07 September 2018

Hard times ahead for D&O insurance

This article was written by Mandy Tsang and Travis Toemoe

The market for directors and officers (Ds&Os) liability insurance policies had begun to harden during the first half of 2017. That “hardening” has continued with insurers now inserting “royal commission exclusion” into policies. Such exclusions are generally broadly drafted and could significantly undercut coverage moving forward. They should be carefully checked.

Insurance premiums for D&O policies were already on the increase before the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (RC). The hardening of the D&O market, in part driven by the rise in class actions, have also seen tougher underwriting and higher deductibles.

Insurers have sought to confine their exposure to the RC by introducing exclusions, in particular for financial services institutions. Generally, these exclusions are broad. This breadth is partly due to the RC’s wide term of reference.  Under the term of reference, the RC had powers to examine “misconduct” (defined widely) for a wide range of entities, including the big four banks, other banks, insurers, financial advice providers, super funds, investment banks and other companies holding an Australian Financial Services License. The evidence produced to the RC has been voluminous and numerous submissions have been made by various entities. Therefore any exclusions which are referrable to the terms of reference or documents submitted to the RC will have a similarly broad effect.

Counsel assisting the RC has submitted that numerous adverse findings were open against various financial institutions. They included various statutory breaches which are the very “Wrongful Act” that a financial institution would look to for coverage from their professional indemnity (PI) insurance policy or under the Securities Claims sections of their D&O Policy. For Ds&Os, they will also be looking to their D&O Policies (and potentially the PI Policies) for cover. In particular, findings for inadequate systems and policies within a financial institution would be of particular concern to Ds&Os who might have responsibilities for such systems and policies. Therefore, any exclusion referrable to adverse findings made by Counsel assisting could greatly undermine coverage.

The result is that there is real uncertainty around what coverage is afforded under the PI and D&O policies moving forward if such exclusions are included. On a reasonably open broad construction of some exclusions, the D&O and PI policies would provide little to no cover if the exclusions are included, both for past and future claims. Ds&Os would be particularly vulnerable if they are unable to obtain coverage under the D&O policy and are also legally prohibited from being indemnified by their financial institution, especially for defence costs. 

It is not unusual that insurers would seek to confine known risk to prior period policies. However the RC presents more challenges than the usual specific matter exclusion because the conduct considered in the RC is so wide ranging, rather than confined to a specific set of facts of circumstances. The adverse findings submitted by the Counsel Assisting includes findings that the entity engaged in “conduct that fell below community standards and expectation”. Such general findings make it difficult to pinpoint the nature of the breach that is alleged against the insured. Finally, those involved would not know the exact factual and legal findings which may be made against them until the Commissioner releases his reports.

Where insurers are seeking to introduce RC exclusions to a company’s D&O or PI policies, the language of the exclusion should be carefully considered to limit the scope as much as possible. At first instance, companies should explore whether it would be possible to resist an RC exclusion altogether, although this may be very difficult. If this cannot be achieved, requests could be made to limit the application of the RC exclusion to particular sections of the D&O policy.

It would be also prudent for financial institutions to notify circumstances which may give rise to a claim coming out of the RC prior to renewal. Companies should weigh up the benefit of a broad notification against the risk of aggregating all claims to one policy period. The scope of the notification should be informed by the scope of the proposed RC exclusion.

D&O insurance is a cyclical market. Currently companies, in particular financial institutions, are facing some hard times ahead.

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