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How Agents Can Prepare D&O Clients for Insolvency

Despite the good news in the D&O market, uncertainty remains as the economy faces a period of higher inflation and a possible recession, which could lead to an increase in D&O claims.
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how agents can prepare d&o clients for insolvency

Financial results for the first half of 2022 for the directors & officers insurance market indicate market conditions have improved. The direct loss ratio fell to 53.4%, improving on the 54.7% for the full year of 2021, according to Fitch Ratings, which also found that the market chartered a direct combined operating ratio above 90% and an earned premium growth of 22%.

However, despite the good news, uncertainty remains as the economy faces a period of higher inflation and a possible recession, which could lead to an increase in corporate insolvencies and, therefore, an increase in D&O claims.

“Without question, the unprecedented federal, state and local government financial support helped corporate entities weather the economic fallout of the pandemic and keep millions of people employed," says Mark Azzolino, head of management liability, The Hartford. “Fortunately, many businesses were also able to streamline and optimize their operations while also restructuring debt to help mitigate financial stresses in the near term." 

Nevertheless, “the withdrawal of the government financial support, the impact of the global supply chain crisis, high inflation rates and potential for a mild recession are significant risk factors for businesses of all sizes," Azzolino added.

Boards are vulnerable to a litany of business exposures, and in particular “a lot of companies in the more speculative industries, such as tech, biotech and pharmaceutical, have seen their shares discounted in today's market," says Jim Rizzo, executive risk underwriter, Beazley. “We're seeing a similar discounting on the private equity side—this has been a big downside in how these companies are being valued and their ability to raise funds." 

Currently, “we are seeing the impact of how the surge in special purpose acquisition company (SPAC) activity that has taken companies public—some that may not have been ready— putting pressure on these companies to meet shareholder expectations to perform and manage heightened expenses and challenges of being a public company," says Ziad Kubursi, head of financial and executive liability, The Hartford. “These can potentially lead to financial challenges that may result in a heightened litigation environment," potentially derailing the financial health of any company.

If a company is filing for Chapter 11 bankruptcy, corporations should “exercise extreme prudence, because bankruptcy-related litigation often includes allegations of some form of fraudulent transfer," Rizzo says. “If you spin off a subsidiary to try to raise funds that fortify your balance sheet, you might be selling off one of the most important aspects of the organization and effectively taking that away from the creditors in a bankruptcy proceeding."

Once bankruptcy has been declared, qualified agents or consultants can ensure that all the rules and procedures are adhered to.

“As directors of the corporation, underwriters expect the board to exercise good judgment and make sound business decisions for the company," says Patrick Mitchell, executive risks lead, Coalition Inc. “Additionally, it is expected that before making any major decisions about the company, the board has conducted due diligence and explored the viability of all potential options."

Agents can ensure a company is “focused on and aware of the substantial costs that a business might face in merely defending a lawsuit, even if there ultimately is no liability," Azzolino says. “D&O products provide coverage for defense costs in the event of a covered claim, and those costs can be devastating to a privately held business." 

“Many D&O products also give small and medium-sized businesses access to law firms experienced in managing and defending allegations, which is an impactful benefit of the insurance coverage," Azzolino adds. 

Collaboration between an agent and carrier can “ensure a company has the appropriate terms and conditions to guide it through a period of transition brought on by filing for bankruptcy," Rizzo says. “That includes putting in an extended-term policy that can allow the company to enter Chapter 11, the restructuring period and a prepaid runoff at the end."

Additionally, value-added services, such as helplines or informational resources from carriers, are tools agents can help clients access.

To ease the process, “use experts to solicit outside help, including attorneys, advisors and financial advisors, before starting the communication process with vendors, lenders and shareholders," Rizzo says. “Make sure [your client] has the right strategy in hand to continue your business as a debtor possession and make sure you're giving the appropriate messaging—because the last thing you want to do is pay the wrong party and settle the wrong liability and then be accused of fraudulent transfer."

Olivia Overman is IA content editor.

Monday, December 5, 2022
Big I Markets