The content and third-party quotes in this article were sourced from a special report sponsored by AIG (“The implications of Brexit on D&O risk”), published in the Q3 2016 European edition of StrategicRISK.
While the impact of this year’s Brexit referendum result on UK businesses remains to be seen, leaders across nearly all sectors — from finance to retail — can take steps now to help manage potential risks and demonstrate their preparedness to the market. This includes understanding and managing directors’ and officers’ (D&O) risk, such as business leaders being held accountable for miscommunications or mismanaged risks related to Brexit.
Since the financial crisis, D&Os have already been facing higher levels of scrutiny and claims activity.
“Regulators have taken increased action against D&Os in recent years, perhaps in an effort to ensure better corporate governance and to prevent a repeat of the financial crisis,” explains Noona R. A. Barlow, European head of liabilities and financial lines claims at AIG.
This trend is not only a public company phenomenon; private and non-profit companies are also facing high-value D&O claims, suggesting that directors from different sectors may face significant exposure from claims and need the support of an experienced insurer to navigate related risks.
In a world of greater scrutiny, demands for sharper governance, and uncertainty surrounding the business and economic impact of Brexit, what steps should UK businesses consider taking in the coming months?
- Making D&O liabilities a board agenda item. Corporate boards must stay one step ahead by identifying D&O risks, assessing them, and ensuring leadership teams are managing them adequately.
- Putting the right D&O coverage in place. Companies should review their executive protection program — a good regular practice to ensure it is sufficiently robust and addresses the evolving risk context. Not only do risk managers need to confirm the company has the right D&O insurance in place — as the terms of D&O policies can vary widely — key people within the organization also need to understand their obligations under the policy to ensure they comply with the terms.
“Be sure that you understand what needs to be notified and disclosed to insurers so that rights under your insurance aren’t inadvertently lost for failure to do so,” warns Leslie Kurshan, head of product development in the financial and professional practice at Marsh.
Remember that Brexit may not only affect what D&O coverage a company needs, but where that insurance needs to be purchased. Currently, companies can buy D&O coverage from a UK-based carrier that will cover their European operations; in the future, however, an insurer may no longer be able to provide this service from London. Instead, companies might need to purchase individual policies in EU countries issued by an insurer licensed to operate in those territories.
- Reviewing business models under the Brexit lens. Risk and strategy managers need to work together with senior leadership to identify how Brexit will impact the company’s business model, strategies, markets, and key stakeholders such as suppliers, staff, and partners. It may be necessary to develop refreshed business models and strategies for the board to consider, and conduct a quarterly business review that looks at Brexit-related risks as they continue to surface in the coming months and years.
- Equipping the board with dynamic and relevant risk information. Instead of presenting a static snapshot of risks disconnected from board member priorities, risk managers are responsible for making risk information dynamic, relevant, and aligned with the business model and strategy of the company. As Institute of Risk Management Technical Director Paul Hopkin explains: “The fact that UK boards are challenged with the obligation to develop a longer-term viability statement has resulted in better engagement of board members with risk management and enhanced the board discussion of risk.”
- Proactively managing credit risk. The uncertainty and volatility caused by Brexit will pose real risks to UK companies’ financial planning, particularly in the area of trade credit. “We are likely to see a high level of insolvencies, of projects put on hold — and of losses. All of this will affect trade credit and firms need to manage this risk more proactively,” says Neil Ross, AIG’s EMEA regional manager for trade credit.
While credit risk management may traditionally be the responsibility of the corporate treasurer in a large company, in a Brexit scenario, the risk manager needs to be intimately involved, especially given the importance of insurance in securing a successful outcome.
- Managing credit risk in new markets. Brexit will likely force companies to become more export-focused and increase trade in less familiar markets, requiring serious consideration of how to manage credit risk. One way to do this is through trade credit insurance (TCI), which can offer companies a degree of certainty over their cash flow. TCI provides protection for companies that sell goods or services on credit terms and are exposed to the risk of non-payment as a result of a domestic or export customer’s insolvency, protracted default, or political risks that may prevent buyers from fulfilling their payment obligations.
While TCI market penetration is relatively low — around 20% in the UK — Brexit is making it more essential than ever, both as a protector and a business tool providing a competitive edge. As Neil Ross describes, “TCI is not just a commodity but a highly effective management tool to help companies avoid taking on other companies’ risks, and thus minimize bad debt.
Furthermore, companies without TCI could find their D&O policy limits are spent defending claims arising from the firm’s failure to purchase TCI, meaning there could be nothing left for the benefit of the director in the event of a “real” claim. Noona Barlow notes: “We have seen several similar claims against directors as a result of a company’s failure to have any trade credit insurance.”
- Protecting key employees. Another significant risk associated with Brexit is the potential for changes to the residency status of key expat staff that may affect their ability to work. To address this uncertainty, AIG recently launched an addition to its D&O policies that will cover legal challenges in the event of permanent residency applications being rejected pre-Brexit, and the subsequent challenges to repatriation orders post-Brexit. This will also cover legal costs for executives living in the UK and EU to fight a repatriation order as a result of termination of the UK’s EU membership. Should the legal challenge to the repatriation order be unsuccessful, the addition will also cover reasonable relocation costs of repatriation.
Prepare and protect — but also stay nimble. Risk and opportunity are two sides of the same coin. In the coming months and years, one of the biggest risks for individual companies — and the broader UK economy — is that decision-makers simply stop taking their businesses forward given the unfolding backdrop of Brexit.
Companies can use thoughtful and dynamic risk management — along with the protection of D&O insurance and TCI — as enablers in this uncertain landscape.
To read more about how AIG’s Directors and Officers liability insurance helps directors face the future and conduct their business with confidence, please visit: https://www.aig.co.uk/innovative-products/business-insurance-products/financial-lines/directors-and-officers-liability
The content contained herein is intended for general informational purposes only. Companies and individuals should not solely rely on the information or suggestions provided in this article for the prevention or mitigation of the risks discussed herein.