In August last year the career of then-President Dilma Rousseff was cut short by the “Lava Jato” corruption enquiry which has now enveloped a large portion of Brazil’s political class.
The investigation, led by federal judge Sergio Moro, alleges systematic corruption and the use of multi-million dollar kickbacks at firms, including Odebrecht, Embraer and state-owned oil company Petrobras.
For insurers, the political instability and apparent culture of corruption makes Brazil a challenging place to do business.
Painstaking investigations into Petrobras and Odebrecht have alleged extraordinary cultures of corruption, including entire divisions of firms allegedly set up to organise the bribing of clients.
While re/insurers in the region keep their heads down in a bid to ride out the storm, spiralling costs from aggressive action on corruption resulted in a clear increase in firms taking out directors’ and officers’ liability (D&O) policies to cover possible defence costs for senior management following the start of investigations in 2014.
In the immediate aftermath of Lava Jato, premiums, retentions and deductibles increased, hardening the market, but underwriters working in the country now say they face a softening market.
Darren Powell, active underwriter at Allied World’s Lloyd’s Syndicate 2232, tells Reactions that a sudden spike in demand for D&O covers followed the Petrobras and Odebrecht scandals: “We certainly saw an uptick in demand for D&O policies following the Petrobras and Odebrecht scandals.
“However, I would say that towards the end of 2016 we saw a slowdown in the takeup of policies,” he adds.
The underwriter warns of the need for prudence, given the risks posed by the prospect of deeply-entrenched corruption across Brazilian corporate culture: “We’re moving forward cautiously with this line of business because it may well prove to be quite high-risk. In addition to rising costs of legal defence, the big question is: has all the corruption stuff come out yet, or is there more to come? How engrained is this in Brazilian corporate culture?”
Concern over where a subsequent scandal may spring from encourages unhelpful instability, forcing underwriters to push for more exclusions and exceptions in a bid to rationalise where claims might arise next.
The national anti-corruption drive has led politicians to bargain with prosecutors and exchange testimony for reduced prison sentences and admit to the extraordinary extent of bribery taking place.
As the investigation continues to compromise the elite of Brazil’s business and political class, the way in which defendants cut deals with courtrooms has considerable implications for D&O claims. Should the insurer pay defence costs in the face of confirmed corruption? And if a client is imprisoned before a final judgement, what does this mean for the payment of defence costs?
According to a report by Diego Assef, senior specialist financial lines at Allianz Global Corporate & Specialty, a range of factors including economic disruption and a rise in civil litigation have spurred an increase in D&O purchases over the past few years: “Civil lawsuits in Brazil, as well as securities class actions suits in the US, antitrust violations, a severe and still ongoing financial recession and a strict government regulated environment against companies and their executives is driving increased D&O purchases,” Assef says.
While the use of D&O policies to pay regulatory fines and penalties is forbidden under law within UK and US legal systems, the attitude of Brazilian law towards the payment of fines was ambiguous until last year.
Following a circular issued by the Brazilian regulator in October, insurers are now allowed to pay claims for penalties received for financial wrongdoing. While giving clarity, this move could also spark an increase in policy uptake – and some apprehension among underwriters – amid fears of fines to come.
According to Matthew Wescott, partner at law firm DAC Beachcroft, there was previously a lack of certainty over the extent to which a statutory settlement with the Brazilian securities commission, known as a “TAC”, would be a fine or a contractual settlement agreement. “Recent Brazilian case law has confirmed that it is the latter, with obvious implications for D&O coverage,” he explains.
Despite the positive news for insureds, however, the cost of undertaking internal investigations to establish exactly whether wrongdoing has taken place is not covered by such D&O policies: “Where companies are seeking leniency, they are self-reporting. In order to make decisions about how they approach alleged wrongdoing they have to carry out big, expensive internal investigations, which requires expensive lawyers and consultants. This is not necessarily covered by D&O policies and so insureds should carefully review their policy wording before incurring such expenses, in order to assess whether they will be covered” Wescott adds.
David Gonzalez, American International Group’s regional manager for Latin America and the Caribbean, speaking in an interview with Financier Worldwide, also noted the costs that mount up in the most complicated of D&O cases.
“All the costs have increased across the board. Legal fees add up quickly, especially if you want to use one of the top law firms that can resolve the matter quickly and efficiently,” said Gonzalez. “During these times, it is important to not only have the right D&O liability insurance policy but also the right claims handling professional who will work with clients to get the best possible defence.”
A downturn in construction
A reduction in the number of public construction projects being built is a corollary of Brazil’s political instability.
This has hit construction insurance lines across the board, according to Powell at Allied World, creating an atmosphere of uncertainty for insurers writing construction policies.
“A lot of the construction projects we saw being commissioned a few years ago have been suspended. If you drive through the country it is clear there has been significant underinvestment in Brazilian infrastructure,” he says.
“We are still writing construction, and recently established the Allied World LatAm Construction Consortium, based in Madrid. This provides a base for a number of Spanish contractors who focused their business on South America following the 2007/08 economic downturn,” Powell adds.
The economic downturn, political turmoil and increasingly revelatory investigations are key critical concerns for construction risk insurers.
With Petrobras responsible for around 90% of oil and gas spending – 10% of the country’s gross domestic product – certain highly-leveraged contractors are facing bankruptcy or the downsizing of projects.
Brazilian reinsurance: a regulatory shift
As the anti-graft investigations move the country’s D&O market, the shape of the regulatory environment for foreign reinsurers in Brazil has also begun to change.
Reinsurance premiums ceded to foreign reinsurers gross of commission hit BRL6.25bn in 2016, up from BRL6.23bn in the prior year, according to Terra Brasis Re’s Terra report. The figures show foreign firms taking a bigger share of domestic business.
Brazilian insurers were previously obliged to offer Brazilian reinsurers at least 40% of premiums ceded on a preferential basis, however this has begun to change.
Law 322, introduced in July 2015, facilitates the staged reduction of the proportion of business Brazilian insurers must offer to Brazilian reinsurers. Following the passing of the law, the percentage of business that must be placed with domestic players decreased to 30% in January 2017 and will decline by 5% annually to reach a minimum floor of 15% in January 2020. However, the right of first refusal remains at 40% indefinitely.
While the change afoot for reinsurance may mark a regulatory watershed, broader shifts across political and commercial environments do not happen overnight and in the meantime prove a challenge for underwriters to navigate.
Both the Brazilian business community and the country’s population at large are clear that they wish to wipe the slate clean and move on.
As Powell says: “The situation in the country seems to have settled down a bit, and there is a greater sense of optimism in the air. Many people who own their own businesses are sick of what’s gone on in terms of the corruption – they just want to move forward.”
Lava Jato: a tale of corruption
Last month the “Lava Jato” corruption enquiry, which has focused on the payment of bribes by large Brazilian multinationals, reached high noon.
The investigation extended its reach to snare President Michel Temer in a sting operation that allegedly caught the country’s leader taking a bribe.
This latest development means all five of Brazil’s living past and former presidents are implicated in the scandal, which has seen former president Luiz Inacio Lula da Silva summoned to give evidence on suspicion of accepting a flat as a bribe linked to corruption at state oil firm Petrobras.
Futures of the benchmark Ibovespa gauge plunged 10% and shares in Spanish insurer Mapfre slumped by -4.8% in the 24 hours following the operation against Temer.
The investigation, which brought down Dilma Rousseff, reveals a complex regime of bribery at state oil firm Petrobras – which prosecutors allege was directly connected to then-ruling Brazilian Workers’ Party (PT).
After PT appointed their own candidates to executive positions at Petrobras, funds from the firm were syphoned off to buy contacts and fund the party’s election campaign. PT still denies the claims.
Over 12 other firms have been implicated in the investigation, which has involved financial authorities and regulators from around the world.
Brazilian aerospace conglomerate Embraer was dragged into the international investigation in October last year after it agreed to pay $205m to resolve a probe from the inquiry that alleged the payment of kickbacks for deals relating to countries including the Dominican Republic, Saudi Arabia and Mozambique.
And in December, Brazilian construction giant Odebrecht signed a leniency deal with authorities in the US and Switzerland, paying $2.6bn in fines after admitting the payment of bribes for contracts.
Since June 2015, 77 senior executives at the firm have been jailed, including chief executive Marcelo Odebrecht.