Early this spring, when I wrote the first installment in this series of updates about the impact of the coronavirus outbreak on the D&O liability and insurance arena, the general assumption was that the virus would spread for a couple of months during the spring and that by summertime things would be returning to normal. Very few people I know were predicting that when July actually did roll around that the number of confirmed cases, both nationally and globally, would be setting daily record highs. Even as recently as my most recent update last month, there were hopeful signs as the country re-opened for business. Unfortunately, the disease has proven to be more widely-distributed and the outbreak longer-lasting than earlier anticipated, and the expectations about the pandemic’s economic, social, and political impacts have also changed. All of these developments have implications for the pandemic’s impact on the D&O arena as well. In this latest update, I review the the pandemic’s D&O consequences and likely future impact.
As we enter the fifth month of the coronavirus outbreak in the U.S., the COVID-19-related D&O claims continue to accumulate. There have now been a total of 16 COVID-19-related securities class action lawsuits filed. The lawsuits filed so far fall into three basic categories: (1) cases involving companies that experienced COVID-19 in their facilities (such as the lawsuits against cruise lines Carnival Corporation and Norwegian Cruise Lines and private prison operator The Geo Group); (2) cases involving companies that are alleged to have made misrepresentations about the company’s ability to gain from the pandemic (such as lawsuits against diagnostic testing company Co-Diagnostics and vaccine maker Inovio); and (3) cases involving companies that have experienced financial issues or operating disruptions as a result of the pandemic (such as the lawsuit against Elanco Animal Health and Colony Capital). There are a couple of cases that do not fall into one of these three categories, such as the PPP-related lawsuit filed against Wells Fargo, and the privacy-related lawsuit filed against Zoom.
While I have the current tally of COVID-19 securities suits at 16, there are other published tallies that have a different number. For example, the Stanford Law School Securities Class Action Clearinghouse has the current number at 12. The website helpfully lists each of the 12 cases in its tally on its website, here (click on the COVID-19 link). The four cases on my tally that the Stanford Clearinghouse has not included are the securities suits that have been filed against Zoom; Colony Capital; Wells Fargo; and iAnthus Capital Holdings. Each of the company names in the preceding sentence are linked to the blog posts in which I explain my reasoning for including these cases in my tally. The difference between the two tallies does underscore one problem with trying to track these kinds of cases cases; it can be quite difficult in defining what makes a case “COVID-19-related.” I suspect that this difficulty will only grow as time goes on.
In the context of the massive volume of securities lawsuits that have been filed in the U.S. over the last three and a half years, a total of 16 cases (or 12 cases, if you prefer) over the course of five months is not a huge number of cases. At one level, this relatively modest number is hardly surprising; from the outset, I have been predicting that the number of coronavirus outbreak-related securities suits would be less than the number of securities suits filed in the wake of the global financial crisis more than a decade ago. My reasoning on this is that the pandemic came out of the blue, so to speak; before March, companies were not making statements about their ability to respond to a pandemic or to government shutdown orders. For most companies, there are going to be relatively few pre-pandemic company statements that plaintiffs’ lawyers might be able to try to seize upon to allege that companies misled investors.
However, as we are now months into the pandemic and as signs are that the pandemic will be with us for some time to come, and as companies have been making statements about the pandemic’s impact on their finances, operations, and business prospects, the number of items that plaintiffs’ lawyers might try to characterize as misrepresentations is growing. In addition, as the duration of the pandemic lengthens into the uncertain future, the pandemic’s grinding impact on companies’ revenues, liquidity, ability to service debt, ability to maintain supply chains and distribution networks and so on will increase the stress companies are experiencing. All of these factors suggest to me that most of the coronavirus-related lawsuits are yet to come. Indeed, the statements or actions on which the plaintiffs will rely likely have not yet even been made.
Since the pandemic’s beginning, observers have been predicting that one of the likely results of the outbreak would be a wave of bankruptcies. And there have indeed been a number of high-profile bankruptcies, such as Hertz, Neiman Marcus, and Brooks Brothers. Indeed, according to a July 17, 2020 New York Times Dealbook column (here), about 3,600 companies filed for Chapter 11 bankruptcy in the first half of 2020, the highest number since 2012. However, as the article also notes, the number of filings declined in June, as the effects of government programs to stabilize the economy and earlier-than-expected reopenings in some states bolstered some businesses’ performance.
As the more recent renewed surge in confirmed coronavirus cases has kicked in, companies face a renewed test of being able to survive another spell of little to no revenue. As the article puts it, the pendulum has swung “back toward fear,” and what comes next “could be ugly.” Companies have already leveraged all of their assets, leaving little room to maneuver. Up until now many lenders have been willing to give relief on debt covenants, “but if borrowers need more money, they may find lenders unwilling or unable to front the cash.” So far, the article notes, retailers and energy companies have been hit the hardest, but the next found of filings “could hit the travel industry hard,” including airlines, hotels, and airplane leasing companies.
Also, so far, the bankruptcies have been relatively orderly, in the form of prepacked arrangements or collaborative restructuring workouts. As the pandemic’s duration lengthens uncertainly into the future, the bankruptcies could become less orderly and more adversarial, as lenders and creditors may be fighting for their own survival or at least their own financial health. A more adversarial process could lead to increased numbers of bankruptcy-related D&O claims, as creditors become more aggressive and more willing to assign blame.
Impact on the D&O Marketplace
The recent spike in the number of confirmed cases and the clear suggestion that the pandemic is going to go on for some time to come has also had an impact on D&O insurance underwriters and on the insurance placement process.
From the outset of the outbreak and of government shutdown orders, the D&O insurers have been very focused on the outbreak’s impact on applicants’ financial condition. Most of the insurers have COVID-19 questionnaires they require applicants to complete, in order to for the underwriters to understand how the outbreak and stay at home orders are affecting applicants’ financial condition, business operations, and prospects. Most of the questions go to revenue, liquidity, ability to service debt, and debt covenants. D&O insurance underwriters are well aware of and wary of both the bankruptcy statistics cited in the preceding paragraphs; with the recent upsurge in the number of coronavirus cases, for D&O insurers as well as for others, the pendulum has also swung back toward fear.
The underwriters’ wariness was reflected in the recently completed July 1 renewal cycle. As has been the case throughout this year, all applicants saw their premium levels increase. Most public company policyholders saw their total premiums increase in amounts that ranged from 10-15% to 35-40%, with the largest percentage increases in the excess layers, and the total premium increases for policyholders in certain industry segments perceived as higher risk seeing overall increases of as much as 100% or more. Even private companies are seeing premium increases (largely because of the perceived increased financial risk), generally in the range of 10% to 20%, but with some companies seeing higher increases. For many insurance buyers, their recent renewal represented the second round of increases, after they experienced substantial increases during the 2019 renewal cycle.
In many instances, at the most recent renewal, many of the insurers reduced their limits exposed on the applicants’ accounts. For example, insurers that might have had a $5 million limit up in the prior year reduced their limit to $2 million. This process of reducing capacity began in 2019, particularly in the public company space, but it has significantly increased to a wider number and variety of companies, and in both the public and private company space. The carriers’ reduced capacity required an additional number of insurers to be brought in to fill out a program, a consequence that lengthened out the renewal process and made it time-consuming, labor-intensive, and highly unpredictable. The fact that many of the insurers are not entertaining new business submissions makes the process of trying to fill out a program even more challenging. During the recently completed July 1 renewal season, there were a number of programs that did not come together until the very last days of June.
In addition to reducing their capacity, many insurers have also been increasing the self-insured retention they are requiring. The process of increasing the retention also began during the 2019 renewal cycle but it has definitely increased in 2020. Some insurers are also tightening up their exposure in certain specific areas, such as eliminating antitrust coverage, reducing sublimits for certain specified exposures, or, for example, eliminating sublimited defense coverage for wage and hour claims.
Earlier in the pandemic, some D&O insurers were also including on their quotes COVID-19 or infectious disease exclusions and some insurers (particularly in the London market) continue to quote with these types of exclusions at least for certain types of risks. Overall, however, the inclusion of these types of exclusions is relatively rare, especially by comparison with certain other insurance industry segments (such as E&O).
Some insurers are also including bankruptcy or creditors’ claims exclusions, at least for certain types of risk. These kinds of exclusions are obviously highly undesirable, as bankruptcy is obviously the time when the availability of this type of coverage is most important. These types of exclusions are more prevalent with smaller private companies. For some insurers in some instances, these types of exclusion are a sort of default mechanism, to be included on the policy in the event that the underwriter feels he or she has not been given sufficient (or sufficiently satisfying) information about the applicant’s financial condition.
For most insurance buyers, the process has become significantly more unsatisfying and even distressing. The magnitude of the price increases has surprised or even shocked some buyers. The price increase is of course particularly unwelcome for companies whose businesses may be struggling due to the pandemic and the government shut down orders. While we work with buyers to try to help expectations and to work through what has become a challenging process, some buyers, conditioned by years of price decreases and relatively stress free placements, find it difficult to adjust to the changed insurance environment.
Many buyers want to know what their alternatives are. Some buyers are closely reviewing the amount of insurance they are buying and in some cases deciding to reduce their limits. While this option is always a possibility, it is one we try to discourage. The present moment seems like a particularly poor time to be reducing the amount of insurance a company buys.
Other companies are looking at alternative structures, such as changing the structure or mix of insurance in the program, for example, to reduce the amount of A/B/C coverage and increase the amount of Side A in the program. This may make sense for some companies, but it does increase the company’s balance sheet exposure. In addition, as Side A insurers have become more cautious in the current challenging economy, additional Side A limits may be hard to find. In the current environment, swapping A/B/C layers for Side A layers may not actually produce cost savings sufficient to justify the change and the reduction in coverage.
There are of course even more extreme alternatives, such as that chosen by Tesla Motors (about which refer here) and Pulse Biosciences (refer here), in which the companies’ boards accepted personal indemnification from a senior company official in lieu of D&O insurance. This alternative is not going to be an available option for many companies, and other companies’ boards may conclude that they would prefer to have the protection of a disinterested third-party insurer rather than that of someone connected to the company on whose board they are serving.
One question that frequently arises about the current hard market for D&O insurance is about how much longer it will last. I continue to be pessimistic; I believe the hard market will continue at least through the rest of this year and even well into 2021. However, I recently had a conversation with an experienced D&O insurance professional who was more optimistic. He cited the arrival of a new underwriting facility in London and the fundraising that certain other insurers have undertaken in the capital markets as indications of the first things that have to happen for competition to return to the D&O space. I agree that there are a few things that have happened that are the kinds of things that have to start happening for competition to return. However, in my view, there still are not enough of these things and not enough things that are either individually or in the aggregate sufficient to start making a difference. For now, I remain pessimistic. Until we see significant new capacity coming into the market and until it starts to have a significant impact, the current hard market conditions are likely to continue.
For now, what I am telling the company officials with whom I speak to expect their D&O insurance placement process to be time-consuming, labor-intensive, and unpredictable. I am also telling the company officials that I expect that the current hard market will continue at least for the balance of this year and into 2021.