The D&O application process often surprises many leadership teams. It is complex and requires the disclosure of sensitive information. But with the right help, an organisation’s directors and officers will be adequately protected for years to come.
Organisations seeking D&O coverage must first complete a formal application process. The application is used by insurers to understand an organisation’s operations and is relied on by its underwriters to issue policy pricing and conditions.
To ensure there is no ambiguity in determining what documents comprise of an application, the term is often specifically defined within a policy. Whilst this definition can vary, it generally consists of a proposal form and supporting documents.
The proposal form
A proposal form is the formal application document completed by an organisation’s directors and officers. It is the method in which an organisation provides an insurer with underwriting information, by answering a broad range of questions relating to its operating activities and managerial related risk exposures.
Supporting documents complement the information contained within the proposal form and allow an underwriter to analyse the finer details of an organisation. They generally consist of documents such as:
- Audited financial accounts
- Annual reports
- Company announcements
- Share prospectuses
- Professional profiles of senior management
Quality applications get better results! From an applicant’s perspective, the more relevant and accurate the information provided, the more comfortable an underwriter will be with the risk; possibility leading to more favourable terms.
Insurance contracts are bound by the legal doctrine of urberrima fides, a Latin phrase meaning ‘utmost good faith’. Acting with utmost good faith means that all parties to an insurance contract are under a strict duty to deal open and honestly with each other, disclosing all material facts during the application process. For an organisation and its management, this entails satisfying a duty of disclosure.
A material fact‘ is any piece of knowledge that could influence an underwriter when deciding whether or not to accept a risk. An underwriter relies on the information presented to them to make key judgements on an applicant’s risk profile, and they use this analysis as a basis for determining a policy’s terms and conditions. It is therefore of utmost importance that this information be completely and accurately disclosed.
From a policyholder’s point of view, if material facts are not correctly disclosed and an underwriter is induced to offer coverage for something they would not have done if correct disclosure were made, there can be serious consequences.
Prior claims and circumstances
An insurer requires that an applicant disclose all prior claims, and any circumstances that may give rise to future liability. All such prior claims and circumstances are then excluded from coverage moving forward.
If an insurer believes that an applicant has knowingly withheld information about the existence of prior claims, it may attempt to avoid covering any claim related to the non-disclosure or omission.
Important! Underwriters take into account an organisation’s disclosure of prior claims when determining a policy’s premium and terms of coverage.
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Continuous disclosure is essential
Satisfying a duty of disclosure isn’t just a once off occurrence. An organisation and its executives are wholly responsible for keeping underwriters advised of accurate information throughout the entire application process.
This means that underwriters should be notified if facts or circumstances change between the initial application and when coverage is eventually bound. Due to the serious implications of non-disclosure, it is in management’s best interest to promote transparency and continuous disclosure of all relevant details.
Consequences of non-disclosure and misrepresentation
So, what happens in the event that you miss something?
Non-disclosure and misrepresentation in the application process can have serious consequences for policyholders. If an organisation or its executives fail to disclose relevant information or misrepresents a material fact, an insurer is likely to have one of three legal remedies available:
1. Contract avoidance
If non-disclosure or misrepresentation occurs during the application process, an insurer may have grounds to avoid the insurance contract. This is especially relevant in situations involving fraudulent non-disclosure or misrepresentation, such as when an executive deliberately lies or alters supporting documents in order to induce an underwriter to offer coverage.
By avoiding the contract, the insurer is entitled to treat the policy as if it never existed. This will result in the policy being cancelled effective from the date of the application. The cancellation of a policy means that all existing claims will be declined, as well as effectively eliminating coverage for any claims or circumstances which arise in the future.
2. Reduction in liability
When an innocent non-disclosure or misrepresentation is made, rather than avoiding the contract completely an insurer may elect to reduce its liability by arguing that its position has been prejudiced by the non-disclosure or misrepresentation.
By reducing its liability, an insurer can attempt to limit the level of coverage available for a particular claim. This remedy aims to place the insurer in the same position it would have been in if disclosure were made correctly. A reduction in liability may also comprise of an insurer imposing certain conditions or sub-limits, which would have been in effect had proper disclosure occurred.
3. No effect
If the non-disclosure or misrepresentation would not have affected an underwriter’s decision to accept the risk, for the same premium, terms and conditions, full coverage may still apply.
The representations clause identifies whose knowledge of a non-disclosed or misrepresented material fact can affect the D&O coverage of an organisation. In other words, it outlines who is responsible for speaking on behalf of the organisational entity during the application process.
For example, consider a D&O application completed by the CEO of an organisation. If a department manager has failed to inform him of a material fact, which would have affected the terms of insurance issued to the organisation, will the organisation’s coverage be affected by CEO’s non-disclosure, even though he honestly thought that all relevant information was provided to the underwriter?
Many policies account for these challenges by outlining which executives within an organisation are responsible for satisfying an organisation’s disclosure requirements. Because of the serious implications of non-disclosure and misrepresentation, the list of personnel whose knowledge can affect an organisation’s coverage is usually small, consisting only of high-level managers such as the CEO, CFO and general counsel.
Severability, in the context of D&O, relates to how instances of non-disclosure and misrepresentation by one executive, affects another. It outlines whether the knowledge of one executive will be imputed onto other executives or the organisation. In other words, how is the coverage for an innocent individual affected when another person makes a critical non-disclosure or misrepresentation?
In other words, how is the coverage for an innocent individual affected when another person makes a critical non-disclosure or misrepresentation?
As noted in the representations clause, usually only senior management’s knowledge will be imputed onto the coverage of an organisation. For individuals, many policies are now constructed to be fully severable.
Severability means that the knowledge of each person is separated from the knowledge of others. Therefore, non-disclosure or misrepresentation by one executive won’t affect the coverage applying to anyone else; provided, of course, that they are not aware of the misrepresentation.
Some insurers are willing to promise that once an application for coverage has been approved and a policy is in place, that coverage is non-rescindable. This means that an active policy cannot be revoked or cancelled, even after the discovery of a non-disclosure or misrepresentation.
If a policy is not completely non-rescindable, it may be at least partly non-rescindable; usually in relation to Side-A coverage. In this case, if an insurer has grounds to cancel a policy, Side-A coverage will remain in place to ensure that management remains protected in instances where indemnification is not available from their organisation.
D&O, like many forms of financial lines coverage, is non-renewable in the sense that a policy cannot be simply renewed or ‘rolled-over’ into the next insurance period. Instead, as a D&O policy approaches expiry it must be reapplied for, in a similar manner to its original application. Then, before expiration, a replacement policy must be effected for the following year.
This ‘renewal’ process is almost identical to the application process, requiring the completion of proposal documents and submission of supporting documents. For smaller and less risky accounts, an underwriter may provide a faster ‘express’ renewal option to policyholders, by asking them to complete a short declaration, allowing them to note any substantial changes to its business activities or turnover.
As you can see, applying for D&O coverage isn’t necessarily a straightforward process. It takes a little time and patience, and justifies the need for experienced underwriters, brokers and risk managers to assist organisations in navigating some of the common pitfalls.