Volatile Markets, U.S. Lawsuits, ESG Issues and SPACs Create New Risks for Managers: Allianz

Board members and company executives are increasingly being held liable in a variety of scenarios. Today's market volatility, with the increased threat of asset bubbles and inflation, the prospect of an increasing number of insolvencies as a result of the pandemic environment, rising scrutiny of companies' environmental, social, and governance (ESG) performance, and the urgency for robust cyber resilience are key risks for Directors and Officers (D&Os) to watch in 2022.

Source: Allianz | Published on December 15, 2021

Global risk concerns

"A number of new lawsuit filings, the recent willingness of certain courts to extend long-arm jurisdiction, and a potentially record-breaking settlement announced in October 2021 all point to increased US litigation risk for directors and officers of non-US-domiciled companies."

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

"The actions and culture of organizations, as well as their directors and officers, are being scrutinized by a wide range of stakeholders, with litigation risk being a primary concern," says Shanil Williams, Global Head of Financial Lines at AGCS.

"This comes against the backdrop of a stabilizing D&O market, though capacity remains tight in some segments and many companies would like to purchase more limits than the industry can provide." Market remediation has progressed, including our own portfolio at AGCS, and this will gradually relieve the pressure that some of our clients are experiencing. We are taking a conservative and disciplined underwriting approach, and we must remain wary of the current volatile business environment while closely monitoring loss trend patterns. However, the D&O insurance space is slowly but steadily reintroducing opportunities for profitable growth in select pockets – which we are eager to pursue."

Uncertain insolvency issues remain a hot topic in the D&O industry

The withdrawal of pandemic-era support measures paves the way for a gradual normalization of business insolvencies in 2022. After two years of decline, the Euler Hermes Global Insolvency Index is expected to rebound by +15 percent year on year in 2022. (-6 percent forecast in 2021 and -12 percent in 2020). While the wave of insolvencies has been milder than expected thus far, mixed trends are expected around the world. In less developed markets, such as Africa and Latin America, the number of bankruptcies is expected to rise faster than in more developed economies, such as France, Germany, and the United States, where the impact of government assistance is expected to last longer. Insolvency has traditionally been a major cause of D&O claims, as insolvency practitioners seek to recoup losses from directors. Following insolvency, stakeholders may pursue directors in a variety of ways, including claiming that boards failed to adequately prepare for a pandemic or for extended periods of reduced income.

Key issues include market volatility, climate change, and digitalization

In the current economic climate, the financial services industry, as well as companies from other sectors, face numerous risk management challenges. Markets are likely to become more volatile as the risk of asset bubbles and rising inflation in various parts of the world increases. Simultaneously, 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 adequate and timely disclosure of the risk that climate change poses to the company or financial instrument in which they invest. The prospect of climate change litigation or 'greenwashing' allegations, as well as the tightening regulatory environment, could all have an impact on D&Os.

Meanwhile, digitalization has accelerated in the aftermath of Covid-19, increasing companies' cyber and IT security risks. This necessitates that the firm's senior management remain actively involved in steering the ICT (information and communication technologies) risk management framework. "IT outages and service disruptions, as well as cyber-attacks, could result in significant business interruption costs and increased operating expenses due to a variety of factors such as customer redress, consultancy costs, income loss, and regulatory fines." Last but not least, brand reputation can suffer as well. "All of this can have an impact on a company's stock price, with management held accountable for the level of preparedness," says Joseph Caruso, Regional Head Financial Institutions North America.

Increased litigation risk in the United States

Litigation risk remains a top D&O concern, particularly shareholder derivative actions, which are increasingly being brought in US courts on behalf of foreign companies. "A number of new lawsuit filings, the recent willingness of certain courts to extend long-arm jurisdiction, and a potentially record-breaking settlement announced in October 2021 all point to heightened US litigation risk for directors and officers of non-US domiciled companies," says David Ackerman, Global Claims Key Case Management at AGCS.

Since early 2020, a group of plaintiffs' firms has filed more than ten derivative lawsuits in New York state courts on behalf of shareholders of non-US corporations, seeking to hold directors and officers legally and financially liable for various breaches of duty to their corporations. The financial barriers to bringing a lawsuit in the United States are significantly lower than in many other countries, and US courts and juries are considered more plaintiff-friendly than in many other countries. The ramifications for directors and officers who are forced to defend themselves in derivative litigation in US courts can be severe. In what may turn out to be a record-breaking settlement for a US derivative lawsuit, defendants agreed in October of this year to pay a minimum of US$300 million 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, following allegations of corporate misconduct.

In the United States, the report notes that a decision by the Delaware Supreme Court in 2019, Marchand v. Barnhill, which focused on the fallout from a listeria outbreak, is potentially leading to greater exposure for individual corporate directors in the form of shareholder derivative suits, as it is seen to have lowered the previously high standard required for plantiffs to prove a board's failure to comply with their duty of care, as established in the landmark Caplan decision. Board members must re-evaluate whether their D&O insurance program provides adequate Side A coverage (which covers liabilities incurred by an individual in their capacity as a director or officer).

SPACs are being scrutinized

Another emerging risk in the global D&O insurance space is the rise of Special Purpose Acquisition Companies (SPACs), also known as "blank check companies." These represent a more rapid path to public markets. Smoother procedures, fewer regulatory and process burdens, easier capital sourcing, and shorter timelines to complete a merger with target companies are driving the growth of SPACs over traditional IPOs.

The number of SPAC mergers announced and completed in the United States during the first half of 2021 more than doubled the full-year total of 2020, with 359 SPAC filings raising a total of US$95 billion. SPAC growth in Europe may not be on the scale of the US boom, but there is still a growing expectation that it will increase despite a less favorable company law environment in Europe. In Asia, the market is gradually gaining traction, with a significant increase in companies in China, Hong Kong, and Singapore as a new route to capital markets.

SPACs carry a unique set of 'insurance-relevant' risks, and losses are already being reported to the D&O market, as both the SPAC and the private target company typically obtain D&O coverage. "Exposures could potentially result from mismanagement, fraud or intentional and material misrepresentation, inaccurate or inadequate financial information, or violations of rules or disclosure duties," says AGCS Global Head of Financial Institutions David Van den Berghe.

In addition, failure to complete the transaction within the two-year period, insider trading during the time a SPAC goes public, the wrong target to acquire, or a lack of adequate due diligence in the target company could all be factors. The risk of the going-forward company failing to perform as expected or failing to comply with the new duties of being a publicly-traded company must also be considered post-merger.

About Allianz Global Corporate & Specialty SE

Allianz Global Corporate & Specialty (AGCS) is a leading global corporate insurance carrier and an important business unit within the Allianz Group. Across 10 dedicated lines of business, we provide risk consulting, Property-Casualty insurance solutions, and alternative risk transfer for a diverse range of commercial, corporate, and specialty risks.

Our clients are as diverse as business itself, ranging from Fortune Global 500 corporations to small businesses and private individuals. Wineries, satellite operators, and Hollywood film productions are among them, as are the world's largest consumer brands, tech companies, and the global aviation and shipping industries. They all look to AGCS for smart solutions to their most complex risks in a fast-paced, multinational business environment, and they rely on us to provide an exceptional claims experience.

AGCS employs approximately 4,400 people worldwide, with its own teams in 31 countries and through the Allianz Group network and partners in over 200 countries and territories. We have strong and stable financial ratings as one of Allianz Group's largest Property-Casualty units. AGCS generated a total of €9.3 billion in gross premium globally in 2020.