D&O Zombies - Not Just a Halloween Horror
- Sam Cornelius
- Oct 31, 2021
- 5 min read
Updated: Nov 20, 2021
When we think of zombies, several different images likely spring to mind. Whether you first think of the shuffling, decayed corpses hungry for human brains or the newer, faster, and more aggressive ‘infected’, almost certainly the first thing you don’t think of is D&O insurance.
Yet, unlike those fictional films we love to indulge this time of year, zombies are a very real risk to insurers and clients alike. In this Halloween special, we look at two zombies that can and do threaten the D&O (and beyond) landscape.
Zombie Companies
In their recent ‘SONAR 2021: New emerging risk insights’, global reinsurance giant Swiss Re have labelled Zombie companies as a 4 out of 5 risk on their barometer, with a high risk of the impact being seen within the next 3 years. Zombie companies are nothing new, but the various worldwide government stimulus and support structures introduced in the wake of COVID-19, and which are starting to or already have been withdrawn have created an excess amount of zombie companies, with their impending financial defaults stood like dominos just waiting to collapse.
What is a zombie company?
A zombie company is broadly defined as a company that earns enough to operate and service debt but have no ability to pay off their debts. Zombie companies operate in a state of true breakeven (or loss) and have no excess capital to invest in growth. Much like a classic Romero zombie, they shuffle along, not really living and yet not quite dead.
What is the risk?
Company watch reported in September 2021 that there were over 235,000 zombie companies in the UK, an increase of 46% on the year before. The total negative worth of these UK zombies alone is a whopping £340 billion (yes, with a ‘B’). Zombie companies have an extreme ability to impact the financial services sector in particular, and their large-scale collapse would spell disaster for many. Swiss Re noted in their SONAR 2021 report:
“Regarding potential financial market implications, zombie companies may simply not be able to pay back their loans, leading to a notable rise in non-performing loans. And so, in the long-term, once emergency fiscal measures start being lifted, rising interest rates could impact the refinancing costs, and thus profitability, of zombie SMEs. This could in turn have negative balance sheet implications for those banks highly exposed to non-performing loans”
This knock-on effect would be disastrous for not only insurers of the zombie companies themselves, but any larger FI insurers who underwrite the risk of the exposed banks. Companies and traders who have debt owed to them by these companies would quickly find their own balance sheets impacted, and the knock-on of defaults continues both upwards to the major financial institutions and downward to other SMEs, sole traders, and families.
The risk of such large-scale defaults is, apparently, very real and very urgent. Credit insurer Atradius has predicted global insolvency rates to spike in 2022 by 33%, with the UK alone expecting a 70% increase in defaults in the next year.
How do we mitigate this risk?
As with most things, the simple answer is careful underwriting. For those especially invested in financial institutions, underwriters need to understand who their client is lending too and their ability to weather defaults of any nature. For those insurers operating in the SME sector, the task is much harder as very little information on a company’s trading partners is likely available. Insurer’s may need to be wary around companies with poor reserves or high debt ratios, or that themselves run the risk of becoming a zombie company.
In broader terms, Swiss Re argue that government policy is the only true way to avoid a financial zombie apocalypse. Policymakers must think carefully and plan and act accordingly as to which sectors and when have their financial support withdrawn in order to avoid a credit default surge.
Zombie Claims
Zombie claims are not a new problem for D&O insurers, but, in the wake of the rise of social media and movements such as #MeToo, as well as emerging and increasing frequency of litigation in the climate and pollution sector, zombie claims present a greater risk that ever to insurers and their clients.
What is a zombie claim?
Put simply, a zombie claim is a matter you thought dealt with that comes back long after you thought it was dead. This could be an allegation of sexual harassment, racist or other inappropriate behaviour against one or more directors of a company (or the company itself), or it could be, for example, a claim for pollution at a site the company has long since sold off or abandoned.
What’s the risk?
For insurers, zombie claims represent a technical challenge of their wording. As international broker WTW note:
“With alleged conduct potentially spanning years or decades, the challenge of sorting through D&O coverage issues may make those claims the scariest, too. Questions over claim timing, notice and the relationship between claims under traditional claims-made D&O insurance coverage can even leave well-insured executives wondering which, if any, of their D&O insurance policies will protect them”
Zombie claims are a challenge for brokers in ensuring their client has the right coverage. Will their D&O policy cover them if such an evet occurs? What is the wording of the insuring clause, what is the claims-basis? How do they define linked claims? Has this issue been notified before? If so, to who? Does that insurer still even exist?
For insurers, the risk is taking on what looks to be clean risk, but one which has hidden time-bombs just waiting for someone to set the whole thing off. In the age of the internet, whistleblowing, and social media activism once the cat is out of the bag it cannot ever be truly put back in, rightly or wrongly. So how does an insurer defend it's client against such allegations spanning back over many years?
How can we mitigate this risk?
Careful underwriting only goes so far when dealing with zombie claims – When dealing with the exposure of these risks, insurer’s need to rely on the risk management and professional abilities of their broker partners, who should ensure the board has conducted reasonable checks into their own history and truthfully disclosed any skeletons in the closest.
On the client side of things, there has been an increase in demand for so called ‘zombie coverage’, especially regarding pollution liability. These clauses provide explicit coverages for sites long since disowned by the company. These clauses could see life in the reputational sector as well, so brokers will need to work with their underwriting partners to come up with appropriate coverage for their clients.
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