Smaller firms need protection too

ecent changes to corporate legislation have raised the question as to whether directors of UK SMEs should take out directors’ and officers’ cover (D&O).

Given the current climate, is there now a more pressing need for companies, and their directors, to protect themselves from the litigation that often comes with the job?

According to the DTI, SMEs make up 99.9% of businesses in the UK , yet it is estimated that only 15% to 20% currently buy D&O cover. At the plc level, nearly all companies buy D&O.

Andy White, chief executive of Towergate Risk Solutions, says that while many SMEs will find it difficult to relate to the need for such cover, more directors are recognising the need for protection from litigation.

White says: “Claims emanating from health and safety, employment disputes and breach of duty currently have a higher profile within the UK.

“However, directors are becoming more aware of increasing litigation and their own individual exposures. Our job as a broker is to make clients aware of the ever-changing legislation and highlight the need to have such cover.”

A survey conducted last year by Hiscox of 521 SMEs revealed that after concerns over higher energy and rent bills, the cost of regulation and the threat of speculative lawsuits topped their list of worries.

As well as seeking to develop their business in an increasingly complex economy, directors have to comply with a myriad of legislation, including health and safety, trading standards, employment and the environment.

Callum Taylor, management liability underwriter at Hiscox, says that concerns about personal wealth may impact on SMEs looking at D&O cover. “Directors of UK companies have historically, in varying degrees, protected their unlimited personal liability by purchasing D&O cover.

“Unfortunately, this type of protection alone is no longer sufficient, with directors’ future livelihoods placed at risk from the threat of a legal attack on their company. The ownership of SMEs is often restricted to the company’s directors and their families; therefore, any costs incurred or awards made against the company will impact directly on the director’s personal wealth.”

Taylor also indicated that there is room for further growth as management liability is becoming a more affordable cover solution for the mid-market company sector.

Changes in legislation

The demand for D&O cover could be driven by changes in legislation. As a result of the Companies Act 2006, a director’s duty is now governed by statute, which is a legal obligation, rather than case law.

White explains: “For the first time directors are under a statutory duty to consider the impact of their decisions on the community and environment.

“Demand for D&O liability policies will grow in line with our increasingly litigious society. Actions against directors and officers will clearly accelerate as statutory bodies enforce changes in legislation.

“In America, it is standard practice that directorships are not accepted without D&O cover being in place. This is becoming increasingly common in the UK.”

Another piece of legislation that is becoming more relevant is the Civil Contingencies Act 2004. This requires local authorities, the NHS, utilities, solicitors, accountants and insurance brokers to have a tried and tested business continuity plan in place.

If a company does not have such a plan and the business suffers a major loss due, perhaps, to fire or flood, the company’s directors may then be at risk from shareholders or statutory body actions.

Taylor points to the introduction of the Corporate Manslaughter Act as cause for concern for SMEs and directors.

He explains: “When this new act is introduced, business owners face the possibility of prosecution and an unlimited fine for management failure leading to the death of an employee or third party should they be found guilty.

“This legislation could also lead to companies facing prosecution for breach of their duty of care in areas not previously considered. An example of this could be a company’s failure to ensure its employees’ cars are kept in a roadworthy condition when being used in the course of their employment, even in cases where employees are using their own cars.”

Surely this means that D&O cover is becoming more necessary, given more heads could roll?

White believes that the extremely soft market conditions will slow this process, adding: “I am not sure that insurers will become more forensic in their underwriting attitudes.”

Embracing D&O cover

Meanwhile, not all SMEs are shying away from purchasing D&O. Howard Pearson, managing director of Scottish broker Giles Insurance, highlighted the fact that SMEs are increasingly buying more D&O cover, particularly those with outside directors on the board.

Pearson says: “A regular discussion point among companies with American exposure is extradition cover. D&O cover automatically excludes wilful and fraudulent acts. Care is needed to see how this exclusion applies to defence costs before judgement.

Taylor says that D&O premiums should remain steady unless impacted by a downturn in the economy, leading to greater numbers of company failures or an increase in employment claims.”

In this litigious climate, brokers are now charged with arming themselves to the teeth with the necessary technical know-how.

The knowledge base of UK brokers has increased in recent years but more focus needs to be placed on all areas of potential management liability for SME and middle market companies, says Taylor.

“They should be familiar with relevant claims knowledge in areas where the company could be exposed, be it to regulation or company change via acquisition or sale of a division.”

White points out the importance of using plain English and layman’s terms “to ensure that the client understands what he is buying, as often the language utilised within D&O policies can be complex.”

Pearson adds: “What brokers need to do is to focus on appropriate limits of D&O policy by remembering that defence costs could erode the limit. For example, if a director buys only a £500,000 limit, it may buy him only a half month in court.”

The need for SMEs to consider protection from legal action is becoming more apparant and brokers should be prepared to explain the benefits when smaller firms’ focus turns to D&O.