Insurance Making Life Tough For Companies

Sydney Morning Herald

Saturday July 24, 2004

STEPHEN BARTHOLOMEUSZ

This week the Corporations and Markets Advisory Committee issued a report on directors and officers' insurance that provides an insight into the increased risks faced by company boards and managements.

The committee's research is part of a broader exploration of directors' duties and liabilities commissioned by the Federal Government in 2002. Its significance lies in the inferences that can be drawn from changes in the pricing and availability of directors' and officers' insurance.

The committee's findings have to be qualified because the pricing and availability of liability insurance is a function of conditions in insurance markets as well as the environment within which companies operate.

The period under scrutiny - from 2001 - has been difficult for insurers. The September 11 attacks on the World Trade Centre ravaged the industry, destroying massive amounts of capital.

That had a significant impact on both the global industry's capacity to underwrite risk of all kinds and the pricing of those risks it was prepared to underwrite. The collapse of HIH also withdrew substantial capacity from this market.

Nevertheless, the broad trends in pricing and availability of coverage in the research are consistent with what one would expect even if the insurance market had been stable and adequately capitalised.

The committee found that since 2001 average premiums have increased by 30 to 50 per cent a year, with much higher increases for "less attractive risks". There are signs that the rate of growth is slowing, with renewal increases of 15 to 20 per cent this year.

The research also found that insurers have become more selective in the risks they are prepared to cover. There are more exclusions, some companies can't get cover at all and others may be reducing their cover in response to the increased costs.

The factors that most appear to influence the availability and pricing of cover are the type of activity undertaken by the company, its financial condition, its claims history, its size and its status - listed companies have greater legal exposures than unlisted entities.

The issue of insurance affects the ability of companies to attract and retain high-quality directors and executives.

Uncovered and uncapped personal liability is a disincentive to accept a position, particularly as recent corporate reform legislation has undermined the value of corporate indemnities for the actions of directors and officers and insurance policies increasingly exclude risks that the legislation imposes.

In the past decade, particularly since the collapse of Enron sparked a global wave of corporate law reform, directors and managers can face legal action for breaches of their duties.

Class actions are becoming more common and directors are increasingly being held liable for what would have once been regarded as management failures.

The increase in shareholder activism and aggression adds discomfort and a heightened risk of reputational damage to the greater personal financial risks in the corporate environment.

The CAMAC findings, therefore, are consistent with the general increase in risk that directors and managers face.

While the report is ostensibly about insurance coverage, it is actually about the underlying real risks reflected in the pricing and availability of that cover.

Company directors are becoming increasingly risk averse, not just because of the greater personal liabilities they face but because of the reputational damage associated with the failures that create those exposures.

Difficulties with insurance exacerbate the anxieties and disincentives that already exist in the corporate world.

The liability issues would also tend to amplify the pressures on directors in particular to focus on process rather than performance.

Directors and executives already complain about the layers of new requirements for conformance with various sets of governance guidelines and the extent to which boards are now fixated with conformance rather than performance issues.

They also complain that the increased risks, without compensating increases in rewards, are deterring competent people from joining boards, particularly at the smaller end of the market.

The absence of distinction between the contribution/culpability of non-executives and executives in corporate misjudgements and failures is another issue - boards are now held equally accountable by shareholders, and sometimes the courts, for incidences of management failure. There is an expectation gap in relation to non-executive performance that inflates the risks they face.

Combined with the governance-led thrust against directors sitting on more than a handful of boards, and the impact of declining chief executive tenures and rising incidence of forced CEO departures on the depth of the pool of competent directors and its ability to regenerate itself, there is a developing supply issue.

Good governance is dependent on good directors and executives, as is good performance. It is not in shareholders' interests, nor in the interest of the wider community, to cause directors and executives to become so focused on conformance and personal risk management that they become completely risk-averse.

That isn't simply an issue of insurance coverage. The rising cost and reducing coverage of directors and officers' insurance reflects a real increase in risk within the corporate environment that has been imposed on it by the failings of a few and by communities, legislators and regulators that are increasingly intolerant of any level of failure.

CAMAC's continuing work may contribute towards a better informed and perhaps more balanced discussion about the reasonable expectations we should have of directors and executives and the level of financial and reputational risk they should reasonably be subjected to. It is in everyone's interest, not just directors and executives, that it should.

bartho@smh.com.au

© 2004 Sydney Morning Herald

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