Briefing: Rampant regulation poses threat to D&O claim volume

By editor Katie Scott

Although the insurance industry is usually laser focused on regulation that hails from the FCA’s office, broker Gallagher has warned that insurers and brokers need to immediately undertake proactive risk management measures for their corporate clients as incoming legal acts have the potential to ramp up directors’ and officers’ liability (D&O) claims volume.

According to the ABI, D&O insurance “covers the cost of compensation claims made against business directors and key managers for alleged wrongful acts”.

Examples of these “wrongful acts” include a breach of trust or duty, neglect, error, wrongful trading or misleading statements.

According to Gallagher’s Bracing for impact: Navigating regulatory risk report, published in August 2024, the Economic Crime and Corporate Transparency Act 2023 (ECCTA) could have a “significant” impact on D&O claims.

This regulation, which Gallagher predicts will come into force either later this year or in 2025, “introduces a new corporate offence for failing to prevent fraud”.

This means that “companies will be held liable if criminal activity is carried out for their benefit without adequate fraud prevention procedures in place”, the report explained.

As for the impact of this act on D&O cover, Gallagher noted that “insurers will scrutinise a company’s policies and procedures when assessing and underwriting risks” for this line of business moving forward.

Therefore, “without robust fraud prevention measures, businesses may experience increased claims against their directors and officers”.

Steve Bear, executive director for financial risks at Gallagher, said: “The ECCTA has really crept up on customers and insurers alike and there is a real danger of it falling between some cracks when it comes to insurable loss.

“D&O policies commonly exclude claims against the company itself and successful allegations of fraud. [While] crime policies can be purchased, the lack of first party loss – if anything, the company may have actually benefited – makes it a tough area of coverage, so it’s important that brokers and insurers are aligned.”

The ECCTA gained Royal Assent on 26 October 2023. It was first introduced at the House of Commons on 22 September 2022.

The impact of ESG

Another area that is attracting greater regulatory focus is environmental, social and governance (ESG) commitments. In fact, this was the topic of a webinar I chaired for Insurance Times’ sister title Strategic Risk in June 2024.

During the online panel discussion, Amar Rahman, global head of climate and sustainability solutions at Zurich Insurance, emphasised the role of proactive risk management when looking at the ESG environment, as well as a focus on resilience.

He explained: “[Risk managers] need to take an operations and strategic view of the risks posed by the climate [to] your business. As with any other risk, be it your car or protecting an asset from risks such as fire damage, you would not simply rely on insurance.

“In terms of fire risk, you may well look to install sprinkler systems and fire retardant materials. And in [the] case of the car, you would ensure it was well maintained and that it [was] driven with care and attention. To rely solely on insurance would simply be a case of bad risk management.

“There needs to be a focus on resilience.”

There is definitely a nervousness from senior business leaders around being seen to deliver on ESG.

Gallagher’s aforementioned report cited prior research which found that 62% of senior leaders at large UK businesses are concerned that their ESG targets put them at risk of litigation – especially as 54% of respondents also believe that legal action over missed ESG targets is far more likely now compared to 10 years ago.

A further D&O risk factor here is that 72% of the polled senior leaders noted that they felt pressure to set ESG targets without actually being sure how they were going to reach them.

These figures came from a survey Gallagher conducted of 600 senior leaders at UK companies with more than 500 employees. The statistics were originally published in February 2024.

The European Union’s (EU) Corporate Reporting Sustainability Directive (CRSD) could therefore pile further stress and confusion onto company directors and officers, potentially resulting in D&O claims.

The report explained: “The directive came into force in 2023 and by 2028, non-EU parent companies with annual EU revenues of at least €150m (£126m) in the last two years and an EU-based subsidiary must report on sustainability, diversity, corruption and other related factors.”

As part of these new reporting requirements, “companies must assess and disclose their impact on topics such as climate change, pollution, water resources, biodiversity and worker and consumer rights”, as well as set ESG targets that align with the directive’s “minimum disclosure requirements, including specific metrics, timeframes and reporting practices”.

This regulation also has the potential to impact insurance firms themselves as many brokers in recent years have opted to extend their M&A net to Europe after UK-based acquisition targets dwindled following a spate of consolidation that picked up pace just prior to the Covid-19 pandemic.

For example, PIB Group has bought entities in Poland, Romania and Spain.

Does more regulation equate to more D&O claims?

Bear explained that despite the stringent rules outlined in new regulations, there is still a degree of uncertainty for directors and officers – especially around ESG targets – which could pose a claims threat.

He said: “On the one hand, it’s easy to assume that more regulation means more D&O claims – but without a codified set of rules to follow, companies and their directors are left to their own devices and best endeavours, which creates a lot of uncertainty.

“In a wider economic sense, many would agree that we don’t want the UK to become the world’s safest graveyard as a place to do business, but directors also need guidance when it comes to new regulation and how to avoid falling foul of it.

“We have already seen claims from activist groups, for example, because green credential claims made on company websites prove to be wide of the mark and this only serves to reinforce the concerns revealed in our research.”

Gallagher’s report defined a “proactive approach to regulatory changes” as “crucial” to managing a possible uptick in D&O claims, which “includes staying informed about pending legislation, engaging with industry associations and legal experts and assessing the potential impact on [organisations’] risk profile”.

Bear added: “Conducting a comprehensive assessment of D&O insurance coverage is essential to ensure adequate protection against potential claims and associated legal costs.”

ESG and supporting the transition to net zero carbon dioxide emissions is certainly the next big threat for D&O cover – the last was probably firms’ responses to the Covid-19 pandemic.

Part of the issue here lies in the fact that the goal posts are continuously moved in reaction to environmental developments and governmental actions, for example, so any business strategy around ESG also needs to be fluid and adaptable.

Brokers have to keep having the ESG conversation with their clients, as well as keep their fingers on the pulse of regulatory activity, if they are to keep a lid on the volume of possible D&O claims.