The Soaring Costs of Insuring Directors and Officers in the UK and a Comparative Look at the UK and Germany

After a decade of insureds benefitting from a fall in D&O insurance rates on a year-on-year basis, D&O insurance premium rates in the UK have been steadily rising the past couple of years and appear set to increase further as the UK relaxes restrictions imposed to deal with the COVID-19 pandemic.

The upwards trend of insurance premiums in the UK

Brokers have been noting that insureds were experiencing dizzying D&O premium increases long before the pandemic struck.[1] In their Global Insurance Markets Index report of July 2021[2], Marsh JLT Specialty note that pricing increases in FINPRO lines began to rise in Q4 2017, largely driven by increases in D&O premiums. By Q4 2019, there was a 28% increase and by Q4 2020, a whopping 90% increase in rates.

Whilst the COVID-19 pandemic may have ground businesses to a halt, it only served to continue to motivate increases in D&O rates in the UK. According to Marsh JLT Specialty in their H1 2020 market update focusing on the experience of FTSE 350 companies, FTSE 350 purchasers experienced dramatic increases of, on average, 178%.[3] However, Marsh notes in its 2021 report[4] “In the first half of 2021 there were signs of improvement in the UK commercial directors and officers (D&O) insurance market, with the pace of pricing increases slowing in both quarters. New capacity has entered the market – with more than a dozen new insurers writing commercial D&O in the UK market. This has improved supply and is driving competition in some pockets. This slowdown in price increases is expected to continue into the second half of 2021.”

Whilst numbers have dipped slightly in the first half of 2021, Marsh notes “A number of new insurers entered the D&O market, which seemed to have reached its pricing peak, although some clients saw triple-digit increases.”[5]

Nonetheless, pricing is still significantly higher than was seen prior to Q4 2017.

Why prices in the UK have soared in recent years

We have observed a number of factors contributing to the rises, both in terms of the situation prior to and as a result of the COVID-19 pandemic.

First, companies in the UK have faced a growing number of exposures on all fronts with an increased focus on issues such as the move to mandatory climate change-related financial disclosures made by D&Os, the compliance of D&Os with corporate governance practices (which were widely reformed and expanded on in recent years and with more on the horizon with the reform of audit) and how companies deal with sexual harassment in light of the “MeToo” movement. In addition, companies have had increases in cyber-attacks and tougher regulations around data protection to contend with in the UK. Key to all these developments is a focus on individual accountability, putting D&Os squarely in the line of fire.

In connection with this, and representing the largest exposure for D&Os in the UK, there has been increased regulatory scrutiny and investigations in the UK, following the global financial crisis and high-profile corporate scandals, such as Volkswagen and Tesco, and corporate collapses, such as Carillion. Regulators are increasingly taking an aggressive stance, seeking to hold wrongdoers to account and to uphold market confidence and protect consumers. And the range of regulators/prosecutors who could bring actions against D&Os is vast – the list includes the Financial Conduct Authority (FCA), the Prudential Regulatory Authority (PRA), the Health & Safety Executive (HSE), the Environment Agency (EA) and the Pensions Regulator (tPR). Private prosecutions are also becoming more prevalent.

In particular, the FCA has stepped up activity in recent years, though there was a slight dip in 2020 due to pandemic disruption and diverted resources. However, there has been an increase in activity since Autumn 2020 and the FCA’s 2021/22 Business Plan was keen to stress that it will be a more proactive and assertive regulator. As such, we can certainly expect activity to rebound and, for example, greater scrutiny of listed companies’ disclosures regarding material changes in their financial performance given the significant impact to businesses over the past 18 months.

The FCA has also announced and/or issued a number of regulatory changes, which may lead to increased regulatory exposures for companies in the UK. For example, the implementation of the new Financial Services Act 2021 which (1) changes money laundering provisions; (2) increases the maximum penalties for insider dealing; and (3) sets out a more streamlined procedure for the FCA to cancel a firm’s permissions with respect to regulated activities. In addition, there are ongoing reviews into, amongst other things, unauthorised business, the limits of the regulatory perimeter and liquidity mismatch, all of which could lead to further exposures. The FCA is also considering implementing a new consumer duty of care, which, if brought in, will set a higher level of consumer protection in retail financial markets for firms to adhere to.

In addition to this, there has been an increase in criminal action by the FCA. For instance, earlier this year, in March 2021, the FCA initiated criminal proceedings against the British bank NatWest Plc, in relation to allegations that NatWest failed to monitor and properly scrutinise transactions in breach of the UK Money Laundering Regulations 2007. These proceedings recently culminated with NatWest pleading guilty to the criminal charges brought against it by the FCA and companies in the UK eagerly await the sentencing outcome. There has also been an increased focus on allegations of bribery and corruption which, from our experience, tend to be more protracted and complex. These investigations, and any subsequent claims arising from the same, are also, in our view, some of the costliest for insureds and, therefore, insurers, to deal with. Further, new criminal offences which could be directed at D&Os have been created in relation to data protection and pensions, for example.

This is set against a moving backdrop regarding corporate criminal liabilities. The Law Commission is currently considering whether more “failure to prevent” offences should be introduced (seen currently in the Bribery Act 2010 and the Criminal Finances Act 2017) and whether the “identification principle” should be reformed. This is where, in order for the company to be held liable, a prosecutor must prove that the individuals involved in the crime represent the “directing mind and will” of that company, i.e. the individuals' actions are to be considered those of the company. This is very difficult to establish and has led to a low number of convictions, and the reforms seek to redress this.

As such, these reforms could lead to an increased risk of prosecution for corporates and D&Os. D&Os could face direct prosecutions, as well as subsequent prosecutions following corporates entering into Deferred Prosecution Agreements with prosecutors, which require significant cooperation, often in the shape of identifying the individual wrongdoers, in order to secure the deal.

Other reasons for the significant increases to rates that we are seeing include an increasing trend of high-profile collective and shareholder actions, uncertainties posed by Brexit and a general increase in litigation as a result of disruptions caused by, and the mishandling of, the COVID-19 situation.

A comparative look at litigation costs in the UK and Germany

These exposures are compounded by the fact that the UK has, for a number of years now, been an expensive jurisdiction to litigate in on all fronts – civil, criminal and regulatory – leading to higher insurance premiums.

From our experience, criminal proceedings in the UK are particularly costly, with costs per insured often on average amounting to around £2-3.5 million and upward to £5 million in worst-case scenarios. The costs of FCA proceedings will be considerable as well with initial enforcement proceedings, heard before the Regulatory Decisions Committee (RDC), often taking over a year. In the event of a referral by the defendant to the Upper Tribunal, it will face de novo proceedings with a full-blown regulatory trial which takes around 18 months.

These costs are far in excess of costs of litigation in Germany for a number of reasons:

• Juries (for criminal proceedings): Due to the structure of jury trials, a multiple of two can be automatically applied by virtue of juries needing approximately twice the amount of time to get through the evidence than a single or a bench of judges. Criminal proceedings in the UK also have to contend with the possibility of hung or discharged juries requiring a retrial, as happened in the case against former traders at Barclays accused of conspiring to rig Libor benchmark interest rates. Whilst retrials tend to be quicker, having to rerun the entire proceedings adds a multiplier of around 1.5-2 to coverage requirements.

• Representation: Defence team requirements also appear to be higher in the UK. In Germany, the defendant is usually represented by one or two lawyers throughout the proceedings. In the UK, in order to achieve parity in criminal proceedings with the prosecution in major white-collar trials, the defence team will typically instruct a QC, a junior barrister, a partner and associate, along with support from trainees and paralegals. The amount of personnel required in the UK is therefore 3-4 times greater than in Germany. As Professor Michael Zander demonstrated: “To have one taxi meter running is less expensive than to have two”.

• London uplift: A further uplift on account of London rates has to be applied. The legal world is very London-centric, in particular the criminal defence world, with the SFO and FCA both being located in London and cases being heard in the London courts and tribunals. In Germany, however, public prosecutors are generally part of the administration of the Bundesländer (constituent states). Therefore, economic crime prosecutions are normally carried out by specialised prosecutors with a great degree more decentralisation.

• Disclosure: Civil proceedings in the UK are also subject to onerous disclosure regimes, requiring parties to undertake an extensive search for documents and disclose documents that are adverse and supportive to the parties’ cases. Whilst the UK Government has undertaken strides in recent years to trial the new disclosure pilot, the scheme has yet to be rolled out on a broader scale.

With all the multipliers and uplifts mentioned above, it is easy to understand why criminal proceedings in the UK result in costs of £2-3.5 million per defendant and with insurance coverage often being depleted, especially in the case of multiple defendants. This is in contrast to Germany where insurance coverage of between €200,000 – 400,000 per defendant will usually suffice. However, some drift towards higher seven-digit figures has been recently observed in criminal proceedings in Germany.

Given the significant costs exposure in the UK, one can see why D&O premiums are affected.

The outlook – 2021 and beyond

As seen in the Marsh reports and in other sources[6], a softening of D&O prices in the UK is occurring as more optimism in the economy starts to return and capacity increases. However, whilst there may be a softening of the curve, companies and their D&Os in the UK are likely to continue to experience a challenging landscape with the subsequent impact on D&O insurance premium rates.