The full extent of the regulatory risk facing C-suite executives was laid bare in a report published by Gallagher earlier this week, which highlighted the operational, legal and administrative burdens these risks can incur. Citing statistics from the UK Centre for Policy Studies, the research noted that annual net regulatory costs for businesses have increased by £6 billion while executives look to manage and mitigate these costs in the context of a fast-evolving business environment.
Considering the capacity of regulatory risk to restrict a company’s ability to conduct business, how aware are directors and officers of the risks they face – and what is the role of the broker in helping to manage their exposures?
Sharing his perspective as someone who joined the broking market after some 15 years working with Chubb and AIG, Steve Bear (pictured) said it’s an “eye-opener” to see how many clients don’t necessarily understand the fundamental building blocks of D&O. Now almost five years into his role as executive director of financial & professional risks at Gallagher, he highlighted that across the full spectrum of clients his team supports, there are executives who don’t fully understand the D&O cover they’re buying or, and more worryingly, the full extent of their own exposures.
“It's not just the more nuanced aspects of this that are being missed, it’s also the simple ‘D&O 101’ things - like understanding that if you’re a director of a company, your liability is not limited,” he said. “I’ve met clients that don’t necessarily grasp that, which is why I think it’s so important to have these discussions and to put in place the right education about this risk and how it can be managed.”
In terms of what he’s hearing is keeping D&O insurance clients awake at night, Bear noted that financial pressures have long been the “cornerstone” of D&O claims, as the vast majority of these tend to find their roots in some form of a financial loss. Whether it’s a lender who hasn’t been repaid, a customer who hasn’t seen contracted through to completion, or a shareholder who has taken a hit due to a drop in share price, there’s often a strong financial component to these claims.
In addition, there is a trend away from strictly financial-led claims and the growing focus on business activities, as shaped by the regulatory lens that sits around them. “We increasingly see underwriters really looking at wider ESG factors – in fact, drop the ‘G’ because good governance has always been highly important. It’s the ‘E’ and the ‘S’ that clients are actually more concerned about now,” Bear said.
Gallagher’s report into ‘Navigating Regulatory Risk’ revealed that 62% of senior leaders at large UK businesses are concerned that their ESG targets put them at risk of litigation. Meanwhile, 72% admitted they felt pressure to set these targets without a concrete game plan of how to achieve them and 54% believe legal action over missed ESG targets is far more likely now than a decade ago.
It’s unsurprising that environmental risks have risen to the fore, he said, as climate events and climate change have been front-page news, attracting the attention of media, government and investors alike for some time now. However, he is seeing that it’s actually the social factors that are proving the most difficult for D&O clients to wrap their heads around because the exposure is poorly defined and, as a result, can seem quite limitless. “As an example, it’s hard to grasp that you are responsible for your entire supply chain when you’re manufacturing goods and you have a duty to make sure every component part is sourced from a good supplier who has maintained good working practices.
“Then there’s also the level of social outrage – fuelled by social media – that can follow any kind of bad corporate behaviour or even just unfortunate corporate events. The reality is that companies can and do go bankrupt. Competition dictates that in a free and open economy, not every company will succeed. But there’s outrage over a company failing while directors are well paid, or over the government not stepping in to rescue jobs. Ultimately, the buck stops somewhere and it’s normally at the boardroom door.”
Once upon a time, taking up a few NED positions was the logical next step for executives reaching retirement age and looking to keep their hand in the corporate world. “In times past, it was quite a cushy little number but now, regulators are cutting their teeth and looking beyond the main exec board to establish checks and balances among these NEDs who are supposed to be independent and call out when something is too risky, or the business practice isn’t sitting right,” Bear said.
Adding commentary to Gallagher’s recent report, Bear noted that increased regulation poses a ‘double-edged sword’ for D&O insurers. While it’s easy to assume that more regulation means more D&O claims, he said, without a codified set of rules to follow, “companies and their directors are left to their own devices and best endeavours, which creates a lot of uncertainty.” Certainly, he said, his team are seeing that the purchasing decisions around D&O insurance are being driven as much by NEDs as the main board.
“We’ve had clients phoning up to say they’ve had some investment and they’re putting a new NED on the board who’s asking they buy D&O cover, and they want a quote,” he said. “It’s understandable that NEDs are increasingly concerned about their exposure but the main board is likely to be the first target which may use up most of the limit leaving non-execs having to fund their own defence.
“And it’s normally after the main board has been investigated that the regulators or the claimant will move onto how the NEDs didn’t stop the main board from making a mess of things. And when bringing a claim against them, often there’s very little limit left.”
