D&O demand set to soar as UK audit regime puts directors in the spotlight

The UK government has announced plans to implement new reforms to the UK’s audit regime, which could significantly increase the need for directors’ and officers’ (D&O) insurance.

On 18 March, the Department for Business, Energy and Industrial Strategy launched a consultation on reforms designed to modernise the UK’s audit and corporate governance regime.

The reforms aim to break up dominance of ‘Big Four’ audit firms and require large businesses to be more transparent about their finances, helping to avoid company failures and safeguard British jobs.

The consultation, which closes on 9 July, proposes that directors of large businesses could face fines or suspensions for serious failings – for example, significant errors with accounts, hiding crucial information from auditors, or leaving the door open to fraud.

Under the new regime, directors would be required to publish annual resilience statements, audits would consider wider performance metrics, including against key climate targets, and a smaller “challenger” firm would need to be appointed to conduct a meaningful portion of firms’ annual audit.

Furthermore, large businesses would be barred from paying out dividends and bonuses when they could be facing insolvency and they would be expected to write into directors’ contracts that their bonuses will be repaid in the event of collapses or serious director failings up to two years after the pay award.

Directors in the crosshairs

Francis Kean, partner in McGill and Partners’ financial lines team, explained that the new rules will put directors and officers firmly in the crosshairs should there be any misconduct.

“Directors of companies will face increasing personal liability under the new reforms,” he said.

“Under the new proposals, regulatory enforcement powers will be strengthened and broadened. Directors of large companies will become individually responsible for the accuracy of the company’s financial statements and will face fines and even disqualification orders if found to have breached their duties.

“This poses a significantly enhanced risk for directors who are less likely to be able to rely as heavily on professional advice and input from auditors and accountants.

“All directors should continue to ensure they have the adequate directors’ and officers’ liability cover in place to ensure they are covered in the event of a breach.”

Matteo Cerretti, partner and deputy global insurance head at global legal business DWF, said greater responsibilities for directors will impact insurers.

“The profitability of the D&O insurance sector is being challenged due to a number of factors, including increasing competition and rising levels of litigation, alongside a general cultural shift to bring more D&O security claims both against individuals and companies,” he said.

“The increased number, severity and tail of claims has inevitably resulted in higher rates for D&O insurance being offered on the market.”

DWF added that not all of the proposed new UK regulations immediately increases insurers’ D&O exposure, as regulatory fines and sanctions are uninsurable by law. However, the costs of serving as a director are dramatically rising in the UK - these not only include compliance-related costs, but also the costs of litigation and insurance.

Double-edged sword

Alex Barnes, partner in the insurance practice at accountant and audit firm BDO, said the proposals, while not unexpected, are far-reaching for insurers - both as businesses and for those that offer D&O cover.

He said: “Insurers are designated as public interest companies and, as such, if they [use] one of the big four audit firms, they will need to appoint a smaller challenger audit firm - that will only make the audit more burdensome.

“In terms of their clients, non-executive and executive directors will be faced with extra responsibility and D&O insurance exposures are bound to increase.

“Insurers had hoped they could be excluded from classification as a public interest entity. However, they have been viewed as companies which should they fail, would impact the wider public.

“Not only have insurers been deemed as a public interest entity, but the new rules increase the scope of firms which come under the new regime, as it includes all firms that the government deems to be large.

“As such, D&O insurers can expect to see increased demand given that more firms and their directors will fall under the new rules when they are implemented.”