Allianz: Volatile markets, US lawsuits, ESG issues and SPACs create new risks for managers

  • AGCS report identifies trends for risk managers,
    brokers and insurers in the Directors and Officers (D&O) space.
  • Pandemic-related insolvency risks have not yet
    been fully averted, while risk of asset bubbles and inflation are a rising
  • Shareholder
    derivative suits in the US against foreign companies are becoming more frequent.
  • SPACs are
    on the rise globally – and come with a number of D&O risks. In Asia the
    market is gaining momentum with a significant uptick in companies in China,
    Hong Kong and Singapore as a new route to accessing capital markets
  • AGCS
    market outlook: “D&O insurance market is showing signs of stabilizing in
    terms of capacity. However, the potential for further loss trend inflation
    remains and requires a disciplined underwriting approach.”

OutReach – 15 December 2021  Board members and company executives can be held liable for an
increasing range of scenarios. Today’s market volatility, with the increased
threat of asset bubbles and inflation, the prospect of a growing number of
insolvencies due to the pandemic environment, together with rising scrutiny
around the environmental, social and governance (ESG) performance of companies
and the urgency for robust cyber resilience are key risks for Directors and Officers (D&Os) to watch in 2022.

Risk managers and their D&O insurers
should also closely monitor potential exposures to US derivative actions and
other forms of litigation, while also not underestimating the challenges around
increasingly popular SPACs (special purpose acquisition companies), according
to the latest edition of Allianz Global Corporate & Specialty (AGCS)’ annual D&O report.

“The actions and culture of
organizations and their directors and officers are coming under heightened scrutiny
from a wide range of stakeholders, with litigation risk a primary concern,” says
Shanil Williams, Global Head of Financial Lines at AGCS.

“This comes against the backdrop
of a stabilizing D&O marketplace, although capacity is still tight in some
segments and many companies would like to buy more limits than the industry can
offer. The market remediation has advanced, including our own portfolio at
AGCS, and this will gradually ease the pressure that some of our clients are
facing. We are adopting a cautious and disciplined underwriting approach and
need to remain wary about the current volatile business environment and closely
monitor loss trend patterns. However, the D&O insurance space is slowly,
but surely, offering opportunities for profitable growth again in selected
pockets – and we are eager to pursue these.”

insolvency issues continue to be key topic in the D&O space

The withdrawal of support measures
for companies established during the pandemic sets the stage for a gradual
normalization of business insolvencies in 2022. The Euler Hermes Global Insolvency
Index is
likely to post a +15% y/y rebound in 2022, after two consecutive years of
decline (-6% forecast in 2021 and -12% in 2020). While the wave of insolvencies
has so far been milder than anticipated, mixed trends are expected across the
world. In less developed markets, such as Africa or Latin America, the number
of insolvencies is expected to increase faster compared to more developed
economies, such as France, Germany and the US, where the impact of the
governmental support is expected to last for longer. Traditionally, insolvency
is a major cause of D&O claims as insolvency practitioners look to recoup
losses from directors. There are many ways that stakeholders could go after
directors following insolvency, such as alleging that boards failed to prepare
adequately for a pandemic or for prolonged periods of reduced income.

volatility, climate change and digitalization key issues

The financial services industry,
but also companies from other sectors, continues to face multiple risk
management challenges in the current economic climate. Markets are likely to
become more volatile with the increased risk of asset bubbles and inflation
rising in different parts of the world. At the same time, more banks and
insurers are expected to assign individual responsibility for overseeing
financial risks arising from climate change, while investors are paying closer
attention to the adequate and timely disclosure of the risk that it poses for
the company or financial instrument they invest in. The tightening regulatory
environment, the prospect of climate change litigation or ‘greenwashing’
allegations could all potentially impact D&Os. Cases have focused on the nature of investments, although there is a rise
in litigation to drive behavioral shifts and force disclosure debate.

Meanwhile, digitalization has
further accelerated following Covid-19, creating enhanced cyber and IT security
exposures for companies. This requires firms’ senior management to maintain an
active role in steering the ICT (information and communication technologies) risk
management framework. “IT outages and service disruptions or cyber-attacks
could bring significant business interruption costs and increased operating
expenses from a variety of causes including customer redress, consultancy
costs, loss of income and regulatory fines. Last, but not least, brand
reputation can also suffer. All this can ultimately impact a company’s stock
price with management being held responsible for the level of preparedness,”
says Jenny Wilhelm, Regional Head of Financial Lines Asia.

litigation risk in the US

Litigation risk continues to be
a top D&O concern, in particular around shareholder derivative actions
which are increasingly being brought on behalf of foreign companies in US courts.
“A number of new lawsuit filings, the recent openness of certain courts to
extending long-arm jurisdiction, and a possibly record-breaking settlement
announced in October 2021, point to heightened US litigation risk for directors
and officers of non-US domiciled companies,” David Ackerman, Global Claims Key
Case Management at AGCS emphasizes.

Since early 2020, a group of
plaintiffs’ firms has brought more than 10 derivative lawsuits in New York state
courts on behalf of shareholders of non-US companies seeking to hold directors
and officers legally and financially accountable for various breaches of duty
to their corporations. The financial hurdles to bring suit in the US are
significantly lower than in many other countries, while US courts and juries
are considered more plaintiff-friendly than many others around the world. The
consequences to directors and officers forced to defend themselves in
derivative litigation before US courts can be severe. In what may turn out to
be a record-setting settlement for a US derivative lawsuit, in October of this
year defendants agreed to pay a minimum of US$300mn to settle litigation brought in a New York state court by
shareholders of Renren, a social media corporation based in China, and
incorporated in the Cayman Islands, after allegations of corporate misconduct.

Scrutiny over SPACs

Another emerging risk in the global D&O insurance space comes from the growth
of so-called Special Purpose Acquisition Companies (SPACs), also known as
‘blank check companies’. These represent a faster track to public markets. Advantages
fueling the growth of SPACs over traditional Initial Public Offerings (IPOs)
include smoother procedures, less regulatory and process burdens, easier
capital sourcing and shorter timelines to complete a merger with target
companies. During the first half of 2021, the number of SPAC mergers in the US,
both announced and completed, more than doubled the full year total of 2020
with 359 SPAC filings, garnering a combined US$95bn
raised. The growth of SPACs in Europe may not match the scale of the US boom,
but there is still a growing expectation that it will increase despite a less favorable
company law environment compared to the US. In Asia the market is slowly
gaining momentum with a significant uptick in companies in China, Hong Kong and
Singapore as a new route to accessing capital markets.

So far the SPAC boom has been
largely concentrated in high-growth industries such as technology, financial
services and healthcare. Earlier this month, Grab – the car-hailing service in South East Asia, made its stock market
debut on New York’s Nasdaq trading platform.

scrutiny and enforcement over the SPAC sector have also increased after two
years of booming activity. The scrutiny and lawsuits have piled more risk on
the market for D&O insurance. One issue in Hong Kong is securing
liability insurance for SPAC directors and officers against incorrect
statements and negligence. The cost of such coverage has materially steepened for
many Chinese firms listed in the U.S. because of increased scrutiny and
activism in recent years.

SPACs carry a set of specific
‘insurance-relevant’ risks, and losses are already reported to be flowing
through to the D&O market as both the SPAC and the private target company
typically obtain D&O coverage. “Exposures could potentially stem from mismanagement,
fraud or intentional and material misrepresentation, inaccurate or inadequate
financial information or violations of rules or disclosure duties,” says David
Van den Berghe, Global Head of Financial Institutions at AGCS.

In addition, a failure to
finalize the transaction within the two-year period, insider trading during the
time a SPAC goes public, a wrong selection of a target to acquire or the lack
of adequate due diligence in the target company could also come into play.
Post-merger the risk of the go-forward company to perform as expected or
failure to comply with the new duties of being a publicly-listed company also
needs to be considered.

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