D&O insurance in 2023: Softening market, hardening judicial approach to penalties

After five years of consistently difficult and prohibitive market conditions, capacity is finally starting to return to the Australian D&O insurance market.

2022 saw the first decreases in D&O premiums and coverage restrictions for many years, which have continued to decline well into 2023. In its mid-year insurance report, Marsh highlighted that D&O premiums in Australia have reduced between 10 and 25% in the first half of 2023.^[1] Across almost all other insurance classes, premiums continued to rise, though at more moderate rates than in previous years. Similarly, Bellrock reported that, between July 2022 to July 2023, there have been reductions in D&O premiums of up to 50% in small-cap publicly traded companies.^[2]

So, why is the D&O market softening?

The softening D&O market can likely be attributed to a number of new insurers entering the market and offering competitive prices and existing carriers reducing premiums to retain market share. Several London insurers are actively seeking Australian-domiciled businesses, and demonstrating significant interest in:

• Side A and B only programmes (and so avoiding the significant risk of covering securities class actions against the company);
• insuring private companies; and/or
• insuring companies outside of the ASX200.^[3]

This overseas insurer interest is likely putting price pressure on Australian insurers. In their H1 2023 report on D&O Insurance, Aon noted that a number of insurers have also released or are releasing new or refreshed primary policy wordings, in an attempt to retain current or entice desired clients.^[4]

Additionally, brokers have pointed to the dulling mergers and acquisitions environments in Australia and overseas as further drivers of the D&O market’s softening.^[5]

In the softer market, is Side C back?

As noted in our September 2020 article, Side C (company cover for securities claim) and Side B (company reimbursement cover) cover were common casualties of the hardened D&O market, with Side C becoming increasingly less common.

In their October 2023 report, Gallagher noted that, in the softening Australian market, consideration is now being given to the purchase of “coverages such as Side C”.^[6] However, many insurers and companies still appear to be primarily interested in Side A (direct cover for individuals) and B (balance sheet protection for companies' indemnification obligations). We are seeing an uptake in Side A-only D&O policies, with Side B being dropped by larger companies less concerned about balance sheet protection.

In harder market conditions, companies reduced the need to seek Side C cover by making alternative risk allocation arrangements, many of which are still in place today. From an insurer’s perspective, outside of the US, Australia has become one of most likely jurisdictions in which companies may face significant class action litigation.^[7]

In a 2023 report prepared by the Australian Prudential Regulatory Authority’s (APRA), it examined policy and claims data and identified a significant growth in D&O claims volume, with large D&O claims (>$1 million) almost tripling from the period from 2009 - 2015 to 2019 – 2021.^[8] APRA chiefly attributed this increase to a growth in shareholder class action activity. Whilst the number of shareholder class action filings in Australia fell to only 8 in FY21, it increased to 13 in FY22, and 14 in FY23.^[9]

For as long as global inflation perseveres, there is a risk in the securities class actions space that claims values, in addition to claims volume, will surge. Certainly, Allianz Global Corporate and Specialty has predicted inflation may continue to increase future claims through larger settlements.^[10] If this manifests, we do not imagine Side C will return to the market in force.

Payment of penalties - can directors still get cover under their D&O policy?

Should directors and officers fail to perform their statutory and common law duties, they may face fines and penalties. To manage this risk, companies typically offer indemnities (via deeds) to their directors and officers, but only to the maximum extent permitted by law. In some instances, the company will be legally prohibited from offering an indemnity whatsoever. For example, where a director attracts a liability for certain pecuniary penalties under the Corporations Act 2001 (Cth) (Corps Act), the company cannot indemnify them.^[11]

Separately, companies may seek to call on their D&O policies with Side B cover, to reimburse them for an indemnity offered to a director. Where the company cannot indemnify the director, the director may try to claim under the D&O policy themselves under Side A. However, many D&O policies now contain terms which specifically exclude cover for these penalties, should they be issued. 

Some statutes specifically prohibit directors recovering under insurance or indemnity arrangements in respect of certain monetary penalties, for example, fines for contraventions of workers’ health and safety (WHS) laws. Most recently, in September 2023, the Work Health and Safety Act 2011 (Cth) (WHS Act) was amended to include these “no insurance” provisions.^[12] Similar provisions are already in place in several state and territory WHS statutes, including in ACT, NSW, Western Australia and Victoria.^[13]

Even if a director is issued a penalty, which is not excluded under their D&O policy or not uninsurable under statute, recent cases demonstrate that the Court may still intervene and override an otherwise responsive insurance or indemnification arrangement. They do so by ordering that a director must pay a penalty personally, notwithstanding they may have cover under an insurance policy or an indemnity from the company.^[14]

On 29 August 2023, the Federal Court made a personal payment or non-indemnification order against a senior manager of BlueScope Steel, Mr Ellis.^[15] Mr Ellis was found to have breached cartel conduct provisions of the Competition and Consumer Act 2010 (CCA) on several occasions. He was ordered to pay an aggregate penalty of $575,000.^[16]

Mr Ellis was insured under a D&O policy, which would have provided cover in respect of this penalty. The CCA does not contain prohibitions on insuring penalties similar to those in the WHS Act as discussed above. Nevertheless, the Court held that Mr Ellis had to personally pay the penalty, and was not to receive indemnification or insurance for any part thereof. The Court held that the purpose of the CCA fine was to deter directors from calculating the rewards of engaging in illegal conduct and balancing these against the risk of being caught, and the deterrent effect of CCA fines and other penalties should not be undermined by the ability of company directors and officers to insure against a penalty’s financial cost.^[17]This is an important decision for directors. Penalties under the CCA, whilst sometimes non-indemnifiable by the company, could nevertheless be insurable because the CCA did not contain prohibitions on insurance similar to section 199B of the Corps Act. This decision demonstrates the Court’s preparedness to impose further limitations on the availability of insurance cover.

This case followed the reasoning in Australian Building and Construction Commissioner v Construction, Forestry, Mining and Energy Union (2018) 262 CLR 157, where an employee was ordered to personally pay a $18,000 penalty under the Fair Work Act 2009 (Cth). For directors, these cases emphasise the importance of understanding and performing one’s statutory and common law duties. If they fail to do so, even the most comprehensive D&O policies may not always save them from paying for the entire penalty out of their own pocket.

Where does that leave us?

The D&O insurance space continues to evolve - affected by global economic conditions, market competition, claims settlements, legislative amendments and judicial decisions. If the softer market persists into 2024, policyholders may have more bargaining power with their insurers. That said, companies should keep in mind that D&O policies are just one of a number of tools in their risk-management arsenal, which they can seek to alter and adapt as this space develops.