Open to the elements

Martin Friel investigates the growing popularity of D&O and how this insurance is being tailored to suit the needs of smaller firms

Small to medium-sized enterprises (SME) need directors' and officers' (D&O) cover. It's as simple as that. Not convinced? Still think it's something that only large listed companies need worry about? Think again. The flurry of legislative changes that have been introduced of late should focus the minds of all SMEs and their insurance arrangers and providers. The spotlight on corporate liability means that all companies, including SMEs, are coming under increasing scrutiny and, as such, their liability exposures will increase sharply.

Still not buying it? Then let us refer you to the first case to be brought under the Corporate Manslaughter Act. The Crown Prosecution Service (CPS) has pretty much thrown the book at Cotswold Geotechnical. This is a relatively small company and the feeling in the market is that the CPS is going for an easy target in the hope of securing an early conviction under the new legislation. To take on a large corporate now, the type of company the Act was designed for, is seen as being too risky so the spotlight has fallen on an SME. Convinced yet?

So if SMEs are so exposed, why haven't they been keen to buy D&O cover?

Size matters

Historically, SMEs have managed to get by without the need for this cover as there was a common misconception that they were not as likely to be sued as a listed company. For example, if it was a family firm with no external shareholders, the feeling was that they were not as vulnerable to litigation. This of course wasn't the case but the perception persisted, so many did not believe that they required the cover.

In tandem with this, the D&O cover that was available 20-30 years ago really wasn't suited to the needs of smaller firms. It was primarily targeted at large corporates and was of little use to SMEs. It seems that insurers expected them to fit into their D&O box rather than making the effort to tailor the products to the lower end of the spectrum. As a result, the take-up of D&O cover in this sector has been traditionally slow.

But that appears to be changing. To a man, providers report a steady increase in both interest and utilisation of D&O in this sector. The logical explanation to this would seem to be that these types of companies are reacting to the pressures of the recession and are protecting themselves from potential litigation. But drill a bit deeper and it is clear that there are many reasons for the increase and the state of the economy is the least prominent.

First of all, as we've already touched on, recent legislative changes have made this type of cover more pertinent than ever. The impact of the Corporate Manslaughter Act has been augmented by the Companies Act 2006 and businesses, particularly SMEs, are set to come under the legal spotlight and face a new landscape of potential litigation. For instance, employment claims between 2007-08 rose from 130,000 to 190,000, a significant one-year increase.

"These figures cover the period before the recession really kicked in," says Callum Taylor, management liability underwriting manager at Hiscox.

"And that number looks like it will increase, so there is clearly a very significant exposure there. The Companies Act has brought the duties of directors into focus and has made it easier to sue them. But for SMEs, the main exposures are of the company as a whole in areas such as regulation, employment health and safety (H&S), trading standards and tax. Employment claims account for eight out of 10 claims made under D&O policies," he explains.

Simon Taylor, marketing director at Primary General agrees. "It is more likely to be smaller companies that suffer as they don't have full time HR departments or H&S managers. Claims arising from these areas can be very damaging for them even if they are insured. The time and effort it takes to attend to these issues can be very detrimental," he says.

"They don't necessarily know the risks they are running by not taking out D&O cover. Their brokers in particular need to point out the pitfalls to them," he argues.

But it appears there is a dawning awareness of these risks.

The Annual Small Business Survey 2007-08 conducted by the Department for Business Enterprise & Regulatory Reform found that of those who cited regulations as the biggest obstacle to business success, 32% cited H&S legislation as being the most concerning, with 17% citing employment legislation.

So it is clear that workplace legislation is a pressing concern and as this concern grows, SMEs are looking increasingly toward securing protection against the exposures that these regulations bring. But this only partly explains the growing popularity of D&O in this sector.

Tailored products

Many market commentators point to the make-up of the products that are being offered for an explanation. Whereas in the past insurers were offering policies that were designed for larger corporates, they seem to have woken up to the fact that SMEs need something a bit more bespoke for their sector.

"Changes in what these policies cover have taken place as pure D&O wasn't very attractive to SMEs," says Jonathan Corman, partner in the finance and professional risk group at Browne Jacobson.

"What has made D&O more marketable to this sector is that they have made it a three-legged product. Employment liability cover, regulatory and liability claims cover and H&S cover to accommodate the corporate manslaughter changes have been tucked in to make it more appealing to small businesses. They can see the value of these types of policies," he explains.

Simon Million, UK and Ireland D&O manager for Ace, agrees but argues that this has led to an increasing commoditisation of the product.

"The policies have gone as wide as they can now. They have been tailored to the SME market as they need different areas of coverage, which perhaps wouldn't be required by multinationals," he says. "But at the smaller end of the scale, it has become more of a commodity and subsequently more volume driven."

Claims risk

It is generally agreed across the market that there has been an inevitable commoditisation of the product in this sector but do providers not then run the risk of compromising the quality of the underwriting, thereby exposing themselves to the likelihood of an increase in claims frequency?

Mr Million doesn't believe so. "This hasn't affected the quality of the underwriting - we would offer an SME the same wording as a multinational," he claims. But he does concede that the underwriting isn't as labour intensive at the smaller end of the scale.

There doesn't appear to be any real fear that the product being provided to SMEs is of an inferior quality in terms of underwriting and coverage provided. Although it is becoming more commoditised "insurers will tighten up coverage on individual risks," says Simon Fell, underwriting manager at Markel.

"It is a commodity in terms of pricing but at the smaller end providers are looking at how big the business is, what the business does, whether it makes a profit and so on. If these kinds of boxes can be ticked, the rating can go out at a few hundred pounds," he explains.

And although he says he is seeing more enquiries that require bespoke underwriting, he claims that in general it has become pure volume.

"There are a lot of people interested in it now and the level of premiums required are quite low," he says.

This creeping commoditisation has also made the product easier to sell for brokers and not just because it is coming in at an attractive price. Such is the standardisation of some of the products, it is now possible for brokers to secure cover for their clients online.

As partner at Browne Jacobson, Mr Corman, explains: "It has become much easier to sell - some insurers have the whole thing computerised at the lower end of the spectrum. They have the underwriting criteria online, the proposal can be done online and this reduces their administrative costs so they can offer the product at very reasonable premiums."

Mark Shreeve, chief executive of Angel Underwriting, is a fan of online trading in this sector.

"Over half of our business is done online. You need a first class system as everyone in the chain wants details and results immediately. The expectation level is very high but you need a blended approach to it," he argues.

"It's still a non-standard class of business and many brokers like the comfort factor of picking up the phone to an underwriter. We will continue to provide that and I would strongly caution against fully commoditising this class of business," he warns, "as SMEs come in all shapes and sizes".

But perhaps the most telling contribution to this increase in the take-up of D&O cover has been made by brokers. It is the intermediary who has had the role of explaining to these companies the benefits of having this kind of cover in place. It has been an educational process for everyone and it appears that it is starting to bear fruit now.

"It's been a hard slog," admits Jim Gaskin, professional and financial lines manager, technical underwriting at Zurich.

"We have been targeting this marketplace for five years now. It has been about education, working on partnerships and helping brokers sell that message on. We have been hosting roadshows, workshops and helping them to understand the benefits of D&O for their SME clients," he says.

But he has a word of warning: the market has recently seen the entrance of a host of new players and he is concerned that some of them may not have the expertise to truly understand what they are underwriting, something that brokers need to be mindful of.

"A number of new carriers have appeared, which in one sense is good as it raises awareness and forces other insurers to be more creative and clever in their delivery. However, there is a danger that some carriers may not understand the dangers of D&O underwriting," he stresses.

And there's an added word of caution from Markel's Mr Fell.

"Although the product has become commoditised in recent years, it is still specialist. Brokers have to be careful about the value of the contract they are providing. When it gets price driven [compounded by increased capacity] the quality of the policy can sometimes be forgotten," he says.

But in general, it seems that all the providers are aware of the crucial role that brokers have to play in all this.

Bronwen Horn, financial lines development underwriter at Novae, puts the increase in demand down to a combination of reaction to the financial crisis, marketing and, most importantly, broker expertise in the area.

"Brokers have been increasing their financial lines expertise across the board as they've recognised that it is a clear area of exposure for their clients and we are giving them the tools to sell the products," she says.

Brokers are crucial to the growing popularity of D&O among SMEs and there are several reasons why they should be getting involved as much as they can. On a very basic level, it makes financial sense.

"Now is a good time for brokers to be selling this. The pricing is very competitive, especially for the cover that is being offered," says Ms Horn.

But it's more than that. It gives brokers the opportunity to show that they really are taking their clients' best interests on board.

As Mr Taylor explains: "All brokers want to help their clients protect against risk and I think as an industry we have been focusing too much on protecting the client on price. We may have moved away from the main purpose - protecting the clients from their risks."

The good news is that all the providers see this as a growing market.

"It will be interesting to see what happens when the financial crisis is over," says Gwyneth McShane, associate director at Aon's professional services group.

"I don't think the growth we have seen is a knee-jerk reaction. There are still a huge number of SMEs not taking this policy on and theoretically there is a need for all our clients to have D&O cover and, at the moment, they don't. In the past, it has often been seen as an add-on but brokers and clients alike are now seeing it as a product with great worth in its own right," she claims.

Estimates put market penetration at 40%. So, with brokers having a crucial role to play and reasons to why clients should have the cover becoming more pertinent, it appears that for those that can provide the scale or secure the necessary insurer partnerships, this really is an untapped market waiting to be efficiently exploited. n