Insurers are placing an increased emphasis on the risk profile of the directors, officers and overall governance of the respective entities, says the Institute of Directors. File photo Photo: zimmytws/123RF
Company directors are being warned insurers will swerve covering them for liability if they do not know the ins and outs of their businesses.
A new report from the Institute of Directors (IoD) and insurance broker Marsh NZ identified social disruption, climate change, and environmental, social, and governance - or ESG - as emerging risks directors need to be across this year.
"We believe the potential impacts of these emerging risks and the likely severity of their consequences should drive a new level of inquiry by each director and officer," the report said.
"Allegations of wrongful acts by directors or officers are the key drivers of claims, so having a deeper understanding of their proximate cause and likely consequences is essential."
The institute's general manager at the Governance Leadership Centre, Guy Beatson, said insurers were putting directors through their paces when assessing them for liability insurance - also known as D&O insurance, which covers directors and officers.
Insurers were placing an increased emphasis on the risk profile of the directors, officers and overall governance of the respective entities, Beatson said.
"There is more focus on these things," he said.
"Insurers are asking harder questions and if the insurers aren't getting good answers in terms of that good practice governance and all those dimensions, they will either refuse cover in some cases, or they'll narrow the scope of their cover or raise the price.
"So that's a pretty good incentive for directors across all sorts of entities which have this sort of cover, to pay really strong attention to that culture, conduct, ESG, business continuity, risk management and all of those aspects of good governance."
Beatson said the tougher stance from insurers promoted good governance among directors.
"It came as a surprise to me," he said.
"I thought that when you look at some of this insurance, it would create a range of what economists call moral hazard, that is people just getting the insurance and basically doing what they needed to do.
"But you suddenly find that actually, the insurer is asking these questions means that that's doing part of the reinforcement of good practice governance that we want to see."
The IoD's 2022/23 Directors' Fees report found 89.5 percent of organisations provided directors with liability insurance.
"Directors are facing new and changing challenges, risks, legislation, and stakeholder expectations," Beatson said.
"Each year, the percentage of organisations surveyed by the IoD with D&O insurance is increasing, with a corresponding decrease in the percentage of directors who are wary about taking on governance roles due to increased personal liability."
The report said the insurance market would be impacted by the looming economic downturn, alongside the emerging risks identified, and a surge of D&O claims was expected as the economy worsened.
Beatson said the biggest claims would be around liquidations and receiverships, with liquidators often seeking some sort of compensation from directors they believed had breached their duties.
"But there are other things that occur through this, what we've seen through Covid is people being more litigious, in some sense, in various ways.
"You could see people looking to the performance of directors, say if their share price were to go down, there's something called Side C cover that's referenced in the document, as well as people thinking that the duties were breached, perhaps in terms of commitments made around climate change, for example, which is some some of the stuff that's happening overseas and to a lesser extent, in New Zealand."
A study by Marsh UK between 2005 and 2015 found D&O claims increased by 75 percent during the Global Financial Crisis, peaking in 2012.
The study recorded a steady increase over a two-year period (between 2005 and 2007), with an average number of annual claims rising from 200 to 300. Claims totalled 1685 in 2012.
Beatson advised directors and officers to prepare for an uncertain year.
"Directors should understand what their duties are, understand the difference that they make in terms of having good practice governance for the performance of their organisations and look at it through the positive lens and see the directors and officers insurance is a backstop, rather than trying to just mitigate risk.
"Directors need to pay much, much more attention to the changing risk landscape for the entities, and there's a lot more work to do to think about how to identify those risks and manage them."
He said as directors faced greater liability for the decisions they made at the table, D&O cover would be critical.