The opportunities generative AI (GenAI) offers businesses across most industries are seemingly limitless. Yet, risks abound for organizations’ directors and officers (D&Os), and, therefore, the D&O insurance market, according to Allianz Commercial’s recently published report, “Directors and Officers Insurance Insights 2024.”
The report cites a global annual survey by McKinsey that states one-third of respondents’ organizations use GenAI regularly in at least one business function. “While the competitive advantages seem limitless, there will also be challenges associated with the adoption of the technology that organizations should consider,” according to the Allianz report. These include cybersecurity threats; increased regulatory risk; demand for more corporate transparency; unrealistic investor expectations; and threats over the responsible use of GenAI technology.
Privacy and copyright violations have already been filed against several AI companies, the report notes. “These cases, along with the items noted above, have the potential to bring securities claims, intellectual property claims, breach of fiduciary duty claims, misrepresentation claims, and shareholder and derivative lawsuits.” Therefore, the responsibility of understanding the technology and its appropriate use for business falls on leadership. Organizations can mitigate risk associated with GenAI, however, by “setting up best practices and employing agile methods to keep governance, compliance protocols, and legal frameworks current and able to adapt to the technology as it evolves.”
Hannah Tindal, regional head of commercial D&O at Allianz Commercial in London, tells CLM, “In addition to the potential challenges outlined in the report, company readiness for AI deployment is of concern as companies may lack the critical infrastructure to not only deploy the technology but also may not have fully developed risk management plans and monitoring in place to ensure the technology does not bring undo harm to their organization. Employing the right experts and ensuring all stakeholders come together to consider all the critical issues will ensure companies have a responsible framework to move ahead.”
Market Dynamics and the State of the D&O Insurance Sector
Throughout 2023, both public and private companies benefitted from competitive market pricing and broader coverage terms, according to the report. New entrants to the insurance market, along with the reduced number of Initial Public Offerings (IPOs), “provided companies with a more favorable D&O market versus the shift in the market due to profitability challenges seen in 2020/2021, which lead to higher premiums, stricter terms, and reduced capacity in both primary and excess insurance,” the report explains.
Class action activity also affects the insurance sector. “Looking at the end of 2023, federal securities class actions sat at 201 (as of Dec. 11) versus 197 in 2022 and 212 in 2021. However,” the report continues, “the total settlement dollars are up significantly versus historical levels…. According to insurance brokerage, Woodruff Sawyer, total settlement dollars paid out in all of 2022 were [$2.4 billion], and in the first half of 2023, that total is already at [$3.1 billion]. Even with a $1 billion settlement excluded from the data set, the settlement figure for the first half of 2023 is the highest it has been in the last 10 years.”
Economic Risks
“Refinancing of existing debt is proving a shock to the system for some firms,” according to the report. “After years of low interest rates, firms refinancing debt are feeling the effects on their profit and loss statements (P&L). While the ability to provide positive earnings before interest, taxes, depreciation, and amortization (EBITDA) message remains, the impact is clearly being felt for many firms within their cash flow.”
Furthermore, the report adds that economic growth around the world remains “disappointing,” and that the likelihood of recessions in the U.S. and U.K. continues to grow. The report also discusses the 2023 U.S. banking crisis, which began in March. Some of the reasons behind the crisis, according to the report, included poor banking practices, rising interest rates, and social media. However, although the report states that the crisis appears to be over, “there are two factors to keep an eye on. First, we are watching banks with large commercial property portfolios. Some banks are selling property loans at a discount, even when borrowers are current with repayments, a sign of their intent to reduce exposure to the commercial real estate market.”
Geopolitical Risks
Geopolitical issues, such as the war in Ukraine and the war between Israel and Hamas, also have significant impacts on risk, according to the report. The Ukraine war, which brought heavy sanctions against Russia and Belarus and the halting of trade in the territories, is a prime example. “[D&Os] should be prepared for the aftermath of the conflict if or when it ends,” the report states. “Is there a strategy in place to return to these territories and with the increasing focus on environmental, social, and governance issues how will stakeholders respond to the ‘social’ decisions taken by the board?” These global conflicts also bring to light the need for businesses to protect their employees by ensuring their safety in high-risk areas, such as kidnap and ransom processes, the report advises.
“Organizations are operating in highly complex and rapidly evolving environments,” Tindal concluded. “Managing these risks requires companies to have solid governance procedures and strong risk management frameworks that are able to evolve with these uncertainties.”