What Now? Addressing a Crisis of Complexity Resulting from a Hardening D&O Insurance Market

A decade of increasing competition among insurers for business resulted in a “race to the bottom” pricing model and dramatically expanded terms and conditions for director and officer (D&O) liability insurance. Now, the once soft market has swung in the other direction. The past several quarters have involved double-digit rate hikes and increased retentions as a result of ever-broadening exposures within the space, an overall increase in the number of D&O claims, a decrease in the supply of insurers providing coverage, and recent record-breaking settlements within the space.¹

D&O insurance – a close cousin of professional indemnity insurance (called Errors and Omissions, or E&O insurance) – is specialty insurance that protects directors and offers from liability arising from erroneous acts and omissions committed in their capacities as directors and officers. It protects not only the company itself, but also its directors and officers from personal liability.

The following exposures have been the largest contributors to this recent market shift:

• Securities: For the third consecutive year, more than 400 securities class actions were filed with the federal courts. This represents the highest number of recorded lawsuits since the passage of the Private Securities Litigation Reform Act (PSLRA) in 1995.²  Of particular note, the #MeToo movement has opened a new frontier for shareholder derivative lawsuits against companies relating to sexual misconduct allegations and allegations of widespread toxic cultures. For instance, allegations against directors and officers at CBS Corporation, Lululemon Athletica, Nike, and Google parent Alphabet Inc., have impacted overall stock prices at those companies.³ The average settlement amount for securities class actions settled in 2019 was $12.8 million.⁴

• Cyber: Cyber risks are at an all-time high as more regulators are levying fines and sanctions against companies that fail to comply with the latest privacy regulations. For example, the 2018 California Consumer Practice Act (CCPA) created new consumer rights relating to access to, deletion of, and sharing of personal information collected by businesses.⁵ More requirements became effective on January 1, 2020, with enforcement actions by the attorney general beginning July 1, 2020. Penalties for failing to cure deficiencies after a 30-day notice will result in fines of $2,500 for “unintentional” violations and $7,500 for “intentional” violations.⁶

Moreover, some companies have already entered into record-breaking settlements in response to private class actions filed by consumers. For instance, on January 29, 2020, Facebook announced in its Form 10-K that it agreed to pay a record-breaking $550 million to settle a biometric data privacy class action lawsuit in connection with the company’s use of facial recognition software.⁷

• Antitrust: There also is an increasing number of civil actions seeking to hold directors and officers personally liable for their failure to detect and prevent corporate wrongdoing arising from antitrust enforcement actions. This aligns with the U.S. Department of Justice’s increasing focus on such oversight in its antitrust enforcement guidelines, as exemplified in the 2015 Yates Memo, which discusses individual accountability for corporate wrongdoing.⁸

Each of these areas, and others, may be further impacted as the full effect of the new coronavirus (COVID-19) continues to unfold in the coming months. For example, COVID-19 may expose insureds to potential securities class actions and/or shareholder derivative lawsuits based on a company’s failure to follow the Securities and Exchange Commission’s (SEC’s) latest guidance on coronavirus-related disclosures to investors. Specifically, companies are to provide “investors with insight regarding their assessment of, and plans for addressing, material risks to their business and operations resulting from the coronavirus to the fullest extent practicable to keep investors and markets informed of material developments.”⁹ In fact, initial securities class actions have already been filed based on the insureds’ affirmative misstatements regarding sales tactics in the face of the COVID-19 crisis and/or creation of a potential COVID-19 vaccine.¹⁰ Likewise, as more individuals continue to work from home to avoid exposure to COVID-19, there are potential concerns as to the vulnerability of remote networks utilized by company employees.¹¹

In all, with increased exposures and claims under D&O policies, the question becomes: How do insurers restore profitability to the D&O segment of their underwriting businesses while addressing the new normal of insureds’ increased exposure and claims?

There is no straightforward answer. Several options, however, are being considered by professionals within the D&O space:

• Substantive Changes to Coverage: Some have recommended substantive narrowing of certain coverages depending on the needs of the particular insured. Proposals include, where permissible by state law: (1) limiting coverage for punitive, exemplary or multiple damages; (2) revisiting final adjudication and non-appealable requirements for conduct exclusions; and/or (3) deleting requirement that the insurer demonstrate prejudice in connection with late-notice denials of coverage, among others.¹² Likewise, depending on the insured, there may be smaller, sub-limited coverages that are not necessary. This is especially true for insureds with sufficient reserves to cover such costs themselves, which may include books and records demands, and internal and special litigation committee investigations.¹³

• Other Provisions: Another option to consider for restoring profitability to the D&O segment is to review other policy provisions not related to the scope of coverage, with a lens toward decreasing potential disputes about the application of such provisions. For example, one recommendation is to identify a specific jurisdiction in the choice of law provision.¹⁴

• Amount of Coverage for Directors/Officers Versus the Entity Itself: Because D&O policies provide both entity coverage and coverage to individual directors and officers, another consideration is to focus more readily on the balance of coverage. For example, having broader entity coverage may have a dilutive impact on the overall D&O policy’s limit of liability left available for individual directors and officers for any given policy period.

Regardless of which approach, or combination of approaches, insurers ultimately take in navigating their return to profitability within the D&O space, a solid first step is to initiate placement discussions with brokers early and proactively to address these issues. Likewise, though some changes may be implemented broadly across many insureds, other substantive changes to coverage may be limited to individual negotiations with insureds according to their particular needs.

Overall, only time will tell what the “new normal” in the D&O space will become. Until then, insurers and their insureds have lots to think about as they continue to navigate this new space.