Directors & Officers (D&O) Liability Insurance provides financial protection for wrongful acts arising out of the discharge of directors’ and officers’ governance and management duties. Having such coverage in place is not just beneficial in the event of a claim but can assist an organization in attracting and retaining qualified board members. There is, however, no “standard” coverage, and D&O policy terms can vary greatly. This article poses questions to assist an organization in evaluating some of the nuances and provisions of a D&O policy.
1. Does a D&O policy only protect the individuals serving on an organization’s board of directors?
D&O policies are typically structured with three insuring agreements providing what is called Side A, Side B and Side C coverage.
· Side A coverage insures individual directors and officers against losses that the organization is not legally or financially able to indemnify. This could be due to insolvency or a prohibition in the organization’s by-laws. Side A coverage protects the personal assets of the individual directors and officers and oftentimes is not subject to a monetary retention.
· Side B coverage reimburses an organization for expenses incurred in defending its directors and officers due to its indemnification obligations.
· Side C coverage, often called entity coverage, insures the organization for claims made directly against the organization for wrongful acts by the organization or its directors or officers. For public companies, Side C coverage is typically limited to securities claims only.
2. In addition to settlement costs and damages, does a D&O policy also insure defense costs associated with a claim?
Eroding Limits: Unlike a General Liability policy which often provides defense costs in addition to the listed policy limits, D&O policy limits generally include defense costs within the policy limits, which means that defense costs erode the overall policy limit. Some insurers are able to offer additional, dedicated defense costs, but this varies by insurer and type of exposure.
Insurer vs Insured Duty to Defend: D&O policies are written on either an insurer duty to defend basis or an insured duty to defend basis. Insurer duty to defend requires the insurer to assume control of the claim defense process and selection of counsel. The insurer has both the right and duty to defend a claim, even if any of the allegations are groundless, false or fraudulent. Typically, this arrangement is favorable to the insurer as its panel counsel is familiar with the billing practice and also gives the insurer more control in their effort to minimize coverage payments.
The other option, called insured duty to defend, causes the insured to be responsible for defending a claim and the insurer to be responsible for reimbursing an organization for expenses incurred in defending that claim. This type of arrangement allows for the organization to control its own defense but puts the onus on the entity to respond to legal proceedings in a timely manner. Even with this arrangement, the insurer will still need to approve an organization’s choice of counsel and the rates being charged. We recommend if you have a preferred defense counsel that this be discussed with the insurer ahead of a claim so that the insurer can review and hopefully approve that counsel for use in the event of a claim. Ultimately, the insurer may only agree to pay a portion of the hourly rate and the insured will pay the difference, if a preferred counsel is retained.
3. If an officer of the company is asked to serve on the board of another organization, how is that individual covered?
Individuals who serve on the board of another organization would first look to that organization’s D&O insurance policy for coverage if named in a suit arising out their capacity in such a role. Many D&O policies also provide Outside Entity coverage which provides additional protection for an individual serving as a director, officer, trustee or board member of another organization (Outside Entity). However, this extension typically only applies to participation on not-for-profit boards. This coverage applies excess of any D&O policy coverage purchased by the Outside Entity and would also be excess of any indemnity obligations.
It is typical that Outside Entity coverage is only available if the individual is serving in such a role at the request and knowledge of your organization.
4. What is the appropriate coverage limit to purchase?
No Formula: There is no correct answer and no true scientific method in determining the amount of limit to purchase. When considering the policy limit, we recommend the following:
· Evaluate historical claim frequency and severity for your organization and other similar organizations;
· Consider current litigation trends;
· Identify how the limit structure is shared amongst directors, officers and possibly the entity;
· If a public company, review and consider historical stock price changes and market cap;
· Consider unique exposures such as mergers and acquisitions as well as perform benchmarking against similar organizations’ purchasing practices; and
· Understand where the source of claims can arise, particularly if the organization is in an industry that is regulated by governmental agencies.
After gathering this information, the final decision will be dependent on the organization’s risk tolerance, budget and level of insurance that will provide comfort to the directors and officers serving the organization.
Additional Limits for Board Members: Side A DIC policies do not provide additional Side B or Side C coverage and therefore provide dedicated additional protection for individual directors and officers. This type of policy will also drop down and provide primary coverage if the underlying insurer fails or refuses to pay a claim, attempts to rescind coverage, or becomes insolvent. Some insurers will provide additional Side A coverage within the standard Side A/B/C policy, though this is often provided at a lower sublimit.
In bankruptcy situations, some courts have ruled that the D&O policy is an asset of the estate and therefore bankruptcy trustees may attempt to seize the insurance proceeds. An advantage of purchasing a Side A DIC policy is that there is a much weaker argument for a bankruptcy court to seize a stand-alone Side A policy which does not provide any corporate balance sheet protection. As this policy is only triggered when an organization is unable to indemnify its directors and officers and does not provide entity coverage, we do not recommend reducing the purchased Side A/B/C coverage to replace with Side A DIC limits.
5. If a claim is brought against both the organization and an individual director, in what order will payment be made?
D&O policies have a “priority of payments” provision which states that the insurer will first pay any Side A coverage which protects the named director or officer and then will pay the loss for the entity with the remaining available limit. We would recommend that this provision be written in a way that payments for any Side B coverage (claims against individuals that are reimbursable by the company) are also made prior to payment for the portion of the loss against the entity (Side C).
6. If the insurance application is completed inaccurately or facts are misrepresented, will the policy coverage remain available?
D&O insurance applications are almost always required at the initial placement of coverage as well as at each respective renewal. In addition to being required to obtain a coverage proposal, these applications become a part of the issued policy. The Representations section of a D&O policy should be severable so that coverage remains available for individuals who were unaware of any misrepresentations in the application. Additionally, only the knowledge of particular parties, such as the CEO and CFO, should be imputed to others or the entity. Finally, we recommend that this provision include language stating that the insurer cannot void or rescind the coverage. At a minimum, Side A coverage should be non-rescindable.
7. If an organization no longer exists or decides to terminate the purchase of D&O coverage, is coverage still available for claims alleging wrongful acts during the time that coverage was purchased?
D&O coverage is written on a claims-made basis, which means that it provides coverage in the policy period that a claim is made, regardless of when the event occurred, subject to any retroactive dates. If an organization no longer carries D&O insurance, then coverage would not be available if a claim is brought after the policy coverage terminates unless an Extended Reporting Period is purchased.
Organizations have the option to purchase an Extended Reporting Period (ERP) if coverage does not renew or is terminated for reason other than failure to pay premium. ERPs are considered tail coverage and allow for claims to be reported even after the policy is no longer in place. While the extended period allows for claims to be reported, the alleged wrongful act must have occurred prior to the termination of coverage. We recommend pre-negotiating extended reporting periods of at least one (1), two (2) and three (3) years at pre-negotiated rates. These rates represent a percentage amount of the annual premium.
8. When must a claim be reported? Could an insurance company deny coverage if there is a delay in reporting?
If the failure to notify an insurer prejudices its rights and ability to defend a claim, then the insurer may look to deny coverage by issuing a reservation of rights letter. Therefore, it is critical that an organization understand its reporting requirements. Typically, a claim must be reported to the insurer upon knowledge of an insured. We recommend limiting this requirement to knowledge of particular parties, such as the CEO, CFO and Risk Manager or General Counsel. By limiting the parties for whom knowledge of an incident must be reported, this limits the possibility of late or missed reporting due to individuals who are unfamiliar with the reporting requirements or the scope of coverage under the policy. Additionally, to provide substantial time to gather information, we recommend allowing for the reporting of an incident/claim “as soon as practicable” rather than “immediately”. Notice should be permitted by either certified mail or by email.
9. How has COVID impacted the D&O insurance marketplace?
The D&O insurance market, particularly for public companies, has been hardening since 2019. Insurers are reducing their limit capacity, and seeking increased policy retentions, significant premium increases, and restrictions of coverage terms. Excess policy layers are no longer following primary layer rate changes, which has led to further premium increases in organization’s D&O programs.
As a result of the hardened market, insurers are performing additional underwriting and requesting more information from organizations regarding their exposure data. COVID has further complicated the underwriting process as insurers anticipate COVID-related claims. This has resulted in requests to questions such as how an organization’s management team is handling the pandemic, making proper disclosure to investors and analysts, and other similar items.
Due to the amount of information being requested at renewals and anticipated premium increases, we recommend beginning renewal discussions early to obtain feedback from your insurer(s) and to set early expectations.