The New World of Global D&O Insurance – Part 2
Note: This is the second of a two-part Risk Insider look at D&O.
As indicated in my previous Risk Insider post on Aug. 16, it’s been 10 years since the advent of the first local foreign D&O policies. Since then, many carriers have fine-tuned their process for underwriting and issuing local policies in foreign countries.
So, how should companies determine what countries have significant risk for them, and what are the key factors that should be examined in assessing the local exposure to D&O risk – whether from claims or from regulatory or tax concerns?
Not surprisingly, many multinationals have no interest in acquiring foreign local D&O coverage in countries where they believe their D&O exposure is negligible. After all, no exposure should translate into no premium allocation from the carrier, and thus no taxes or other compliance issues.
Therefore, when determining which countries are candidates for a foreign local D&O policy, it is critical to at least consider the following:
- Local exposures based on size, stock ownership, and brand.
- Types of local operations or business activities and status of the local management.
- Local regulations, including whether local non-admitted D&O coverage is permitted and recognized in country, and any potential taxes or penalties.
- Potential indemnification constraints for each country of concern.
- An assessment of local market conditions, purchasing patterns and claims activity.
Ultimately, each multinational client company [in the U.S., for example] should prioritize its international D&O risks from both a claims and compliance perspective. By assessing “regulatory risks,” such as compulsory requirements, admitted paper, indemnification constraints, tax, regulatory, local market viability, enforcement and local D&O claims history, we have built a “Regulatory Score” for each country.
Not surprisingly, many multinationals have no interest in acquiring foreign local D&O coverage in countries where they believe their D&O exposure is negligible.
Against that very substantial analysis, we have also created a simple “Business Trends” score for each country by measuring how often multinationals do business in these countries, and the extent of such business in each country in terms of the size (revenues or assets) and complexity of their operations.
By substituting your own data on country by country exposures, a customized heat map can be drawn that will help you prioritize the countries which require the most attention from a D&O insurance perspective. A sample graphic for some of the more popular countries follows:
Implementing International D&O coverage through the use of locally issued D&O policies is both important and challenging. Brexit does not help. Although “Freedom of Services” (FOS) policies were never very popular, it was helpful in some cases to place a single U.K. policy to obtain coverage for all European Union countries. And while innovative responses to Brexit have already emerged, we continue to favor local policies in each of your countries of interest.
Finally, we recognize that implementing a strong International D&O strategy puts a large administrative burden on the corporate risk manager and corporate offices in general. A large amount of information is required, which may include the collection of application materials from local operations.
However, the trade-offs are worth the trouble in high-risk countries. Sound advice, patience and persistence are critical to a successful process.
See Part I here.
The New World of Global D&O Insurance
Note: This is the first of a two-part Risk Insider look at D&O.
It’s less than 20 years since the concept of worldwide Directors & Officers Liability (D&O) insurance was introduced. Since that time, the world of international D&O changed dramatically.
In particular, there is much greater awareness that multinational firms may need to secure local D&O policies within their respective countries of operation. The global market for D&O coverage also evolved.
Multinational corporations face some significant emerging exposures that may not be adequately addressed by the traditional global [non-admitted] programs that have historically dominated the market. Several factors have contributed to this shift, including:
- Increased D&O claim frequency and severity outside the United States.
- Greater regulatory enforcement, especially with respect to tax collection.
- A growing number of officers residing in or traveling through foreign operations.
- Taxes on “non-admitted” claims payments.
- Increased local capacity and local market availability in general.
- Indemnification constraints in many countries that can be very significant.
- The potential for undesirable publicity or harm to the corporate “brand.”
These recent market influences created a demand for foreign local [admitted] D&O policies in many countries.
Approximately a decade ago, carriers began to develop and promote their ability to offer and service foreign local D&O policies.
Multinational corporations face some significant emerging exposures that may not be adequately addressed by the traditional global [non-admitted] programs that have historically dominated the market.
Before these programs emerged, the Difference in Conditions (DIC) program approach allowed local operating entities to insure their own operations on an admitted basis in each country of operation.
This led to some companies’ foreign operations determining their own level of exposure and then negotiating and binding coverage with a local carrier — sometimes a different carrier than the one writing the parent company’s “worldwide” policy. That resulted in a few problems but did offer an improvement.
Multinationals headquartered in the U.S. could then use their U.S. D&O program as a DIC policy to address various gaps, just as the local policies would customize themselves to local laws and regulations.
The new and improved DIC program follows the methodology of coordinating all D&O placements throughout the world. Sounds great, but it’s still quite complicated.
For example, a U.S. multinational with significant operations in 30 countries might have sufficient D&O exposure to decide to obtain local policies in each country.
Here is how that strategy might be executed, assuming the multinational’s primary D&O carrier has underwriting capabilities and local policies in all 30 countries:
- 20 countries have an agreement with the U.S. carrier for centralized billing and policy issuance.
- Two of those 20 countries ask for something like a “Know your Customer” [anti-money laundering] form to be completed and may also want a locally signed D&O application.
- Eight countries require local payment and perhaps local policy issuance. One should use local brokers for this.
- The remaining two countries require local applications completed for local underwriting.
A few countries will require payment upfront before binding or perhaps a local signature on the policy at the time of issuance.
Though challenging, there are many significant benefits to structuring this type of program:
- Coverage is placed and premium taxes paid in compliance with local laws.
- Coverage is customized to the unique exposures, yet can be broadened by the coverage written on the “worldwide” D&O policy [usually in the United States].
- Economic leverage based on the size of the headquarters program may lead to lower deductibles in the foreign subsidiary locations.
- Local claims-paying abilities will generate both better advice and greater protection for Side-A D&O liabilities in countries where indemnification is difficult to obtain.
- Corporate gains quality control over the entire program as they direct all purchases.
Now that the need for a customized global D&O program is obvious, the risk can be assessed and prioritized in each country and purchased accordingly.
Cyber: The Overlooked Environmental Threat
“Cyber breach” conjures fears of lost or ransomed data, denial of service, leaked corporate secrets and phishing scams.
But in a world where so many physical operations are automated and controlled by digital technologies, the consequences of cyber attacks extend far beyond the digital realm to include property damage, bodily injury, and even environmental pollution.
Industrial companies that deal with hazardous materials — like power plants, refineries, factories, water treatment facilities or pipelines — are heavily dependent on automated technology to maximize their efficiency. Other sectors use technology to control HVAC systems, power and utilities, placing their properties at risk as well.
Cyber risks like theft of personally identifiable data have been highly publicized in recent years, but physical risks like pollution sparked by a cyber breach may not be as obvious.
“It’s significant to lose 100,000 customers’ Social Security numbers,” said William Bell, Senior Vice President, Environmental, Liberty International Underwriters, “but can you imagine if a waste treatment facility’s operations get hacked, gates open, and thousands of tons of raw sewage go flowing down a local river?”
In many industrial complexes, a network of sensors gathers and monitors data around machinery efficiency and the flow of the materials being processed. They send that information to computer terminals that interpret the data into commands for the hardware elements like motors, pumps and valves.
This automation technology can control, for example, the flow of pipelines, the level of water or waste held in a reservoir, or the gates that hold in and control the release of vast quantities of sewage and other process materials. Hackers who want to cause catastrophe could hijack that system and unleash damaging pollutants.
And it’s already happened.
In 2000, a hacker caused 800,000 liters of untreated sewage to flood the waterways of Maroochy Shire, Australia. In 2009, an IT contractor, disgruntled because he was not hired full-time, disabled leak detection alarm systems on three off-shore oil rigs near Long Beach, Calif.
Just last year, cyber attackers infiltrated the network of a German steel mill through a phishing scam, eventually hacking into the production control system and manipulating a blast furnace so it could not be shut down. The incident led to significant property damage.
According to a leading industrial security expert and executive director of the International Society of Automation, “Today’s operational technologies—such as sensors, SCADA systems, software and other controls that drive modern industrial processes—are vulnerable to cyber attack. The risk of serious damage or compromise to power and chemical plants, oil and gas facilities, chemical and water installations and other vital critical infrastructure assets is real.”
“The hacks could come from anywhere: a teenager looking for entertainment, a disgruntled worker, or more sophisticated criminals or terrorists,” Bell said. “There are certainly groups out there with political and ideological motivations to wreak that kind of havoc.”
“We are working to bring the cyber component of environmental risk to the forefront. Cyber security is not just an IT issue. Industry executives need to be aware of the real-world risks and danger associated with an industrial cyber attack as well as the critical differences between cyber security and operational technology security.”
— William Bell, Senior Vice President, Environmental, Liberty International Underwriters
The cleanup cost of an environmental disaster can climb into the hundreds of millions, and even if a cyber breach triggered the event, a cyber policy alone will not cover the physical and environmental damage it caused.
The risk is even more pointed now, as resource conservation becomes increasingly important. Weather related catastrophe modeling is changing as both flooding and drought become more severe and frequent in different regions of the U.S. Pollution of major waterways and watersheds could have severe consequences if it affects drinking water sources, agriculture and other industrial applications that depend on this resource.
Managing the Risk
Unfortunately, major industrial corporations sometimes address their environmental exposure with some hubris. They trust in their engineers to remove the risk by designing airtight systems, to make a disaster next to impossible. The prospect of buying environmental insurance, then, would be superfluous, an expression of doubt in their science-backed systems.
Despite the strongest risk management efforts, though, no disaster is 100 percent avoidable.
“We are working to bring the cyber component of environmental risk to the forefront,” Bell said. “Cyber security is not just an IT issue. Industry executives need to be aware of the real-world risks and danger associated with an industrial cyber attack as well as the critical differences between cyber security and operational technology security.”
The focus on network security and data protection has distracted industry leaders from strengthening operational technology security. Energy, manufacturing and other industrial sectors lack best practice standards when it comes to securing their automated processes.
After the Homeland Security Act of 2002, the Department of Homeland Security began comprehensive assessments of critical infrastructure’s cyber vulnerability, working with owners and operators to develop solutions. It also offers informational guides for private companies to do the same. The National Institute of Standards and Technology also continues work on its cyber security framework for critical infrastructure. Although this helps to establish some best practices, it does not completely mitigate the risk.
Many businesses don’t see themselves as a target, but they need to look beyond their own operations and property lines. They could be an attractive target due to their proximity to densely populated areas or resources such as waterways and highways, or nationally or historically significant areas. The goal of a cyber terrorist is not always to harm the target itself, but the collateral damage.
The Role of Insurance
“Environmental liability is still by and large viewed as a discretionary purchase,” Bell said, “but the threat of a cyber attack that can manipulate those systems and ultimately lead to a pollution incident is added incentive to buy environmental coverage.”
Liberty International Underwriters’ environmental coverage could respond to many pollution conditions set off by a cyber breach event.
“Property damage, bodily injury and cleanup of any pollution at or emanating from a covered property would likely be taken care of,” Bell said. “The risk is not so much the cyber exposure but the consequence of the attack. The resulting claims and degradation to the environment could be severe, especially if the insured was a target chosen because of their unique position to have a large effect on the local population and environment.”
LIU also offers dedicated Cyber Liability insurance solutions designed to manage and mitigate the cost of responding to a cyber attack and any resultant loss of data and associated liability. Coverage includes proactive data breach response services designed to help organizations comply with regulatory requirements and prevent data breaches.
LIU’s loss control managers are also on hand to conduct assessments of insureds’ properties and facilities to examine potential environmental impacts. They can educate brokers on the importance of enhancing cyber security to prevent an environmental accident in the first place.
“People are relying more and more on their systems, automaton is increasing, and the risk is growing,” Bell said. “We’re all focused on protecting data, but the consequences of a cyber breach can be much farther reaching than data alone.”
To learn more about Liberty International Underwriters’ environmental coverages and services, visit www.LIU-USA.com.
Liberty International Underwriters is the marketing name for the broker-distributed specialty lines business operations of Liberty Mutual Insurance. Certain coverage may be provided by a surplus lines insurer. Surplus lines insurers do not generally participate in state guaranty funds and insureds are therefore not protected by such funds. This literature is a summary only and does not include all terms, conditions, or exclusions of the coverage described. Please refer to the actual policy issued for complete details of coverage and exclusions.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Liberty International Underwriters. The editorial staff of Risk & Insurance had no role in its preparation.