D&O Insurance

New laws, judgements and trends in digitisation have exacerbated the risks of directors and officers in Germany being held liable for misconduct. Their already high liability is being further increased by stricter regulatory provisions and guidelines with respect to IT compliance, data protection and privacy. These new insurance issues concern companies and managers alike. It is now often necessary to adjust different Financial Lines products to obtain good coverage. Such insurance solutions go far beyond Director´s & Officer´s Liability Insurance (D&O).

Market Situation

The German D&O market offers managers good protection at affordable rates. Notwithstanding the already low price level, even further reductions can, in some cases, be realised, usually below 10 per cent. Insurance terms & conditions (Ts&Cs), too, have improved. D&O polices have been extended to include insolvency risk cover. This extension followed a court decision that adversely affects the position of directors and officers: Directors are required to compensate the company for payments made after the company has become illiquid or after it is deemed to be over-indebted (liability for payments following illiquidity or over-indebtedness pursuant to section 64 of the German Limited Liability Companies Act, GmbHG). According to a decision reached by the Higher Regional Court (Oberlandesgericht) in Celle, Germany (ref. AZ 8 W 20/16), such cases are not covered by a D&O policy. However, in view of the highly competitive D&O market, most insurers decided in the wake of the judgement to include liability for payments following illiquidity or over-indebtedness in their coverage.

Despite the fierce competition in this line, a number of D&O insurers have increased their rates in individual cases this year. The reason for this is the insurers' high claims expenses. GDV, the German Insurance Association, last year published figures on the D&O market for the first time. According to these figures, the loss ratio for the years 2015 and 2016 stood at 114.9 per cent and 95 per cent respectively. The inclusion of a potential expense ratio of 30 per cent results, on average, in a combined ratio of 145 per cent and 125 per cent respectively. Certain customers had some sympathy for the price increases demanded by the insurers and paid the higher rates. Other customers, however, opposed the increases and switched D&O insurer.

^* incl. claims management expenses
Figures have been rounded.

Source: GDV

Outlook

The international D&O market is becoming more competitive. Past years have seen record settlement amounts in class actions in the U.S. In the past two years alone, 15 settlements were among the top 100 highest settlement amounts ever recorded.

These included settlement amounts of USD 3.5bn, USD 175m and USD 210m agreed by Petrobas, BP Deepwater Horizon and Salix Pharmaceutical respectively. The U.S. bank Wells Fargo also hit the headlines with a USD 480m settlement reached in a scandal concerning alleged fictitious customer accounts.

D&O insurance rates in Australia have been rising substantially this year. Among other things, this trend is due to a rise in investor lawsuits as a result of the increased number of professional litigation funders, currently 17 companies, and specialised investor law firms. D&O customers in Australia now face further substantial double-digit percentage increases in prices as well as a reluctance on the part of insurers in relation to D&O underwriting.¹

International comparisons and D&O scenarios …

… of the past two years

^* Estimated reserve in the D&O insurance

Source: ISS Securities Class Actions Services 2018

In Germany, too, there is evidence that insurance rates and Ts&Cs could deteriorate in the future.

• The high D&O reserves presumably accumulated during the VW diesel scandal might become a burden for the German market as a whole.
• The German Model Declaratory Action Law (Gesetz zur Musterfeststellungsklage) passed in June 2018 could lead to a higher risk of class actions, a development feared by D&O insurers.
• Litigation funders and investor law firms have also already been active in Germany for some time.
• International claims trends are also affecting the German market. It can be expected, therefore, that some major U.S. claims will be settled in the London D&O market, putting a massive strain on it. This means that insurers with an international background but operating in Germany are, in part, directly affected by international claims payments. This could also affect German risk perception.

Market Trends

In Germany, tighter regulations and digital risks are becoming increasingly important for D&O liability. A wealth of new laws was passed last year, and these have to be considered by company managers. These laws include the new EU General Data Protection Regulation (GDPR) and the German Federal Data Protection Act (Bundesdatenschutzgesetz, BDSG), the Transparency Register Act (Transparenzregistergesetz), the Money Laundering Act (Geldwäschegesetz) and the Combined Section Act (Verbandssanktionengesetz) currently being drafted. Furthermore, the effects of the IT Safety Act, passed in 2015 and being implemented this year, are now being felt. Common to all these laws is the fact that the companies concerned are required to take measures. These measures often entail significant workload.

It appears that many organisations, SMEs in particular, are being overstretched by the complex requirements. What is more, many organisations are still not complying with the new legal rules that are already in force. If they fail to comply with the new legislation, they risk high fines and claims for damages by third parties. What is new is that they must, in some instances, prove to the authorities that they are legally compliant. This obligation applies irrespective of any suspicion and is comparable with a reversal of the burden of proof. Consequently, the perpetual risk of regulatory proceedings before authorities becomes ever more frequent. Unlike before, this is no longer a matter of non-compliance in individual cases.

It is important for managers to know whether they would be entitled to take recourse against regulators in respect of fines imposed on the organisation. This issue is controversial in Germany and regulated differently worldwide.² A supreme court ruling failed to bring clarity in this matter (German Federal Labour Court, ruling dated 29/06/2017 - ref. 8 AZ 189/15 -, PM 30/17). Managers are therefore strongly advised to ensure that their respective D&O insurance Ts&Cs are formulated in their favour.

Damage as a result of cyber and social media crimes is still taking up room in the Financial Lines segments. Losses due to Fake President fraud, i.e. cases where payment is fraudulently prompted from an organisation by a purported senior officer, is still commonplace.

IT-related offences rank high on the list of business offences in the German economy. From an IT compliance perspective, this risk field is liability-relevant on a managerial level. Companies that introduce compliance management systems may face a more positive liability situation and lower fines (German Federal Court (Bundesgerichtshof, BGH), ruling dated 09/05/2017, ref. AZ 1, StR 265/16).

E-Crime in the German Economy

Percentage affected

27 % of the German economy was affected by e-crime in 2013,40 % in 2015 and 38 % in 2017

Source: KPMG Deutschland, e-Crime in der deutschen Wirtschaft 2017

These new insurance issues concern companies and managers alike. In many cases, different Financial Lines products have to be co-ordinated in order to manage the existing risks. This concerns D&O, cyber, fidelity loss and legal expenses insurance products. Joint liability, the transition of claims, claims series clauses and priority agreements are all issues to be solved at contract level. Further issues such as reporting duties and competing obligations arise in the case of loss. Insurers are responding to this situation by taking a point of view that covers various insurance lines. Consequently, there could be a scenario where one insurance line is affected by another such as, for example, the exclusion of President Fraud cases in a D&O policy if a corresponding claim is settled under the fidelity loss policy.