity and diversity.
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