Leaders Face Political, Technological, and Macroeconomic Headwinds
Premiums for both directors and officers and employment practices liability insurance have continued to decline overall, but insurers are more mindful of risk selection.
Directors and officers continue to face significant risks as they navigate regulatory shoals, contend with demands from employees and investors, and try to protect corporate value and longevity in the face of macroeconomic, judicial, and political/cultural volatility.
With more scrutiny over executive pay packages; a spike in social media campaigns against companies for everything from fossil fuel use to emissions and human resources policies; and persistent and extreme cyberrisks, boards and management are beset with an expanding set of duties—and are increasingly exposed to claims of negligence and breach of duty. Add to that wild swings in the stock market and new Public Company Accounting Oversight Board regulations that broaden the possibility of claims over accounting failures, and companies have a widening set of exposures for directors and officers.
That said, the directors and officers (D&O) and employment practices liability (EPL) insurance rate environment has begun to reflect the additional capacity added over the past several years, with renewal premiums now entering negative territory. Favorable risks are showing moderate renewal decreases, often times upward of 10%, while even high exposure sectors are experiencing flat or nominal increases.
Whether this accommodating market will persist depends on numerous variables, including—in the D&O line—the macroeconomic environment and even potentially new market entrants taking a more cautious approach.
EPL rates may be influenced by rising Equal Employment Opportunity Commission (EEOC) actions against companies as well as rising antipathy toward return-to-office policies and multimillion-dollar settlements over wrongful terminations. Rising unemployment also will likely create more wrongful termination complaints as companies make difficult decisions on layoffs, geographical moves, and downsizing.
COSTS AND TRENDS
Insurance premiums for both D&O and EPL insurance have fluctuated substantially over the past two decades but have calmed in general over the past five quarters through June 2024, coming off shock highs during the pandemic. Despite de-escalation of COVID-19 fears, the effect of the pandemic response on the management liability insurance market lingers. Insurers took a cautious approach in 2020 and 2021, pricing in potentially severe losses. When the worst predictions didn’t materialize, those premium hikes led to substantial profits and encouraged more insurance companies to enter the market. As a result, there is adequate availability of both D&O and EPL insurance capacity.
D&O premiums have not only mitigated but in many cases have declined, with 41.5% of accounts nationwide seeing pricing reductions of 1% to 9% in the second quarter of 2024, according to The Council of Insurance Agents and Brokers’ (CIAB) Commercial Property/Casualty Market Index Q2/2024 report. About 29% of accounts experienced no change in premium for the April to June time frame, and about 22% received a 1% to 9% D&O insurance price increase.
Employment practices liability insurance registered a 0.1% overall drop in Q2 2024 pricing, with about 54% of accounts nationwide receiving no change in premium, 22% seeing a 1% to 9% drop, and about 19.5% getting a 1% to 9% hike in the cost of coverage, according to the CIAB report.
Though capacity is abundant and average premiums in D&O and EPL are down, insurers are taking care to avoid known and suspected high risks, so accounts with heavy exposures, poor internal controls, or a negative claims history can’t expect the same favorable premiums reflected in overall averages. Additionally, an aggressive regulatory environment, recent court rulings against directors and officers, inflation, activist investors, and macroeconomic uncertainty are raising concerns and may portend a reevaluation of risk portfolios as we enter 2025.
PRESSURES ON RATES
With the Federal Reserve’s decrease in interest rates, downward pressures on the bond market, and volatility in equities, insurer investment earnings may experience some deceleration, which would impact carriers’ need to protect liquidity in 2025. They may seek to do that through hikes in pricing, deductibles, and attachment points.
D&O Pressures
Organizations with iffy financials are likely to have difficulty finding low to moderate D&O premiums, particularly while we remain in this higher interest and uncertain macro environment.
Securities class actions are one good barometer of D&O claims activity. As seen in Figure 2, first-half 2024 filings are well less than half of full-year filings from previous years in three of the five top exposure categories, with only artificial intelligence (AI) and COVID-19 on trend to match or surpass 2023 numbers.
As the chart indicates, some companies have gotten out over their skis on artificial intelligence and have paid the price. AI continues to be a focal point for the Securities and Exchange Commission (SEC), and private companies are not immune to enforcement over misleading claims and discriminatory algorithms. We believe AI-based D&O claims will continue to rise given the proliferation of AI use and scrutiny over its implications for privacy, discrimination, and value-damaging errors.
Climate/emissions disclosures are poised to develop as a D&O exposure. With the SEC’s finalization of Scope 1 and 2 emissions reporting rules in March, even midsize and small private companies can find themselves caught up in the new accounting requirements. Reporting mandates will be phased in beginning in 2026, and—even though the earliest compliance dates apply to only large accelerated filers—down-tier manufacturers and suppliers of energy will still need to be ready to provide information up the chain to their customers for Scope 2 reporting. Those affected likely include oil, gas, hydro, wind, and solar companies. Boards will need to be on top of accounting and reporting methodologies for that data.
Corporate ESG (environmental, social, and governance) postures and disclosures are likely to continue as a D&O issue. With social media campaigns succeeding against diversity, equity, and inclusion (DEI) policies on the heels of the U.S. Supreme Court’s June 2023 ruling against race-based college admissions policies and an April 2024 decision in Muldrow v. City of St. Louis that lowered the bar for employee discrimination complaints, directors and officers are bracing for DEI lawsuits. On the one hand, companies are facing pushback from customers in the way of lost sales and, in response, have backtracked on their DEI policies. That could lead to shareholder claims that the companies are abandoning or reneging on promises that drew investors. On the other hand, if they don’t revamp DEI policies, the companies could be sued for unfair labor practices by those not receiving preferred hiring, promotion, and other opportunities.
On the environmental side, claims against boards are arising from both sides of the advocacy spectrum—from allegations that companies have misrepresented their environmental commitment or failed to follow through on them to complaints the ESG initiatives have negatively impacted company financial performance.
Geopolitical events, especially trade restrictions and sanctions, are a fourth major area of risk for directors and officers. Technology and financial companies have been the hardest hit by enforcement of sanctions violations, but shippers, energy, and manufacturing companies also are highly exposed. Beyond violating trade restrictions, companies that have subsidiaries, property, or substantial business revenue in or from high-risk nations or regions face potential shareholder claims if those risks aren’t clearly disclosed and carefully managed.
Rounding out the top five D&O exposures is cybersecurity. With cyber breaches now common and spectacular failures of cyber management, such as the CrowdStrike debacle in July, directors and officers are facing complaints that IT is mismanaged and causing shareholders, employees, and customers material financial harm. It is not clear that boards in general have the capability to ensure management is up to the task, and multiple companies—including hospitals, airlines, retailers, banks, and insurers—have been sued over cyber failures.
EPL Pressures
While not yet reflected in the CIAB data, we anticipate upward pressure on EPL rates based on the rising number of EEOC claims, which hit a six-year high in 2023, though they’re far below the average seen during the 2008-2016 period.
In addition to regulatory actions, workplace policies, including return to office (RTO) and COVID-19 vaccination mandates, are still generating complaints. Several COVID-19 cases have resulted in multimillion-dollar settlements and job-reinstatement provisions, and more are in the courts now, with hundreds in the pipeline. Some of the lawsuits allege pay and promotion discrimination, while some address termination of employment. While employers are largely winning RTO lawsuits, legal costs are substantial.
Wrongful termination continues to be a major EPL exposure, one which could increase in incidence as the economy declines and businesses shutter or cutback. A February 2024 U.S. Supreme Court ruling in Murray v. UBS Securities LLC, et al. lowered the burden of proof that whistleblowers must provide regarding the intent of their employers to retaliate, potentially making it easier for whistleblowers to sue and win for wrongful termination. To avoid EPL claims over wrongful termination, management should devote substantially more consideration to the impact of layoffs and firings on protected groups, and companies would be wise to have policies and decisions reviewed by legal counsel.
Wage and hour violations have hit the headlines over the past year, especially in the restaurant industry, and the U.S. Department of Labor (DOL) has been working with aggrieved employees to snare employers. The DOL additionally is continuing its crackdown on employee classification violations. A new DOL rule came into effect in March that applies six factors in determining if a worker is an employee or independent contractor. Boards and management should have wage and hour policies that align because penalties can be stiff. For example, in July, the Office of the Attorney General announced that a construction firm, general contractor, and multiple labor brokers will pay nearly $4 million in restitution for misclassifying construction workers in the District of Columbia.
BRACING FOR 2025
Even if D&O and EPL rates remain flat or depressed at January renewals, costs associated with lawsuits and claims are expected to rise. There are few economists who don’t recognize the recessionary indications in U.S. output, real estate, bank health, and unemployment numbers. Business bankruptcies are up 40.3% for the 12 months ending June 30, 2024, according to the most recent U.S. Courts statistics, and there has been an uptick in business closures of branches and stores.
Additionally, August saw a massive downward adjustment in Bureau of Labor Statistics employment numbers. From April 2023 to March 2024, there were 818,000 jobs reported as created that never existed. The unemployment rate is highly correlated with recessions, and the Federal Reserve is struggling to keep inflation and unemployment low. Companies need to heighten awareness over employment practices, because complaints over wrongful termination and hiring discrimination tend to rise as the unemployment rate grows and workers are unable to find replacement income.
Directors and officers face macroeconomic headwinds along with increasing activism from political, social, economic, and regulatory actors. Cyber criminals are not relenting, and AI and other technologies are developing so rapidly in both opportunity and risk that boards are having difficulty keeping up. D&O insurance protection is indispensable for all directors and officers, especially as the Department of Justice is increasingly interested in pursuing individuals for punishment over corporate wrongdoing.
Strong board involvement with management and getting the right people, such as chief financial officers, chief compliance officers, and chief human resources officers, reporting on the right issues is key so directors can provide best-in-class guidance.
If capacity tightens, which we expect it will, boards should be prepared for a slight rise in premium pricing but, more so, case-specific demands for greater client risk retention in the way of larger deductibles. Companies should also expect further tightening of underwriting standards, where insurers give significantly greater preference to organizations that can demonstrate solid internal controls and financial strength.
For both risk management and crafting tailored D&O and EPL coverage, organizations will need an expert insurance partner. IOA is deeply immersed in management liability issues and has the access to and respect of a variety of reliable carriers. We look forward to helping your business manage risk and protect itself from the challenges ahead.
