COVID-19: The implications for D&O insurance

The D&O insurance market has been under strain for a number of years, with premium increases exceeding 100% a familiar sight. At a time when directors everywhere are trying to navigate challenging waters, the availability of this insurance is more important than ever.

The risks of COVID-19 facing companies and their officers have been recognised and the Australian Government has enacted some important measures in response.  The Coronavirus Economic Response Package Omnibus Act 2020 (Cth) provides an expanded safe harbour for directors (in addition to the safe harbour provided by s588GA of the Corporations Act 2001 (Corps Act)). Under the new s588GAAA, personal liability under s 588G(2) will not apply if a debt is incurred in the ordinary course of the company’s business for a 6 month period from 24 March 2020.  This is effectively a 6-month moratorium on insolvent trading.  The threshold for issuing statutory demands has also increased from $2,000 to $20,000.

These are seen as welcome measures by the D&O insurance market. They will ease the burden on many directors, providing breathing space to assess their risks and financial position without the fear of being inundated with demands and at risk of the severe personal penalties imposed under Corps Act for trading whilst insolvent.

As policies come up for renewal, or new risks are being written, what impact is the crisis likely to have?  What will underwriters need to give them comfort to write policies and what will constitute reasonable terms?

Having spoken to a number of experienced underwriters, they are focussed on the impact of this crisis. Their responses vary depending on whether the insured falls into one of two general groups.

The first group is publicly traded companies. These have been under scrutiny for years and have already been hit hard by class actions and events like the Hayne Royal Commission. For this group, the focus of underwriters in the early days of the pandemic was the company’s exposure to China. This has of course now expanded considerably.

Underwriters are now particularly interested in how the company has already responded to the crisis and what this reveals about its attitude to risk. Did it assess its risk exposure, mobilise crisis management, put in place contingency and other plans in a timely fashion? Did it review its supply chain and distribution channels? How is it handling its workforce?  Does it have adequate remote working and IT capabilities? How is it caring for its people?

What underwriters are trying to assess is a company’s ability to make it through the crisis. This may involve a company making some hard decisions, such as slimming down its workforce, but underwriters will want to be confident that it will bounce back afterwards. In the travel industry for example, there is a big difference between the owners of an airport, who still have a sterling underlying asset but are currently hard-hit, versus online travel companies whose model may not outlast the crisis.

There is also the question of disclosure. How are companies assessing thresholds and have they got the right processes in place to ensure timely and accurate disclosure. No business is immune to the risks COVID-19 presents, with global supply chains thrown into disarray. The unprofitable Side C cover could potentially take another battering with potential securities class actions on the horizon. At least two actions have commenced in the USA in relation to COVID-19, one against a cruise line and another against a pharma company.

As share prices tank, plaintiff firms and litigation funders will be watching the markets carefully to identify any slip-ups.

The other important factor is a company’s underlying financial position. Is the company cashed up? Does it have distributable assets, are covenants at risk and is it likely to get funding?  Cash will be king and companies carrying too much debt might find it difficult.

Then there is the second group: companies more likely to be affected by the government‘s recent announcements. This is likely to be mid-market and private sector entities.  This is higher volume business and less bespoke underwriting is undertaken. There is less ability for underwriters to look at each risk at a granular level. Underwriters run predictive modelling across this higher volume book.

Although the lifting of the threshold is good for those owing money, underwriters are concerned that there may be a secondary impact on the supply side. What if the accounts never get paid? Then there is a substantial risk emerging on the creditor side. These measures are welcome but they will not keep struggling businesses alive permanently.

There are a number of other risks that directors and their insurers will be keeping a close eye on in the months ahead.   While the potential risk exposure of COVID-19 looms large, directors cannot just focus on the issues arising from it. The broadened safe harbour provisions do not relieve directors of their usual duty to perform their role with due diligence and skill. As global markets and supply chains adapt to the new global trade landscape, increased regulation and tightening of borders, so must companies and their boards. Furthermore, the existing risks relating to cyber security and regulatory enforcement actions do not fall away just because of COVID-19. As companies renew their insurance this year, they should also watch out for terms which may restrict coverage for a COVID-19 related claim.

Underwriters are keeping a close eye on employment practices liability claims, occupational health and safety.  A multiplicity of claims may ultimately come out of this crisis depending on how it is managed and will have knock-on effect for insurance capacity generally.

The situation is still unfolding and for the time being capacity remains.  However, companies can expect even greater scrutiny when they seek cover in future.