Surge in class actions and the effect on the D&O market

Spikes in Directors’ & Officers’ Liability (D&O) premiums for public companies are resultant of losses and the uncertainty of shareholder class actions (SCA’s). Of the reported 38 class actions since 1992, more than 76% have been brought against public companies exceeding $1bn in market capitalisation.

Until the decision in TPT Patrol Pty Ltd as trustee for Amies Superannuation Fund v Myer Holdings Limited [2019] FCA 1747 (Meyer) there was no decision on class-actions. They either settled or were struck out. The insurance market reports that of those that settled, the average settlement was $48m which comprised on average of $5m in defence costs.

Alarmingly, 45% of all SCAs commenced over the past 20 years were notified between 2016 to present. All of these remain unresolved.  Market statistics suggest for the 2016 year, against the Australian D&O market of $250m in gross written premium (“GWP”) that ~$400m was reserved in claims.

It gets worse.

For the 2016 to 2018 period reserves are estimated at $1.8bn; that said, reserves for defence costs are being set at $15m by insurers (ie the costs of defending a securities class action has jumped from $5m to $15m). Intel from a leading Australian law firm suggests that of the 8 actions they have defended in the past 7 years, their average costs have been $6m.

Presently the current Australian D&O market (not premium produced to Lloyd’s of London) is estimated at $450-$500m GWP. We think this is resultant of the well-publicised D&O premium increases. We also consider the amount comprises insurance premiums not accounted for previously as in past years they were placed in overseas markets (like Lloyd’s of London). That means D&O premiums are now returning to Australia. That is not a good thing. It means the ‘global hub’ of insurance considers Australian D&O risks “too risky”. It results in less competition to the Australian market which leads to higher premiums, excesses and narrower cover.

Insurers have, over the past 3 years, continued to narrow the breadth of cover under D&O policies for SCAs. There are limited insurers who will  cover SCA claims brought against the company (as distinct from its directors and officers). If they do, we expect they will impose significant excesses and additional premium.

Larger cap companies may opt self-insure; enjoy a greater budget for internal compliance and risk management staff; have established policies and procedures; have greater leverage with insurers to negotiate premium, and are better capitalised to hold higher excess structures and pay greater premiums.

However, smaller cap companies must work on internal governance and compliance and take external professional advice on risk management. Early engagement with the insurance market is extremely important as is comprehensive disclosure to your broker and underwriters.

For insurers, the ‘Meyer’ decision helps to deter claimants from future SCAs given the difficulty of assessing loss even after a finding of liability. That said, with defence costs now reportedly being reserved at $15m on average by insurers to defend an SCA, and with the number of SCAs notified from the 2016 period onwards, Government and Regulatory measures are required to attract insurers back into this insurance class.

Simply put, D&O insurance is becoming unaffordable, particularly for publicly traded small cap companies. Directors will be reluctant to join boards if a company does not have adequate D&O insurance. If public companies are not well managed then they cannot expect to be profitable. That will dissuade investors and investment on our shores.