Directors and Officers liability in global financial meltdown

The unprecedented scale of the global financial crisis poses some interesting questions for how business and government in South Africa and across the world will apportion blame and handle the liability implications of the current crisis.

In South Africa “as the global credit crunch manifests itself in interest rate crises and general confidence, investment and productivity downturns corporate exposures are likely to increase”, says Jack.

As such, the number of Directors and Officers (D&O) liability and professional indemnity (PI) claims lodged with South African insurers is set to grow, matching international trends.

The current international crisis is compounded not only by the poor economic environment but also by the far reaching implications of specific market exposures such as sub-prime, The Madoff Ponzi Scheme and the Stanford scandal.

“Sub-prime exposures have negatively impacted upon most global re-insurers resulting in record breaking financial losses. On top of this they will also be paying out considerably more on D&O and PI losses as more companies fall prey to malpractice complaints. This might jeopardise their ability to meet the inevitable increase in D&O and PI claims”, explains Jack.

In tough times even stable, well run companies show poor results. And since financial performance is a factor in a companies’ D&O rating, in tough times companies are hit twice – firstly by a hardening market, and then again by increased D&O premiums thanks to poorer performance.

That said, organisations cannot claim under either D&O and PI merely because markets have swung against them. For shareholders to bring a D&O or PI action against senior office bearers there must be evidence of mismanagement.

But in the light of the sub-prime crisis things get interesting.

“It could be argued that directors of companies should have known that if you lend money to people who don’t have the ability to pay it back something is likely to go wrong”, says Jack.

And this begs the inevitable liability questions:

• Is it the shareholders fault? Were they greedy?
• Were the directors negligent?
• Did regulating bodies around the world turn a blind eye?
• Are the borrowers themselves not to blame for taking (and spending) money they knew they could not pay back?

In the meantime, says Jack, “There have been filings, of both D&O and negligence, at home and around the world. We just have to wait and see what the various courts will decide and what precedents set.”

In the end though apportioning blame will amount to little more than an academic exercise.

More pertinently, we can predict that all classes of liability insurance will become more expensive as the market hardens around the world.

“The only question left unanswered at the moment is the degree to which it will harden. Will we see 5 – 10% increases, or 30 – 40% increases? ”, says Jack.

Certainly, Jack believes, that however the cost of D&O and PI increases globally, South Africa is likely to show less dramatic increases as a result of the National Credit Act and Exchange Control Regulation.

As such the D&O and PI market in South Africa should be more resilient and more able to ride out significant fallout from the global crisis.

South African banks and other financial institutions, despite being largely insulated from direct exposure to the sub-prime crisis, will be the only exceptions and are likely to attract higher D&O and PI cover.

Increased rates for financial institutions aside, the insurance market in South Africa is more likely to reflect the fallout of the global crisis in increased exclusions.

“The current crisis is also likely to inspire further cover restrictions under both D&O and PI policies, this has already been evidenced by the introduction of both Madoff and Stanford exclusions”, concludes Jack.