The Rising Cost of Corporate Risk: D&O Insurance Under Pressure
The recent bankruptcy of First Brands, a car parts maker, isn’t just a tale of financial woes. It’s a stark illustration of a growing trend: escalating costs and increased scrutiny within the Directors & Officers (D&O) insurance market. The case, involving claims of fraud and drawing the attention of the Department of Justice and the SEC, highlights how D&O policies are being tested like never before.
A $200 Million Safety Net – And Why It’s Being Challenged
First Brands secured a substantial D&O policy – potentially reaching $200 million – to protect its executives from legal liabilities. This figure is unusually high for a private company of its size, typically reserved for Fortune 250 corporations. The fact that insurers like Berkshire Hathaway, Chubb, and AIG were involved underscores the scale of the potential risk. However, creditors are now fiercely contesting the use of these funds, arguing the insurance was a “fortress” built to shield executives rather than protect legitimate stakeholders.
This dispute isn’t isolated. It reflects a broader tension: are D&O policies designed to encourage responsible corporate governance, or simply to provide a financial buffer for potentially reckless behavior? The creditor’s argument – that the insurance should cover liabilities owed to them – is gaining traction as bankruptcy courts grapple with these questions.
The Invoice-Backed Financing Factor: A New Layer of Complexity
The First Brands case is further complicated by its reliance on invoice-backed financing, a form of supply chain finance. This relatively esoteric financial product has come under increased scrutiny in recent years, with concerns about its potential to mask debt and inflate financial performance. The collapse of Greensill Capital in 2021 served as a major wake-up call, exposing the risks associated with these arrangements. Now, First Brands is adding another chapter to this story, demonstrating how these financing methods can amplify D&O exposure.
Did you know? The volume of D&O claims related to invoice-backed financing has increased by over 30% in the last two years, according to a report by Woodruff Sawyer.
The Impact on the Insurance Market: Premiums on the Rise
The First Brands situation, coupled with a general increase in regulatory enforcement and litigation, is driving up D&O insurance premiums. Insurers are reassessing their risk models and becoming more selective about the companies they cover. Renewal rates are soaring, and coverage limits are often being reduced. A recent survey by Marsh McLennan found that D&O premiums increased by an average of 15% in the first quarter of 2024, with even larger increases for companies in high-risk industries.
This trend is particularly pronounced for private companies and those involved in complex financial transactions. Insurers are demanding greater transparency and more rigorous due diligence before issuing policies. They are also scrutinizing the quality of a company’s risk management practices and the experience of its directors and officers.
Beyond Premiums: The Rise of “Claims-Made” Policies and Exclusion Clauses
Insurers aren’t just raising premiums; they’re also tightening policy terms. “Claims-made” policies, which cover claims made during the policy period regardless of when the underlying event occurred, are becoming increasingly common. This shifts more risk onto policyholders, as they must maintain continuous coverage to ensure protection.
Furthermore, insurers are expanding the scope of exclusion clauses, particularly those related to fraud, misconduct, and regulatory investigations. This means that companies may find themselves without coverage for claims that were previously covered.
What Does This Mean for the Future?
The First Brands case is a harbinger of things to come. Expect to see:
- Increased D&O premiums: The upward trend is likely to continue, especially for companies in high-risk sectors.
- Stricter underwriting standards: Insurers will demand more information and conduct more thorough due diligence.
- Greater scrutiny of financial transactions: Invoice-backed financing and other complex financial arrangements will be subject to increased scrutiny.
- More litigation over D&O coverage: Disputes between companies, creditors, and insurers are likely to become more frequent.
Companies need to proactively manage their D&O risk by strengthening their corporate governance practices, investing in robust risk management systems, and maintaining open communication with their insurers.
FAQ: D&O Insurance in a Changing Landscape
- What is D&O insurance? D&O insurance protects the personal assets of a company’s directors and officers from lawsuits alleging wrongful acts in their capacity as leaders.
- Why are D&O premiums increasing? Increased litigation, regulatory scrutiny, and complex financial transactions are driving up costs.
- What can companies do to mitigate D&O risk? Strengthen corporate governance, invest in risk management, and maintain open communication with insurers.
- What is invoice-backed financing? A form of supply chain finance where companies receive early payment on their invoices from a third-party financier.
Pro Tip: Regularly review your D&O policy with your broker and legal counsel to ensure it adequately covers your company’s evolving risk profile.
Want to learn more about managing corporate risk? Explore FT’s coverage of Corporate Governance. Share your thoughts on this evolving landscape in the comments below!
