DIRECTORS & OFFICERS INSURANCE MARKET INSIGHTS

Q1 2019

OVERVIEW• The Directors & Officers (D&O) insurance market for

listed companies continues to deteriorate - Australia’s active class action environment continues to present challenges for D&O insurers.

• Premiums for limits of liability under $70 million continue to be subject to significant premium pressure – excess insurers see the risk of a securities class action claim as similar to the exposure faced by primary insurers.

• Most insureds should anticipate a minimum deductible for securities entity claims between $1-5 million for any one claim.

• D&O capacity in the Australian and London markets remains generally available; however, if securities entity coverage is required, insurers are increasingly selective and thorough in their underwriting reviews.

• Insurers appetite to cover securities entity claims for small ASX insureds - or insureds in more challenging business sectors - is diminishing.

• Looking ahead – for listed companies, upward pressure on premiums will continue. Organisations with smaller market capitalisations may see larger relative premium increases. For non-listed companies, renewals will generally see modest premium increases.

STATE OF THE MARKETD&O insurers of Australian listed companies are now strongly entrenched in strategies to deliver a substantial upward re-alignment of the Australian D&O premium pool. Insurers are taking this action in the face of ongoing profitability challenges emanating from Australia’s active securities class action environment and other significant claims activity.

As D&O insurance market conditions continue to deteriorate, APRA has identified that, notwithstanding pricing correction in 2017 and 2018, “premiums are still insufficient to offset the many prior years of rate reductions and inadequate premiums. Further premium increases are needed to generate a sustainable rate level to cover losses” (APRA, 2018)

The evolving nature of the class action environment and the lack of foreseeability of many securities class actions is hindering some insurers efforts to accurately model future premium requirements. This is demonstrated by the volatility in premiums offered between insurers and is especially evident in layers of insurance purchased between the primary layer and a limit of liability of $70 million.

Insurers’ perceptions of the current risk environment and/or the potential for multiple “full limit” losses is also tempering some insurers appetite for participation on listed organisation D&O programmes, at lower attachment levels, at any premium.

Non-listed organisations are also experiencing some modest upward pressure on premiums based on their individual risk profiles and business sectors. Insured’s who operate within the retail, construction, energy and health sectors are subject to particularly rigorous review by insurers.

Climate change is a risk area receiving increasing focus from both regulators and advocacy groups.

According to Aon’s research, since January 2018, at least 15 securities class actions (including competing class actions) have been filed against Australian listed companies and at least a further 5 are being investigated.

In March 2019 in a historic joint sitting, the Federal and NSW Court of Appeal re-affirmed the Court’s power to make common fund orders in the matters of Westpac Banking Corporation v Lenthall [2019] FCAFC 34 and Brewster v BMW Australia Ltd [2019] NSWCA 35. Common fund orders were introduced in 2016 and have led to an increase in securities class actions being filed as “opt out” or open class actions as they enable the litigation funders’ returns (which is set/approved by the court as a percentage of the proceeds to the class) and plaintiff law firms costs to be shared between all members of the class.

Without the requirement to “bookbuild”, as is the practice with “opt in” or closed class actions, open competing securities class actions have become commonplace.

Australian Law Reform Commission

The regulation of securities class actions continues to be subject to high profile debate following the release, in December 2018, of the Australian Law Reform Commission’s (“ALRC’s”) final recommendations into Integrity, Fairness and Efficiency—An Inquiry into Class Action Proceedings and Third-Party Litigation Funders. The report makes 24 recommendations covering case management and settlement approval, the regulation of litigation funders, solicitor’s fees and conflicts of interest, regulatory redress and a review of substantive law (ALRC, 2019).

If implemented, a recommendation to allow plaintiff law firms to charge contingency fees may increase interest in the pursuit of smaller sized securities class actions. This could further impact insurers bottom line. These smaller securities class actions can be less attractive to litigation funders due to the modest potential returns generated. Should this occur, the availability and cost of D&O insurance (which includes cover for securities class actions), especially for companies with smaller market capitalisation, may be further impacted.

The ALRC has also recommended a review of the ”legal and economic impact of the operation, enforcement, and effects of continuous disclosure obligations and those relating to misleading and deceptive conduct contained in the Corporations Act 2001 (Cth) and the Australian Securities and Investments Commission Act 2001 (Cth)” (ALRC, 2019). Relevantly, ASIC in its submission to the ALRC has expressed a contrary view that, “Shareholder class actions can provide an effective accountability mechanism that helps address the power imbalance between shareholders and defendants. We have not seen any evidence that would suggest a review of these provisions is necessary” (ASIC, 2018).

Directors Under More Scrutiny

Securities class actions are commonly accompanied by ASIC investigations and the roles of directors and other vested with stewardship responsibility continue to become more onerous as their roles become subject to increasingly active oversight by regulatory authorities, shareholders and those acting on their behalf, and by special interest and advocacy groups.

THE RISK LANDSCAPE

Record Funding and Resources for ASIC and APRA

“ASIC will receive $400 million in additional funding in 2019/20, a 25% increase over 2017/18.”

“APRA will receive $150 million in additional funding, a 30% increase over 2017/18”

- The Hon Josh Frydenberg MP, 23 March 2019

In mid-February 2019, following a review of the enforcement regime, legislation was passed for a new penalty framework. ASIC will now have the power to impose harsher penalties for a broader range of corporate wrongdoing including, amongst other measures imposing penalties of up to $525 million for corporations and $1.05 million for individuals (ASIC, 2019).

Royal Commission

The release of the final report of the Royal Commission into the Banking, Superannuation and Financial Services Industry (2019) on February 4, 2019, makes 5 specific recommendations in relation to culture, governance and remuneration for the financial services sector. This includes raising specific questions for consideration in relation to how regulatory, conduct and compliance risks are managed within organisations (Royal Commission, 2019). Insurers look to similar questions in their underwriting reviews and direct insurer/client engagement provides opportunities for clients to differentiate their risk profiles around these pivotal themes.

Premiums

For larger ASX listed organisations, primary insurers who have remained active in the market, are generally prepared to engage early with insureds to outline their renewal requirements. Insurers renewal expectations continue to vary, as they work predominately with levers of pricing and deductibles.

D&O insurance (where it includes entity cover for securities class actions) for some smaller ASX listed organisations is becoming more difficult to obtain or the premiums for the cover are being priced well beyond their preparedness to pay.

Based on Aon’s proprietary data, ASX200 insureds experienced a median 122% increase in primary premiums for H2 2018.

Aon’s data also reveals pressure on the trajectory of rate change as some insurers express frustration with the current conditions through limited pricing flexibility and greater focus on the ‘end game”. For H1 2018 the median increase in primary premiums for ASX200 clients was 89%.

Source: Aon proprietary data

Medium Primary Rate Per Million % Change ASX200 Randomised Basket

H2 2017 to H2 2018

H1 2017 to H1 2018

H2 2016 to H2 2017

H1 2016 to H1 2017

0.00% 20.00% 40.00% 60.00% 80.00% 100.00% 120.00% 140.00%

21.21%

46.66%

89.02%

122.72%

Aon’s ILP (“Increased Limit Premium”) Curve, based on Aon’s proprietary data “demonstrates the extent to which insurers average premium requirements for participation attaching at different limits of liability have increased between 2017/18 and 2018/19.

Most premium pressure is focussed on low attachment layers (i.e. limits of liability below $100 million). As the average securities class action settlement is circa $50 million plus legal costs, insurers are predominately concerned with their potential exposure to a securities class action when participating on limits of liability below $100 million. Insurers premium requirements remain volatile in the first $70 million. many insurers prepared to “walk away” due to perceived inadequate pricing.

Premiums for limits of liability under $70 million continue to be subject to significant premium pressure as insurers see the risk of a securities class action claim as similar to the exposure faced by primary insurers.

0

10000

20000

30000

40000

50000

60000

70000

80000

90000

100000

110000

120000

2018-19 Average Rate per $5m/Capacity - TO DATE

2017-18 Average Rate per $5m/Capacity

ASX200 Randomised Basket ILPCurve

0 $5 $10

$15

$20

$25

$30

$35

$40

$45

$50

$55

$60

$65

$70

$75

$80

$85

$90

$95

$100

$105

$110

$115

$120

$125

$130

$135

$140

$145

$150

$155

$160

$165

$170

$175

$180

$185

$190

$195

$200

$205

$210

$215

$220

$225

$230

$235

$240

$245

Source: Aon proprietary data

Capacity

Key primary insurers in both the Australian and London insurance markets remain committed to the provision of comprehensive D&O coverage to ASX listed organisations. However, where coverage for securities entity claims is required, insurers have become more selective and thorough in their underwriting reviews and many are capping their overall portfolio exposure to securities class action claims. Where coverage is made available, the terms and conditions offered by those insurers are reflective of the Insurers’ drive for sustainability in a particularly challenging environment. Most insurers will limit their capacity outlay to $10 million, however some insurers may be prepared to offer additional capacity on a ventilated basis. A limited number of insurers continue to offer higher limits of liability on either a primary or an excess basis.

Therefore, while securities entity coverage continues to be generally available, for those companies with small market capitalisation, or those organisations who are more speculative in nature, or subject to volatile share price activity, or involved in more challenging business sectors or activities, the availability of securities entity coverage is diminishing as Insurers often perceive an insufficient return for the potential risk. If cover is offered, if may well be at a prohibitive cost.

Filling capacity shortfalls on programmes for limits of liability between the primary and $70 million remains subject to additional pricing pressure and limited insurer appetite, necessitating appropriate strategic planning and early engagement.

Insurers who participate primarily as excess insurers are very cautious with regard to participation below a limit of liability of $70 million to $80 million. Participation below this limit of liability is considered by many insurers to be within the “burn zone” based on average securities class action settlements and associated defence costs.

London insurers appetite for excess participation on D&O programmes for ASX listed organisations has contracted and a divergence in portfolio pricing between London and Australian insurers is no longer evident.

Where coverage for securities entity claims is not required, all insurers continue to have a strong appetite for the provision of D&O coverage across all sizes of listed and unlisted organisations.

Deductibles / Excesses

Insureds should anticipate minimum deductibles for securities entity claims (“Side C”) of between $1 million any one claim and $5 million any one claim based on risk profile and an organisation’s size. At least one leading insurer is imposing a minimum Side C deductible for large ASX listed companies of $10 million any one claim. Based on current experience, at a deductible level of $10 million any one claim, the legal costs associated with the defence of a securities class action will largely be uninsured. With such significant exposure, insured’s balance sheets will be frontline in any securities class action.

Based on risk profile, some insurers are also placing some pressure on Side B (Company Reimbursement) deductibles of up to $1 million any one claim.

Insurers appetite to cover securities entity claims for small ASX insureds or to insureds in more challenging business sectors is diminishing.

Insurers renewal requirements on ASX list organisations will continue to be primarily influenced by the regulatory environment and an organisation’s market capitalisation. Organisations with smaller market capitalisation may see larger percentage increases in premium as insurers demand minimum premiums for exposure to the risk of a securities class action, while organisations with very large market capitalisation will continue to see a realignment of base line pricing as relatively modest “stock drops” may translate into large securities class actions should investigations reveal possible breaches of continuous disclosure obligations or other wrongdoing.

For non-listed companies, primary renewal premiums will be subject to modest premium increases based on individual risk profiles and insurers perceived adequacy of the current premium and deductable levels.

For listed clients it is recommended that the renewal planning be commenced early to ensure that an informed strategy for the renewal of the D&O program can be agreed and early market engagement undertaken. Given the upward pressure on pricing, insurers are seeing a significant increase in the number of submissions creating some congestion in the market. Early engagement with the Insurers together with face-to-face meetings, where viable, to differentiate one’s risk profile will enable the best outcomes to be secured.

Renewal strategy discussions should include a reassessment of the adequacy of limits of liability purchased and the continued appropriateness of any ringfencing of those limits for the protection of directors’ non-indemnified loss.

In the current environment demonstrated contestability of the pricing should be demanded through benchmarking, limited or broad re-marketing activities or other methodologies.

LOOKING AHEAD

ALRC. (2019, January 24). Inquiry into Class Action Proceedings and Third-Party Litigation Funders. Retrieved from Australian Law Reform Commission: https://www.alrc.gov.au/news-media/inquiry-class-action-proceedings-final-report

APRA. (2018). Insight Issue 4 2018; Class Actions and the growing importance of Directors and Officers Insurance. Retrieved from WWW. apra.com.au: https://www.apra.gov.au/class-actions-and-growing-importance-directors-and-officers-insurance

ASIC. (2018, September). Australian Law Reform Commission Inquiry into class action proceedings and third-party litigation funders Submission by the Australian Securities and Investments Comission. Retrieved from alrc.gov.au: https://www.alrc.gov.au/sites/default/files/pdfs/72_australian_securities_and_investments_commission.pdf

ASIC. (2019, February 4). 19-020MR Statement from ASIC Chair James Shipton on the Final Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. Retrieved from Australian Securities and Investment Commission: https://asic.gov.au/about-asic/news-centre/find-a-media-release/2019-releases/19-020mr-statement-from-asic-chair-james-shipton-on-the-final-report-of-the-royal-commission-into-misconduct-in-the-banking-superannuation-and-financial-services-industry/

ASIC. (2019, February 15). ASIC to pursue harsher penalties after laws passed by senate. Retrieved from https://asic.gov.au/about-asic/news-centre/find-a-media-release/2019-releases/19-032mr-asic-to-pursue-harsher-penalties-after-laws-passed-by-senate/

Royal Commission. (2019, February 4). Final Report; Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. Retrieved from royalcommission.gov.au: https://www.royalcommission.gov.au/sites/default/files/2019-02/fsrc-volume-1-final-report.pdf

The Treasury. (2019, March 23). $35 million to extend the Federal Court’s jurisdiction to corporate crime. Retrieved from The Hon Josh Frydenberg MP, Treasurer of the Commonwealth of Australia: http://jaf.ministers.treasury.gov.au/media-release/048-2019/

The Treasury. (2019, March 23). Record funding and resources for ASIC and APRA to help restore trust in Australia’s financial sector. Retrieved from The Hon Josh Frydenberg MP, Treasurer of the Commonwealth of Australia: http://jaf.ministers.treasury.gov.au/media-release/047-2019/

REFERENCES

About Aon

Aon plc (NYSE:AON) is a leading global professional services firm providing a broad range of f risk, retirement and health solutions.

Our 50,000 colleagues in120 countries empower results for clients by using proprietary data and analytics to deliver insights that

reduce volatility and improve performance.

© 2019 Aon Risk Services Australia Limited

ABN 17 000 434 720 | AFSL 241141

This information is intended to provide general insurance related information only. It is not intended to be comprehensive, nor

does it, or should it (under any circumstances) be construed as constituting legal advice. You should seek independent legal or

other professional advice before acting or relying on any of the content of this information. Aon will not be responsible for any

loss, damage, cost or expense you or anyone else incurs in reliance on or user of any information contained in this document.

BBFS0001A 0419

CONTACTJulie Hamilton

National Directors & Officers Liability Practice Leader + 61 2 9253 7607 julie.hamilton@aon.com