"Virtually all" insurers in Australia are now putting royal commission exclusion clauses into new directors and officers liability policies as they prepare for a surge in class actions as a result of the explosive Hayne royal commission hearings, insurance broking giant Marsh has revealed.
Craig Claughton, head of financial and professional practice at Marsh, said the exclusions affected directors of financial services companies, a sector that accounted for more than a third of the market capitalisation of the ASX.
He said the banking royal commission factor was pushing up already rocketing D&O premiums – doubling the cost on average – and increasing the excess payable by several times.
In July The Australian Financial Review reported that some insurers were starting to write exclusions on royal commission-related claims into their D&O policies. Six months on, Mr Claughton said the practice had become almost universal.
"It's not some, it's virtually all now. It's almost impossible to buy D&O cover for a financial institution without a royal commission exclusion," he said.
Mr Claughton said the language of the exclusions was "extremely broad", talking about issues "related to" or "arising from" the royal commission. This meant some financial services companies would be unable to make any D&O claims, as it could be argued all claims could be linked to the royal commission in some way.
He said the big banks were particularly vulnerable to this.
"Through the commission, the five banks have had to present virtually their entire business model. And so if you're excluding anything related to the royal commission, the banks are saying, 'well, you're excluding any form of cover that we might have had, because we've had to tell the royal commission about everything'."
Mr Claughton said insurance companies were reassuring clients that actions arising from events during previous policy periods – before the exclusions were in place – would still be covered. However, he said he doubted this was true, given the royal commission was ongoing.
Commissioner Kenneth Hayne will deliver his final report on February 1. Brook_Mitchell
Cost of premiums double
Like Aon, which flagged the emergence of these exclusions in July, Marsh specialises in putting together complicated insurance packages for large listed companies. This includes providing cover for directors against the risk of being sued, particularly for failure to abide by continuous disclosure rules.
Even before the royal commission, D&O insurance was under increasing pressure because of the rise of litigation funders over the past decade. Litigation funding is an alternative asset class that sprang from the hedge fund sector, whereby investors fund class actions in exchange for a hefty cut of the winnings – sometimes as much as 60 or 70 per cent.
The Insurance Council of Australia says the rise of litigation funding has seen the number of securities class actions increase from just 13 cases between 2004 and 2010, to 42 between 2010 and 2016. The ICA puts the average payout at between $50 million and $75 million, but points out the D&O pool is only about $280 million.
ICA spokesman Campbell Fuller said the number of class actions continued to rise as litigation funders and legal firms became "more confident in the laws and procedures involved in mounting a class action".
NAB chairman Ken Henry was among the directors of big banks to appear before the royal commission. Arsineh Houspian
"The surging cost of insurance payouts, especially for common form securities class actions, has placed D&O insurance under stress. Insurers are reassessing their risk appetite and insurance premiums are under pressure," he said.
Last year the Australian Law Reform Commission held an inquiry into litigation funding, in which this issue received a lot of attention. The ALRC delivered its final report to the Attorney-General's Department on December 21. The government is required to table the paper within the first fifteen sitting days of the year, which means it may not be tabled until after the election.
In its opening discussion paper, the ALRC recommended the government commission a review of the legal and economic impact of the continuous disclosure obligations, including their effect on the cost and availability of directors liability insurance.
Regarding cost, Mr Claughton said average D&O premiums had doubled this year. In the financial sector, where the risk of litigation is considered much higher because of the royal commission, premiums had risen as much as 400 per cent, or in one case 1000 per cent, or 11 times.
As yet, he said the exorbitant premium rises had not put directors off buying the insurance.
"Directors are concerned about the risk, and I think that they will continue to buy these products even at a higher price than today. So I don't think we're at that point where that cost-versus-benefit analysis is stopping a client buying the cover. But if we continue much further I think we will get to that point," Mr Claughton said.
He said this could deter directors from sitting on boards at all.This article was first published by https://www.afr.com/
Author: James Fernyhough