insurance

COVID-19, on top of recent disasters, is pushing insurance to front of mind for many company directors as they consider how the fallout from social distancing will affect their businesses and how their insurance policies will respond.

Insurers around the world have been hit by the impact of the pandemic, although many potential claimants have now discovered that the virus was not actually covered by their policies.

A sense of the scale came in May, when insurance market Lloyd’s of London announced that it expected coronavirus-related claims to cost it between £2.5b and £3.5b. This claims payout would exceed that of the 11 September 2001 World Trade Centre attacks and equal the combined impact of hurricanes Harvey, Irma and Maria in 2017, reckoned to be the costliest year for storms on record.

John Neal, Australian CEO of Lloyd’s of London, told the Financial Times that the COVID-19 pandemic could well be the most expensive event in history for the reinsurance industry and would challenge it as never before. What made COVID-19 unique was not just the devastating human and social impact, but also the massive economic shock.

“Taking all those factors together will challenge the industry as never before, but we will keep focused on supporting our customers and continuing to pay claims over the weeks and months ahead,” said Neal.

John McCabe, senior vice-president and COO of Liberty Specialty Markets Asia Pacific, expects the price of insurance to continue to rise. “The commercial insurance market in Australia has been hardening over recent years, primarily due to the current and forecast claims environment,” he says. “It won’t come as a surprise that premiums in most product lines are rising across the entire industry, which was a trend well before COVID-19.”

At the same time as directors navigate their way through a heightened risk environment and potential claims, they are also facing much tougher decisions when it comes to renewing their organisations’ policies — with prices rising and insurers becoming more cautious about who they will insure and to what extent. Two important themes emerge. Don’t assume you will be covered, check your policy. Secondly, get good advice.

Additionally, in terms of insurance renewals, it is going to be much tougher and more expensive to get insurance. That means directors and managers will have to make difficult decisions on what they need to cover and, again, must ensure they get good advice.

D&O insurance

Nowhere has the effect of COVID-19 been more pronounced than in directors and officers (D&O) insurance, where steeper premiums are forcing directors to make difficult decisions about their level of coverage at the same time as the risk environment has increased. Even in the two years before the pandemic, prices for D&O insurance had surged as underwriters exited the Australian market. Those that remained became increasingly concerned about the rising number of shareholder class actions and this nervousness has been compounded. Marsh’s Global Insurance Market Report revealed the cost of D&O insurance doubled in 2019. In the fourth quarter alone, there was a 32.5 per cent jump in D&O premiums from a year earlier, although some companies had even steeper increases.

“It couldn’t be worse,” says Craig Claughton, managing director and head of FINPRO at broker Marsh. “Insurers are becoming nervous around anything in retail, aviation, hospitality — just about any industry that is either in lockdown or has been significantly affected.”

Claughton now has clients who are spending as much as $20m or $30m on their D&O cover and even then have to accept significant deductibles or excesses. “There are many clients in a really awkward position right now, because as a result of the pandemic they’re looking to cut costs and along comes their D&O renewal, typically either in March or June, and we’re saying, ‘Well, you know that $2m you spent last year, now we need $6m or $7m’,” says Claughton.

At the same time, the health and economic fallout from the COVID-19 crisis has increased the risks directors face. These include risks around insolvent trading and class actions alleging directors have financially mismanaged the company; or that they didn’t have adequate liquidity to ride out the crisis; or that they haven’t properly disclosed material information to the market. They can also face claims they didn’t adequately protect staff and kept the business running longer than they should have.

Regulators have made temporary concessions around insolvent trading and market disclosure to account for the sudden crisis. In late May, the government announced directors and executives providing profit guidance to sharemarket investors will be relieved from continuous disclosure rules for six months. The government will also temporarily amend the Corporations Act 2001 so that companies and their officers will only be liable for continuous disclosure breaches if there is “knowledge, recklessness or negligence” with respect to updates on price-sensitive information. Even so, litigation funders and plaintiff law firms remain active, says Claughton. “They are looking for any reason to commence an action and this can be such a time, I’m afraid.”

When it comes to renewing policies, Claughton encourages directors to consider what they want their D&O policy to cover — just the individuals, the entity itself for shareholder class actions, or both? That said, even if directors decide to do without Side C cover, which includes securities cover, the resulting savings are not particularly significant and so it is “somewhat counterintuitive” for directors to consider doing away with it at the current time. Instead, directors might need to be prepared to take a bigger deductible — or excess — on their policy. Where they might have had a deductible of $250,000 or $500,000 in the past, for instance, they might now be looking at $5m to $10m, says Claughton.

Will the legislative changes have any downward impact on pricing? Michael Herron, national head of professional and financial risks at broker Gallagher, says a short-term reform is unlikely to have any impact on pricing. “If the amendments were to give some certainty with some permanence, this could have an impact,” he says. “For now, we’re talking to D&O insurers about how the regulatory concessions are allowing directors to discharge their duties with more confidence in challenging conditions.” He says the company’s focus is on keeping insurers at the table and negotiating the best outcome for boards, case by case.

The Price of Pandemic

US$203b Estimated total global insurance industry losses

US$107b Estimated underwriting losses

US$96b Estimated value of falls in investment portfolios

Source: Lloyd’s of London

Nailing the narrative

When it comes time to renew D&O policies, Herron says insurers want to see a “good narrative” from directors demonstrating they’re on top of the new environment and the waivers and concessions around disclosure and insolvent trading granted to directors. “Essentially, what the insurers are asking is more about the process — how are the directors and companies coming to decisions around capital raisings or financial reporting?”

Directors should be well briefed and prepared by their brokers so they have a solid position on anything they might need to explain or justify to their insurers when their policies are up for renewal. For instance, many D&O insurers are telling their publicly listed clients they need to have good justifications if they don’t withdraw their earnings guidance from the market in the face of the economic uncertainty caused by the pandemic. “It worries D&O insurers that anybody can make a statement with any certainty about how they are going to be performing financially and what their earnings are going to be in these conditions,” says Herron.

He says the crisis has meant that directors have become more involved in, and better informed about, insurance decisions than previously. In the past, where there was more capacity in the market, renewing D&O insurance was more about getting the best premium and lowest retention or excess. The focus for directors has shifted to “securing the cover and securing it for something you’re prepared to pay for”.

As they look to renew policies, insurers are as a matter of course requesting answers to coronavirus questions almost irrespective of industry. Herron’s colleague, NSW manager of professional and financial risk Robert McCabe, says he has a client, on the face of it minimally impacted by the crisis, yet still being asked 10 specific COVID-19 underwriting questions in addition to the usual underwriting considerations.

Ken Dean FAICD, chair of Mission Australia and a member of the audit and risk committee of Energy Australia, says even before the crisis, directors were looking at their level of D&O cover and weighing up the various exclusions. In the current environment, pricing risk has become especially difficult, both for D&O insurance and general commercial insurance. “That’s the discussion you have every time you come to an insurance renewal — as to who is best placed to understand, price and bear the risk in an environment where things are changing rapidly and we are right in the middle of that at the moment,” says Dean.

As lockdowns and stimulus programs unwind, and governments confront large deficits and adjust their tax and spending as a result, it will have a significant impact on the business environment — and add to the uncertainty around risks in the longer term around business interruption and commercial risks. With company cashflows under pressure, boards will have pointed conversations about what they must insure and what they can do without. “Boards and committees will be having interesting discussions about whether they want to pay very, very high premiums to insure to absorb risk,” says Dean.

“But actually we’re probably in as good a position as anyone to manage, and there’ll be a discussion about what level of cover we really need to take in that environment.”

Business interruption

In the wake of the SARS epidemic of 2002–04, many insurers introduced a general exclusion for claims relating to quarantine and infectious diseases. However, Andrew Howard, a partner in forensic services at BDO Australia, says this doesn’t automatically mean companies won’t be able to claim for coronavirus-related losses for some policies. “Commercial insurance policies are extremely complex and they have a lot of different inclusions, exclusions and different categories,” says Howard, who quantifies insurance losses to help clients make claims.

“So while on face value some people may think they’re immediately excluded, what we’re finding is there are unique coverages in some policies, which are providing avenues for clients and companies to potentially make a claim off the back of COVID-19.”

For instance, says Howard, some policies might have what’s known as a civil authority clause, which covers losses caused when a civil authority such as a government prevents the policyholder or their customers from accessing a premises and companies might find they have a week or two’s cover. Businesses that import goods from overseas or manufacture overseas might be covered for business interruption of their suppliers, which could open another avenue for claims.

“I’d certainly be encouraging everyone to have a good hard look at their policy and then get some sort of expert comment because, as is happening with a number of clients at the moment, there are other potential parts of the policy that could trigger a claim,” he says. Assessing business losses is straightforward for an event such as a fire. However, COVID-19 adds a new level of complexity, raising questions such as how long it will take the business to recover, what will be the path of the pandemic, and how long will it take the economy to recover.

Trade creditor and property insurance

As its name suggests, trade creditor insurance covers businesses that are not repaid by specific creditors. Typically, the trigger for a claim is a default, so unless there is a specific exclusion for pandemics, the claim might be payable, says Howard. Property insurance typically covers physical damage to a property, but there are various exceptions.

“What we are seeing is, potentially, if operations need to shut down where there’s no physical damage, it’ll come back to the definition under the policy,” he says. “But there could be scope there for some coverage or some claim as well for loss of income and profits.” Liberty’s McCabe expects trade credit and financial lines claims to rise as the fallout of company collapses becomes clearer and financial reporting obligations come under scrutiny, but adds that it is too early to tell.

Cyber insurance

The pandemic has heightened the risks of cyber attacks as large numbers of staff work from home and established security procedures fall away. On top of this, employees are using their own technology, potentially with fewer security controls than in the office. As a result, insurers are seeking a lot more detailed information from clients to understand their security networks and controls, says Claughton. Unlike D&O insurance, the cost of cyber insurance has been relatively stable for the past few years, but Claughton expects it will rise as a result of the pandemic.

Event cancellation

With bans on any large gatherings, event promoters have been among those businesses most affected by the COVID-19 crisis. However, Simon Calabrese, national manager entertainment and leisure at Marsh Advantage Insurance, notes almost all event cancellation covers exclude communicable disease within the policy wording.

Nonetheless, he says, this cover can generally be “written back” or “bought back” for an additional premium. “The event risk landscape is one that will continue to challenge event promoters post COVID-19. From 2020, the industry will be faced with unprecedented premium increases, higher deductibles and restrictive coverage across the board,” says Calabrese, who expects insurers to have “a most selective underwriting appetite” in the future.

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