Introduction: a slide into unprofitability For well over a decade, D&O was a highly competitive market, with a significant number of carriers looking to grow portfolios rapidly and regular new entrants, attracted by the historical profitability of the segment. This resulted in year on year premium decreases, significant deployment of capacity and broad coverage as insurers competed for market share.
However, since 2015 the number of claims against large international companies has increased significantly – a trend that is by no means limited to US domiciled companies. At the same time, there has been a significant increase in investigation and defence costs, as well as a rising frequency and severity of settlements. Combined with the consistent prolonged decline in rates, this has meant that the Combined Ratios of insurers has started to rise, and for some, significantly - above 100%. Our understanding is that the negative development of prior year figures, dramatically rising over this period, has put a sharp focus on the long-term profitability and sustainability of D&O portfolios for many insurers.
Capacity constricts and rating increases Like other industrial sectors, the commentary around digitisation is extensive and highly persuasive. However, there is little discussion around the potential risks that may arise out of this evolution. Through regular risk surveys over the past 5 to 10 years, Willis Towers Watson engineers have observed changes to the power station assets where the companies have invested in digital infrastructure. But have the benefits of a more efficient and safer operating environment started to emerge?
The COVID-19 impact on D&O The hardening market conditions seen in the second half of 2019 and Q1 2020 have been further compounded by COVID-19. The fear of a systemic impact across already ailing D&O portfolios now appears to be driving even steeper increases in rate and a corresponding reduction in - or in some cases removal of - capacity. Risks associated with Directors and Officers liability are among the many risks that are at the forefront of underwriters’ minds. In the context of this pandemic, these may include:
So far, the major D&O underwriting areas of focus have been on company liquidity and the industry-specific impact of the virus. In many instances, insurers are seeking extensive information on COVID-19-related risk disclosures, the impact on financial results, operations, product/services shortages, industry-wide concerns, liquidity/solvency and cyber security.
A focus on mining Many insurers have made public statements around their commitment to including ESG metrics in their investment decisions; for some, this commitment has now extended to incorporating similar metrics into their underwriting guidelines. While insurer approaches differ, we have started to see declinatures on certain industry programmes (including mining), purely on the basis of these insurers’ internal ESG guidelines. According to the NERA’s report on recent Trends in (US) Securities Class Action Litigation: 2019 Full-Year Review, “Cases involving allegations related to the environment have remained low, representing less than 5% of filings in each of the past five years”.1 Despite the slow uptick in the US SCAs filed in Federal court, we believe that environmental risk will become more relevant to underwriting D&O risks for mining companies.
Tailings concerns The relatively recent tailings dam disasters continue to be of significant concern and focus for underwriters, with D&O insurers seeking additional information and/or imposing additional limitations including a significant increase in the self-insured retention payable in the event of a tailing’s incident - or even blanket exclusions of cover in respect of tailings operations.
KYC/due diligence concerns In addition to broad exclusions for Pollution and Bodily Injury & Property Damage experienced by the mining sector in recent years, we are now also seeing insurers apply Payments and Gratuities exclusions or again imposing significantly higher retentions for these types of claims. Insurers are keen to know more about companies’ Anti Bribery and Corruption policies and understand the robustness of their KYC/due diligence procedures, with a focus on centralised contract management and their extent of dealings with government. If a mining company has any legacy issues relating these matters, we recommend instigating transparent conversations with insurers to demonstrate the lessons learned and differentiate the “go-forward” exposure. The outlook – more challenges ahead for miners The mining industry across the globe has already been hit with significant rate increases in recent years, but with the rapid market hardening in 2020, it is likely that further rate corrections will be experienced. Applying a significantly higher retention can help to mitigate a degree of premium increases, while alternative programme structures may also be considered, for example a Side-A only programme (i.e. cover for non-indemnifiable loss for an insured person, or main board only coverage). Company co-insurance and the use of captives may also help to create a more sustainable programme over the long term. Such challenging market conditions build a strong case for seeking expert input and assistance from advisers specialising in this sector of the insurance market, to ensure an appropriate balance of coverage is achieved between the corporate and individual D&O’s protection that is tailored to your board and company’s specific needs.
Eve Richards is GB Head of FINEX D&O at Willis Towers Watson. Eve.Richards@willistowerswatson.com
1 https://www.nera.com/content/dam/nera/publications/2020/PUB_Year_End_Trends_012120_Final.pdf
Market correction Much like its European counterpart, the D&O market in North America has experienced an unprecedented shift over the past 12-18 months, which has threatened the future viability of key marketplaces and the insurers which operate within them. Although we have been experiencing market hardening for the last five years or so, what’s changed during this period is the severity of the increases and now terms are now under attack too; that started before COVID-19 and has got worse since. As a result, a significant market correction has been introduced and traditional D&O programs have been negatively impacted due to diminishing capacity, increased rates, and tapered policy language. A few key contributing factors of this accelerated hard market include the increase in the frequency & severity of claims, new exposures, several years of soft market pricing and of course the impact of COVID-19.
Surge in claims coincides with low premium levels The surge in D&O claims from both a frequency and severity perspective has been coupled with low premium levels for several years, leaving insurers in unprofitable territory and unable to continue with their existing portfolio strategy; in some instances, it has forced major insurers to exit participation in the D&O arena. Mining particularly impacted The Natural Resources sector, and the mining segment in particular, has unfortunately experienced a large number of high-profile claims across the industry in recent years. Depressed commodity prices over the past decade has caused several mining operations to experience unprofitable production models, resulting in major financial hurdles such as asset impairments and suspensions. Ultimately, the D&O market experienced a wave of management liability claims, including high profiles securities class actions and bankruptcies due to the deterioration of bottom line performance and stock prices during this sector downturn. Operational disruptions Other recent and noteworthy sources of D&O claims in this segment include operational disruptions in international jurisdictions due to political unrest or competing local interest. Additionally, recent catastrophes and accidents at mine sites resulting in loss of life have also found its their way into the boardroom from an accountability viewpoint, leaving stakeholders and investors questioning managements’ oversight over health, safety and environmental policies.
Short term future underwriting trends Overall, market conditions in North America will continue to be very firm. The market is likely to experience some of the following trends, due to the market correction which we will continue to experience for the remainder of 2020 and into 2021. Premium increases will likely continue through 2021. Challenged industries, together with risks with liquidity concerns and/or claims activity, may see increases significantly higher than the indications below. Dynamic market pricing makes predicting renewal costs unusually difficult, but our expectation is as follows:
In terms of capacity, layers continue to shrink as London syndicate revenue limits constrain appetites and capacity. Larger towers may have to shrink, too; replacement capacity challenging to find and often costly. Carriers are becoming more consistent in their approach to COVID-19 risk. Meanwhile, terms are tightening. For Large Private programs, insurers are focusing on coverage and the exposure at risk, raising attachments and reducing capacity. We are also seeing some recalibration of P/E portfolios. Meanwhile carriers are looking to exclude: Cyber and Privacy, Insolvency and Professional Liability. Furthermore, Derivative Investigation Sub-limits are being pulled back, eliminated or now only offered excess of retentions, which could impact Books & Records coverage. Underwriting criteria remains unchanged, but underwriters are applying more depth and focus, especially for liquidity and COVID-19-related business impacts. Last minute quotes are still possible, but that trend is getting better.
Rating expectation summary
Impact of COVID-19 Apart from performance dynamics, D&O may be one of the lines most affected by the pandemic and the resulting economic challenges. When we look at the mining sector on a global basis, there are several ways that COVID-19 has affected company operations. It is not only the impact of outbreaks within a company’s employee base that has slowed or forced operations to halt but, in some countries, there has been a government directive for non-essential businesses to cease operations. To date, we have seen relatively few US Securities claims that are COVID-19 related; as at the end of June 2020 there were only 16 active COVID-19 Strong Customer Authentications, with none against any mining company. The majority of the cases alleged ‘Non-Disclosure of the potential impact of COVID-19.’ Another category, not being tracked but which may have a more significant impact, are claims that go out of their way to avoid blaming COVID-19. Those claims look at pre-pandemic disclosures and post-pandemic disappointing results and blame any possible disclosure gap or event, other than COVID-19 or the responses to the pandemic. As the effects of global pandemic start to bite, we are seeing many countries move from dealing with the public health impacts of the crisis to starting to try to understand what the short and long-term financial impact will be on the industry.
Commodity demand had dropped before 2020 The mining industry is resilient, but it will take time to get back to profitability. Gold miners are a standout as historically investors rush to gold investments in times of global unrest. Pre-COVID (a term we hear more and more of these days), the demand for many commodities was already low, thereby affecting profitability. In discussions with mining clients, some make reference to the relatively low energy prices being a benefit to them; they hope that these will continue for some time, due to the large proportion of direct operating costs attributable to energy use in mining production. Time will tell.
Going back to basics Directors & Officers Liability underwriters are going back to basics. They are broadly focusing on:
Over-optimistic forward-looking statements? As mining companies return to full or even partial operation, many of them will be making many forward-looking statements about their future business outlook, current financial condition, operating readiness and capabilities, supply chains, ability to service debt and expected future cash flows. However, many of these potential statements may be overly optimistic and could leave a company exposed to potential shareholder litigation. Companies need to just stick to the facts; D&O underwriters will be taking a good look at their current portfolios as well as any new presented opportunities and will look to avoid companies that cannot show restraint.
More companies are restructuring and many of those in or considering bankruptcy As a result of business cessation due to COVID-19 we have started to see companies across several industries file for bankruptcy and/or bankruptcy protection, and mining companies are isolated in this regard. For now, the trend, is most bankruptcies involve pre-arranged or pre-pack restructurings. The bankruptcy process is used to get necessary approvals to restructurings, and those bankruptcies are far less likely to produce D&O claims. However, the longer the pandemic lasts, the more likely that banks will have less room to accommodate debtors with restructuring terms. This means that the bankruptcies of tomorrow may be more challenging to resolve, and creditor claims against executives are more likely. D&O underwriters globally are further tightening policy terms, increasing premiums and lowering policy limits on renewals.
Conclusion: our advice to miners Mining companies need to start their renewal process much earlier than ever before and should plan to meet (virtually or otherwise) all the existing underwriters on their D&O programs. Underwriters are being a great deal more diligent, asking more questions of companies; indeed, there are lists of specific COVID-19 exposure and preparedness questions that need to be addressed before receiving a new or renewal quotation. Some insurers are also adding Communicable Disease Exclusions on new policies - even D&O policies that already have a Bodily Injury exclusion in the base wordings. In summary, the combination of a hard market and global pandemic has created the perfect storm, and the full impact of these economic and market forces will continue to create challenges across the insurance market.
Scott Saddington is Executive Vice President -FINEX and Mergers & Acquisitions and National Broking Leader – Canada, Willis Towers Watson Toronto. Scott.Saddington@WillisTowersWatson.com
