About Kristopher Marsh

Underwriters are responsible for setting the pricing and conditions of D&O policies. By understanding the factors they take into account while doing so, you can ensure that you’re putting your best foot forward when securing terms.

Despite a trend of increasing litigation over the past few years, underwriting practices have been refined to ensure that D&O programmes remain profitable for insurers. Outlined below are some of the aspects considered in the underwriting process.

Ownership structure

The ownership structure of an organisation provides a broad indication of its D&O risk exposure. Its corporate structure, whether it be a public or private company, or non-profit organisation, provides an underwriter with an insight into the type of stakeholders management are accountable to, and therefore, the nature of claims it may receive.

Of all organisation types, publicly listed companies present the highest degree of risk, as its share price movements are carefully monitored by investors and management are subject to onerous compliance obligations. While private companies and non-profit organisations also face many of the same exposures, they are generally considered lower risk by comparison.

Nature of business and experience

An organisation’s business activities often indicate the temperament of its potential claimants. Underwriters look at organisations from a wide range of professions and through the experience gained by analysing claims data across industry sectors, develop preconceived ideas on where the risks lay.

However, it is not only the type of industry which contributes to an organisation’s risk profile, but also its relative experience in that sector. For example, an organisation that has been operating successfully for many years in a high-risk industry such as mining or financial services, would be considered lower risk than a start-up company in the same sector.

In this spirit, underwriters tend to look favourably on organisations that focus on one core business activity rather than being spread thinly across many different services. Additionally, they may be adverse to insuring companies with overly complex business models, especially where management are light on experience.

Financial condition

Annual reports and other supporting documents provide an underwriter with the information required to make judgements on an organisation’s financial health. The analysis of balance sheets, profit and loss statements, and cash flow statements, can help them to understand how money flows throughout the business.

To make sense of it all, an underwriter will begin comparing ‘apples with apples’, by benchmarking an organisation’s key financial ratios against other firms with similar characteristics. There are many that may be used, however, four of the most common include:

• Current ratio: compares an organisation’s assets and liabilities to measure its ability to pay its debts
• Debt-to-equity ratio: displays the proportion of shareholder equity and debt used to fund an organisation’s assets
• Interest cover ratio: determines how easily an organisation can pay the interest on its outstanding debts
• Profit margin: compares net profit against overall revenue to express an organisation’s operating profitability

By doing this, an underwriter can make an informed decision regarding the likelihood of claims arising from financial impairment, i.e. insolvency and bankruptcy. From an underwriter’s perspective, the ideal D&O applicant is an organisation with a robust balance sheet, operating in an industry with a positive economic outlook.

Quality of management

Underwriters will carefully review the qualifications and experience of key executives to determine the quality of an organisation’s leadership team.

To aid this analysis, many publicly listed companies elect to provide underwriters with detailed professional profiles of all key executives. Private and non-profit organisations, on the other hand, may be exempt from providing this information, especially if they have been operating successfully for many years.

Through this process, underwriters can begin to quickly determine whether management have adequate knowledge and capability to successfully perform their duties.

Important! Underwriters may take a conservative stance when considering executives with high public profiles or history with troubled organisations.

Mergers and acquisitions

Mergers and acquisitions (M&A), the process of buying, selling, dividing, and combining organisations, creates unique risk exposures for directors and officers. M&A activity is considered to be relatively high risk, as there are often many stakeholders involved, each with varying interests. By carefully reviewing the details of a specific transaction, an underwriter can analyse its merits and therefore ascertain the possibility of a claim or circumstance arising in its aftermath.

The size and nature of a merger or acquisition has an influence on the likelihood of claims; generally speaking, the larger the transaction, the larger the drama when things don’t turn out as expected. Additionally, stakeholders’ interests are relevant. Stakeholders in a hostile takeover, for instance, are inherently more adversarial, and therefore, litigation is more likely, than say, a friendly takeover.

When offering coverage for M&A activity, underwriters’ may impose certain conditions such as placing a retroactive exclusion, imposing a sub-limit, charging a higher premium, or even declining coverage altogether.

International risks

The existence of international operations is a very important consideration for underwriters. Generally speaking, an organisation with a portion of its annual revenue generated overseas, poses a greater risk than a similar sized organisation operating 100% domestically.

This is particularly the case when an organisation has established local subsidiaries in foreign locations. The increased risks accompanying international operations is largely due to an organisation’s obligation to comply with the rules and regulations of each jurisdiction separately.

The ongoing maintenance of these operations places a huge administrative burden on directors and officers, and in practice, can to be incredibly onerous and susceptible to error; potentially exposing the leadership team and the organisation itself to claims.

Claims history

Reviewing an organisation’s claims history is an obvious and essential component of the underwriting process. Insurance companies by their nature look to acquire profitable accounts, and as a result, seek organisations with a relatively clean claims history.

By analysing previous claims and circumstances, underwriters will attempt to weed out bad risks before offering coverage. From an underwriting point of view, a history of frequent or severe claims is undesirable and organisations are often declined D&O coverage on this basis.

When evaluating an organisation’s claims history, an underwriter will request a complete summary of each incident, as well as the value (or estimated value) of the losses incurred. This information should be disclosed not only when first acquiring coverage, but also during each policy renewal thereafter.

An organisation’s claims history is generally measured in terms of a ‘claims ratio’, which quickly and easily displays the profitability their D&O account. The claims ratio is calculated by dividing the value of claims paid out to a policyholder by the total premiums received by an insurer.

Conclusion

Underwriters are a key decision maker in the D&O insurance acquisition process. They set the pricing and conditions of coverage and take into a range of factors, not only related to an organisation’s management but also the organisation itself. By understanding their considerations in this process, you can better prepare your application to in order to secure a positive result.

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.

The application

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

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.

Disclosure requirements

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.

Material facts

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.

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.

Organisation representation

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.

Application severability

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 others. Therefore, a non-disclosure or misrepresentation by one executive won’t affect the coverage applying to anyone else; provided, of course, that they not aware of the misrepresentation.

Non-rescindable policies

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.

Policy renewal

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.

Conclusion

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.

We all buy insurance hoping we’ll never need to use it. However, there will come a time where you’ll have to notify your D&O insurer of a claim, or at least, a situation which may materialise into one. Below, we explore the things you need to know.

One of the most important concepts of D&O surrounds the notification of claims. D&O provides coverage on a claims-made and notified basis, which requires that a policyholder notifies its insurer at first knowledge of a claim or circumstance that may lead to a claim, for that incident to be covered.

Notification

In a practical sense, D&O policies require claims and circumstances to be notified to an insurer as soon as practical. This requirement is complicated by the fact that policies require a claim or circumstance to be notified in the same period of insurance, in which management first became aware of the incident, for that claim to be covered.

Important! If an executive believes that a certain action or event is likely to materialise into a claim sometime in the future, they should notify their insurer immediately. As long as this is done, an insurer is obligated to cover the incident, even if it doesn’t mature into fully-fledged claim until after the policy has expired.

Late and delayed notifications

Insurers may provide some leeway and allow for a claim notification to be accepted beyond the period of insurance in which it should have been notified. This may occur in situations where an organisation’s D&O policy has an extended reporting period or other benefit permitting late notification, such as continuous coverage.

Consequences of failing to notify

Failing to promptly notify an insurer of a claim or circumstance can affect coverage, even if an insurer has not been prejudiced by the delay. If a notification is made late and there is no provision for late notifications, any subsequent claim may be declined.

Alternatively, if late notifications are permitted, but it is not made within a reasonable timeframe, an insurer may argue that its rights have been prejudiced and attempt to reduce its liability or deny acceptance of the claim on that basis.

Important! Since the notification of claims and circumstances is solely within the control of those insured by a policy, it is their obligation to ensure that it is done so in a timely manner.

What constitutes a claim?

Now that we understand how a claim should be correctly notified, what exactly is a claim or circumstance? While the definition varies from policy to policy, it generally includes any written demand, writ, summons or other legal proceeding made against the policyholder.

Some policies may even consider a verbal allegation of wrongful behaviour, enough to warrant a notification. To be sure, directors and officers should refer to their policy’s wording, for the definition applicable to their situation.

For more information on the definition of a claim, you might like to take a look at this post.

Non-duty to defend

As opposed to many general liability and professional indemnity policies, D&O insurance does not generally impose a duty on the insurer to defend the underlying claim against an insured.

Instead, a policy binds an insurer to indemnify an insured; that is, pay the financial losses incurred by – or pay on behalf of – a policyholder defending a claim. This arrangement is commonly known as a non-duty to defend provision and is found in many stand-alone D&O policies.

Having a policy with non-duty to defend provisions means that it is the insured’s responsibility, and not the insurers, to obtain assistance from legal counsel. However, as an insurer also has a financial interest in reaching a successful outcome, the policyholder is required to obtain its consent before proceeding with their selected defence.

Did you know? As small and medium enterprises are often considered less sophisticated in respect to their risk management practices, many management liability policies impose a duty on the insurer to defend the underlying claim against an insured. This means that it becomes an insurer’s responsibility to appoint lawyers and arrange a defence for those insured.

An economical solution for all

As legal expenses contribute to the cost of a claim and also erode the limit of liability, both the insurer and policyholder require claims to be defended in an efficient and cost-effective manner.

This often leads insurers to allow an insured to proceed with their preferred defence counsel, provided they have a clear grasp of the issues at hand. This being said, if there is any dispute over the fees or qualifications of the counsel selected, an insurer may insist the use of its panel lawyers.

Important! To minimise the chances of disputes when appointing legal counsel, policyholders should notify an insurer of their intentions as early as possible.

Cooperation

Once a claim is underway, an insured has an obligation to cooperate with their insurer. The cooperation clause exists to ensure that a policyholder takes steps to support the defence of a claim, and refrains from interfering with it.

A policy may not explicitly state what constitutes cooperation, however, it is expected that directors and officers provide all information and assistance requested by the insurer, and assist in mitigating further losses where possible. This usually entails being forthcoming with key documents and ensuring that proper disclosure is made regarding the ongoing matters of a claim.

The benefits of transparency

From a policyholder’s perspective, cooperation is the best way to ensure a smooth claims resolution. It allows an insurer to quickly and accurately assess the potential liability of a claim and take proactive steps to help an insured settle it before losses begin to mount.

If an insured fails to cooperate, it can be a source of friction and may contribute to an insurer being tardy in fulfilling its payment obligations. In cases of serious non-cooperation by an insured, an insurer may even be released from its obligations under the policy.

Consent to settlement

An insurer will typically insist on being proactively involved in a claim’s proceedings. In addition to the financing they provide, insurers play a key role in working with an insured and their legal counsel to devise an effective defence and settlement strategy.

Additionally, it’s important to note that a policyholder must first obtain their insurers agreement before a claim can be settled. If there are multiple insurers involved, as is often the case with large D&O programmes, all interested insurers are required to sign off their approval, before settlement can be finalised.

Consequences of obstruction

If a policyholder fails to keep an insurer informed of a claim’s progress, this may lead to issues with gaining settlement authority. For example, if an insurer is informed of a significant increase in a claim’s quantum at the last minute, there may be delays in arranging settlement while the necessary authority is sought.

Who’s involved in the claims process?

When a director or officer is involved in a claim, they often encounter a range of insurance professionals. An insurance broker represents the policyholder’s interest and attempts to guide them through the claims process. They will also have a lawyer, either appointed by themselves or the insurer, to defend the claim on their behalf. Finally, a claims officer represents the interests of the insurer, assessing the claim and interpreting policy coverage.

The hammer clause

In much the same way that an insured must obtain an insurers approval to settle a claim, an insurer must also seek the permission of an insured. However, if an insurer believes that a settlement is in the best interests of both parties, and the insured does not approve the recommended course of action, the insurer may invoke a protective clause referred to as the hammer clause.

By enacting the hammer clause, an insurer limits its liability to the amount that the claim could have been settled for, plus defence costs incurred to the date of the proposed settlement. If a claim ends up costing more than the recommended settlement value, the insurer will not bear any part of the additional cost.

Subrogation

Whenever a D&O insurer indemnifies a policyholder from a covered claim, they automatically inherit the right to subrogate against others. Subrogation permits an insurer to assume the rights of the insured and to recover damages from any party who may be ultimately responsible for causing a loss.

An example of where subrogation may apply is when management relies on inaccurate advice provided by a third party. If this information is used as the basis of an action, which is later proved to be wrongful, and an insurer incurs losses defending the executives involved, the insurer may attempt to recoup its losses from the third party.

Conclusion

Knowing how to correctly report claims and circumstances to an insurer is imperative to the effectiveness of a D&O policy. There are many factors to be considered, however, ultimately it will be the terms of your specific policy and your underwriter relationships that will eventually determine the right process for you.

Every insurance policy has conditions which apply to its function and in this respect, D&O is no different. A policy’s conditions lay out everything that an organisation and its management need to consider for coverage to apply.

D&O insurance protects executives for their current actions, as well as providing ongoing coverage for decisions undertaken in the future. Additionally, D&O is somewhat unique as it also provides retrospective coverage for claims that arise from actions committed in the past.

Retrospective coverage

The retrospective coverage afforded by D&O is typically unlimited. This means that there is no time limitation on how long ago a wrongful act occurred, as long as an insured has satisfied their notification obligations, by reporting the claim or circumstance in the policy period in which it was received.

Retroactive date exclusions

In some circumstances, however, a limitation may be placed on retrospective coverage through the use of a retroactive date. A retroactive date removes coverage for claims, arising as a result of actions committed before the specified date.

If any retroactive date exists, it is usually specified within an organisation’s policy schedule. For the most part, they are manually applied by an underwriter on a case-by-case basis and are used when the underwriter believes that an applicant’s past risk exposures are too great.

They are most commonly placed when an organisation that has been operating for many years without a D&O policy, first applies for coverage.

Territorial and jurisdictional limits

The territorial and jurisdictional limits of a D&O policy are an important consideration for organisations with international operations. Jurisdictional limits refer to the jurisdictional region in which the insurer will respond with coverage, should a legal action arise. Territorial limits refer to the geographical area from which a claim can originate.

Many policies provide worldwide territorial coverage, but may limit the jurisdictional coverage available for regions that are considered highly litigious, such as the United States, Canada or those subject to trade sanction. This means that a policy will cover a claim that originates from these countries, but will not cover any litigation occurring in or relating to their legal systems.

For example, consider a company based in the United Kingdom has a D&O policy with worldwide territorial coverage and jurisdictional coverage of worldwide excluding North America.

If the company’s United States subsidiary is investigated by U.S. authorities, this claim is likely to be declined as coverage is excluded in the U.S. jurisdiction. If the company is investigated by European Union authorities over financial statements, including those related to activities conducted in the U.S., there will be coverage.

Confidentiality

Directors and officers are required to refrain from disclosing information about their D&O insurance coverage. This ensures that the details of their insurance terms and conditions, policy limits and self-insured retentions aren’t revealed to third parties, who may otherwise take advantage of this knowledge.

If an executive reveals this information, a claimant may be encouraged to proceed with an unreasonable demand, knowing that an organisation has ‘deep pockets’, by way of insurer backing. These confidentiality clauses intend to protect the interests of the insurer and prevent abusing the existence of D&O coverage.

Exclusion severability

Many D&O policies contain an exclusion severability provision. Exclusion severability means that an exclusion applying to one executive’s behaviour won’t affect the coverage afforded to another. In other words, an innocent individual will continue to be protected, even if other managers have been found to be acting outside the boundaries of a policy.

For example, if a claim is brought against a board of directors for the deliberate and illegal actions of one executive, such as fraud, a policy exclusion may be triggered. With exclusion severability in place, instead of coverage being excluded for the entire board, the exclusion will only apply to the offending executive.

Presumptive indemnification

To begin to describe the presumptive indemnification clause, it may help to explain the problem it was introduced to solve. There was a time where organisations discovered that by wrongfully withholding corporate indemnification from its managers, they could avoid paying the Side-B self-insured retention. The theory was that a manager could then state he was not indemnified by the organisation and claim under Side-A, where no retention existed. (Pretty cheeky right?)

The theory was that a manager could then state he was not indemnified by the organisation and claim under Side-A, where no retention existed. (Pretty cheeky right?)

Very quickly, presumptive indemnification clauses were introduced, stating that an organisation was presumed to indemnify its directors and officers to the fullest extent as permitted by law, whether in fact it did so. Now, if an organisation wrongfully withheld indemnification, the responsibly of paying the Side-B retention was passed onto the individual. Not surprisingly, this did a good job in preventing organisations from shirking their obligations.

Not surprisingly, this did a good job in preventing organisations from shirking their obligations.

Despite the effectiveness of presumptive indemnification clauses, some insurers may choose not include them. However, this is far from an invitation to try and avoid the Side-B SIR. Instead, if an organisation attempts to push a Side-B claim onto Side-A through the means of wrongful non-indemnification, the insurer may elect to subrogate directly against the organisation to recover the SIR applicable.

For example, let’s say a marketing executive has a defamation claim bought against her for making inappropriate comments on national radio. The executive’s organisation, wishing to distance itself from the incident, decides to wrongfully withhold indemnification, leading the executive to seek protection directly from their D&O insurer.

Because the organisation is contractually obliged to indemnify the executive but chose not to, the insurer then moves to enforce the indemnification contract by seeking recovery of the self-insured retention directly from the organisation.

Policy interpretation

The policy interpretation clause specifies the jurisdiction in which a policy will be governed. In most cases, this will be the laws of the country that the policy is issued. To ensure that all parties to the contract are clear, the applicable jurisdiction is listed within the policy wording. That way, should there be any dispute relating to the interpretation of coverage, those interested understand the laws that will apply.

Costs allocation

The allocation clause outlines that an insurer is liable for losses sustained by an insured organisation and its management, only to the extent that the policy affords coverage. In other words, the insurer will only pay for claims it is legally required to under the terms of the policy.

Allocation typically arises in situations where there are two or more defendants facing the same claim and not all are covered by the same policy. For example, this can occur if an executive and the company they represent are both named in a lawsuit, and the organisation is not insured for entity coverage.

In this case, the insurer will protect the executive according to the terms of the policy, including reimbursing the organisation for expenses incurred on the executive’s behalf.

However, as no entity coverage exists, the insurer won’t cover the organisation for its own liability. Instead, it will negotiate directly with the corporate entity, as an uninsured party, to determine its contribution to the cost of the claim relative to its share of liability.

Change in control

Any alteration to an organisation’s ownership, either relating to the addition or removal of corporate entities, or a change in composition of the board of directors, has flow on effects for the risks faced by directors, officers, and therefore, insurers.

D&O policies contain a change in control provision, which automatically ceases coverage for a policyholder following a transaction that alters its ownership structure. Whilst the definition of a transaction varies, it generally includes any situation where:

• An organisation is merged, acquired or sold
• There is a change in over 50% of the board’s voting power
• An administrator or receiver is appointed
• An organisation is declared bankrupt
• An organisation is wound up

Run-off coverage

Following a change in control, an organisation’s D&O policy will automatically convert into run-off. Run-off is when a policy remains in force, but will only cover claims materialising from actions that have occurred prior to the date of a transaction.

Did you know? Having a policy that automatically converts into run-off is great benefit for policyholders, as any claims or circumstances that materialise from past actions can be notified under the existing policy until the end of the insurance period.

Beyond automatic run-off

Following a change in control and beyond the period of insurance, an organisation should carefully consider acquiring run-off coverage. Run-off coverage provides directors and officers with an extended reporting period to notify their insurer of claims which arise in the future.

By extending the duration of their policy, management will remain covered, even if a claim or circumstance doesn’t arise until many years after the change in control actually occurred.

Important! Run-off coverage is an important risk management tool, as without it, directors and officers are effectively uninsured for actions and decisions made in their past roles.

Long tail exposures

D&O liability risks remain long after a corporate restructure. The statute of limitations applying to each jurisdiction largely determines the timeframe for which management is exposed. Claims can be made against directors and officers many years after they are no longer involved in an organisation’s operations.

In Australia, for example, executives can be held accountable up to 7 years after the discovery of their wrongful behaviour, while in some parts of the United States the statue of limitations is 10 years.

These long tail exposures mean that executives should make conservative decisions about their requirements for run-off coverage, so they are not caught out uninsured years down the track.

Run-off duration options

Insurers have the ability to provide a range of options for run-off coverage. Policies can be effected for anywhere between one and seven years, however, it is generally recommended that coverage be sought for as long as possible. This way, executives are protected until the likelihood of receiving a claim no longer exists.

Run-off premiums are calculated using a range of methods, but all typically reflect the diminishing risk of receiving new claims over time. Run off policies are generally purchased in a one off transaction, with insurers offering discounted rates to organisations that purchase multiple years of coverage up front.

For example, an organisation paying an annual premium of $5,000 per year could be offered the following run-off coverage options:

• Three year policy = 1.5 x annual premium = $7,500
• Five year policy = 2.5 x annual premium = $12,500
• Seven year policy = 3.5 x annual premium = $17,500

Coverage for ongoing operations

When an organisation is subject to a transaction, run-off coverage is generally purchased for the previous operation. Following a change in control, if an organisation continues to operate in its altered form, a new D&O policy must be established to protect directors and officers for their ongoing managerial activities.

Conclusion

In this post, we’ve outlined the major conditions of a D&O policy. As you can see, there are many of them, ranging from the scope of jurisdictional coverage through to what happens if there’s a change in management. Because of their complexity, directors and officers should maintain a close relationship with experienced brokers and underwriters to ensure that all conditions are compiled with.

Risk retention is something we deal with in all kinds of insurance. In D&O matters, a self-insured retention ensures that an organisation’s policy is ready to respond when it’s needed most.

The self-insured retention (SIR) is an important component of a D&O policy. It represents the amount of risk an organisation is willing to absorb before its insurance policy will respond.

A SIR plays a similar role to an excess or deductible used in other classes of insurance. The main difference is that instead of being paid at the beginning of a claim or being deducted at the end, the SIR is the value of loss that must be first incurred by an organisation before its insurer will contribute.

A SIR involves an organisation paying the initial costs of a claim, such as early-stage legal expenses and settlements, until the level of retention is reached. Once this occurs, the policy will respond and the insurer will pay for all further expenses until the claim is finalised, up to the limit of liability.

If a claim is small, and can be settled for a amount less than the retention, an organisation’s D&O policy may not be required to respond at all.

Allowing insurance to perform its purpose

To understand the function of a SIR it helps to revisit the original intention of insurance. Insurance exists to indemnify an insured from significant or catastrophic loss.

If insurance companies were to cover losses of all values, an account could quickly become unprofitable. By insisting that an organisation retain some risk, its insurance coverage is reserved for larger, more significant claims.

A cleaner claims history

From an organisation’s perspective, the benefit of a SIR is that it protects its D&O loss history from claims contamination. Claims contamination means that an organisation can appear unattractive to prospective insurers if it has too many losses on its account.

By managing costs and paying for its own claims under the self-insured retention, an organisation will maintain a cleaner claims history, and reap the rewards of being a higher quality risk, such as better quality terms of coverage and reduced premiums.

Each and every claim

A SIR generally applies to each and every claim. This means that for each separate claim, an organisation must pay for losses up to the level of retention. However, many policies treat multiple claims, arising out of the same wrongful act, as a single claim; and therefore, only attracting one SIR.

An example of this is when an executive is sued by multiple claimants, following a single misdemeanour. In this situation, the costs of all claims against the executive for this incident are likely to contribute to one SIR amount, as the claims are related.

Does a self-insured retention apply?

Each insuring clause of a D&O policy is subject to a separate level of self-insured retention. Below is an outline of how retention is applied.

Retention applying to Side-A

Side-A coverage is typically not subject to self-insured retention. This means that directors and officers, who have not been indemnified by an organisation, can seek protection from an insurer without incurring any costs whatsoever.

The reason why executives do not have to contribute to claim costs relates back to the original purpose of D&O; to protect personal assets. Because executives seeking indemnity under insurance coverage are usually doing so as a matter of last resort, it is unlikely that they have the resources to incur any effective amount of SIR.

As a result, the absence of retention allows them to defend themselves without out-of-pocket expense.

Retention applying to Side-B

Side-B coverage is generally subject to a moderate level of self-insured retention. This is because an organisation is viewed as having the financial resources to contribute to the cost of claim, when defending directors and officers.

When an organisation indemnifies its executives in accordance with its indemnification provisions, it is responsible for incurring costs up to the level of self-insured retention. Only then will an insurer reimburse the organisation for its expenses.

Retention applying to entity coverage

Any entity coverage contained within a D&O is subject to self-insured retention. As with Side-B, an organisation with entity coverage generally uses such protection as part of a broader risk management strategy. As a result, it is expected that the organisation can afford to contribute to its own claim costs, thereby sharing some of the risk with its insurer.

The main difference between the SIR applying to Side-B and entity coverage, is its size. Because an organisation is inherently more prone to litigation than its directors and officers, most entity coverage attracts a relatively high level of retention.

This is especially true of Side-C coverage, which is exposed to large class action claims, and employment practices liability, which attracts frequent claimants.

Selecting a self-insured retention

A range of factors must be considered when selecting the level of self-insured retention. For the most part, these focus on an organisation’s ability to bear the costs of claims, but also on its general risk appetite.

Too high, too low

If a self-insured retention is too high, an organisation may not be able to afford to finance claims to that level, especially if it is defending multiple claims at the same time.

On the other hand, if retention is set too low, the policy may respond too frequently, leading to underwriting losses for the insurer and a poor claims history for the organisation.

Premium benefits for high retentions

For an organisation with consistent cash flows and sound financials, electing a high SIR makes a lot of sense. As with other policy classes, underwriters generally provide discounted premiums for organisations willing to retain a higher level of risk.

However, sometimes organisations do not have a choice, as high retentions are often imposed on risky accounts and frequently claimed policy sections.

Important! An organisation considering a high level of SIR should consider all possible scenarios, as what might appear reasonable in good times can create problems if circumstances change. This is in line with the common observation that claims are more likely to occur when an organisation is performing poorly, which is precisely when there are fewer funds available for contributing to a SIR.

Everything is relative

An organisation’s level of SIR is usually relative to the size of its asset base. Minimum retention levels for Side-B coverage, for example, start at around $5,000 for small organisations. While for large organisations it’s not uncommon to see self-insured retentions of $100,000 or more.

At the end of the day, common sense should prevail. An organisation should consider its own ability to meet retention obligations, and select the highest level it can comfortably afford.

Conclusion

Self-insured retention is a necessary evil of carrying D&O coverage. While many may become frustrated when claims fall within the policy retention, it has its purpose. By selecting a SIR appropriate for an organisations risk environment and financial condition, management will ensure that its insurance coverage is reserved for when it needs it most.

Understanding the function of the limit of liability, as well as selecting an appropriate level of coverage, is a difficult decision for many organisations. Read on to learn more about how it works and what options are available.

The limit of liability specifies the amount of insurance coverage available to a policyholder, for the payment of claims in any one policy period. It sets the maximum value that an insurer is prepared to spend defending and settling claims, on behalf of an organisation and its management.

Any one claim and in the aggregate

The limit of liability applies to each individual claim, as well as all claims in the aggregate. This means it is possible to exhaust a limit by incurring a single large loss or many smaller losses aggregated throughout the period of insurance.

Whichever the case, once the limit is reached, the policy is cancelled and coverage ceases to exist for any additional claims.

To help minimise the effects of claim aggregation, the limit of liability often sits in excess of a self-insured retention. Whether retention applies to a specific claim or not, depends on the insuring clause involved.

Defence costs inclusive

Many D&O policy limits are inclusive of defence costs. This means that the fees of lawyers engaged to defend a claim, contribute to the overall policy limit.  In other words, as a claim is defended the limit of liability is eroded, leaving less funds available for settling the claim at hand as well as paying for any future claims.

For example, if a D&O policy has a $1 million limit of liability and $150,000 is spent on defending and settling a particular claim, $850,000 remains for the defence and settlement of claims occurring throughout the remainder of the policy period.

Defence costs exclusive

Defence costs are not always included in the limit of liability, as some policies, particularly management liability policies, provide coverage on a defence costs exclusive basis. This means that the defence costs are in addition to the limit of liability, thereby reserving the entire policy limit for the settlement of claims.

Important! A defence costs exclusive policy limit, where available, is an advantageous arrangement for any policyholder.

Selecting a limit of liability

Selecting a limit of liability is a challenging task for many organisations. The level of coverage selected can be the difference between being comfortably protected and facing financial ruin.

But what limit of liability can be considered adequate? And how does an organisation decide how much coverage to carry? Unfortunately, selecting a limit of liability is not an exact science, and it depends on a range of factors.

Described below are seven things that should be considered:

1. Ownership structure

An organisation’s ownership structure plays a significant role in determining the level of coverage required. While both public and private organisations face risks with varying complexity, it is public companies that are exposed to the most severe claims. As a result, they typically require much higher policy limits, with many carrying coverage of $100 million or more.

2. Organisation size

The risk exposures faced by an organisation and its management are directly related to its size. The size of an organisation can be measured in a number of ways, such as:

• Annual revenue
• Market capitalisation
• Number of employees

In short, large organisations experience larger and more frequent claims. By comparison, small organisations are generally less risky and have been known to comfortably carry policy limits of as little as $1-5 million.

Did you know? Underwriters may not offer higher levels of coverage where the limit of liability is larger than the total value of the organisation itself. This way, the policy is less likely to be abused as an ‘asset’ of the organisation.

For example, a private company with annual revenues of $2 million, may not be permitted to acquire any more than, say, $5 million of coverage, as this may encourage misuse.

3. The number of directors and officers to be insured

The number of executives requiring protection from a single D&O policy has a significant effect on the level of coverage required. When defending claims, each executive may not have the same interests and therefore, may require their own separate legal counsel.

A limit of liability should take this into account, whilst also reserving enough funds for potential settlements.

4. Operational location

The geographical location of an organisation’s operations and commercial interests should be considered. Organisations operating in foreign markets may face a higher risk of claims due to relative unfamiliarity with local laws and increased compliance obligations.

Additionally, organisations operating in highly litigious jurisdictions, such as the United States and Canada, should pay special attention and consider raising policy limits to account for the additional risk that this brings.

5. Peer benchmarking

A popular method of determining policy limits is benchmarking an organisation’s requirements against the purchasing trends of other similar organisations, in terms of both industry and size.

Whilst comparative information provided by brokers and underwriters is certainly helpful, directors and officers should ensure that their D&O coverage is adequate for their own circumstances.

6. Claims trends

After considering peer benchmarks, it makes sense to take into account claims trends within the D&O market. A lot of insight can be gained by simply staying informed of litigation trends reported in the media. However, many insurers, industry publications and intelligence services such as Advisen, are also an excellent source of claims related data.

7. Budget

Finally, most organisations will need to take into account the cost of acquiring coverage. While an ideal world would provide unlimited resources for purchasing D&O insurance, budgetary constraints are often considered.

Despite cost often being an important factor, especially for smaller operations, executives may be able to reduce these overheads by altering their coverage or the level of self-insured retention.

Implications of entity coverage

By including entity coverage within a D&O policy, the operation of the limit of liability is altered. It can have a positive effect by aligning the interests of an organisation and its insurer, but may also impact negatively by infringing on the protection available to executives when they need it most.

Removing cost allocation disputes

The inclusion of entity coverage removes the tedious issue of costs allocation. In the absence of entity coverage, there is potential for a diversion of interests when an insurer, which is paying on behalf of executives, and an organisation, which is paying for itself, attempt to divide the costs of litigation.

With entity coverage in place, management and the organisation are insured under the same policy. Therefore, the interests of all parties are more closely aligned with the interests of the insurer, possibly leading to a simpler and more straightforward resolution.

Sharing the policy limit

Despite the benefits of incorporating entity coverage into a D&O policy, there can be negative implications. One of the main downsides is how claims against the entity affect the limit of liability.

The limit of liability is typically shared across all sections of a policy. This means that any costs incurred in defending the entity from a claim affects the overall policy limit.

This impact can be significant, as the coverage available to management is effectively reduced while an organisation defends its own interests. In a worst-case scenario, the limit of liability can be eroded to the point of exhaustion, leaving individuals without further coverage for claims.

Ironically, by sharing the policy limit, executives can end up being exposed to the very claims which the purchase of D&O was intended to prevent.  Hence, the inclusion of entity coverage must be carefully considered, so not to leave management unprotected in situations where an organisation cannot indemnify them.

Solutions for shared limit of liability

In recent times, a few solutions have been developed to overcome the issues created by including entity coverage within a D&O policy:

1. Remove entity coverage

By electing not to insure Side-C or EPL coverage, an organisation removes the issues of a shared limit altogether. By doing this, the entire policy limit is preserved for the use of directors and officers (Side-A) and reimbursing the organisation when indemnifying them (Side-B).

2. Purchase stand-alone entity coverage

For employment practices liability and other entity insurances such as crime and statutory liability, an organisation may have the option of removing these coverages from its D&O policy, and instead insuring them on a stand-alone basis.

While this often a more expensive option, it prevents entity claims from contaminating the D&O policy limit.

3. Elect separate towers

When an SME acquires management liability coverage, it may have the option of electing separate towers for each insuring agreement. By isolating each section of coverage, each one gets its own limit of liability. Therefore, say, in the event that the corporate liability coverage applying to the protection to the entity is exhausted, this will not affect the other insuring agreements, which remain intact.

4. Purchase additional Side-A coverage

Many insurers offer stand-alone Side-A coverage to compliment their traditional ‘primary’ D&O policies. Stand-alone Side-A, purchased alongside a primary D&O policy, provides a higher level of Side-A coverage over and above the policy limits of the primary policy.

Stand-alone Side-A coverage ensures that directors and officers remain protected, even if the primary D&O limit is exhausted. Its benefits are often two-fold:

1. Difference-in-limit (DIL): stand-alone Side-A can provide difference-in-limit coverage (DIL); whereby it sits in excess of the Side-A coverage of the primary policy, ready to indemnify individuals if the primary policy limit is completely exhausted, and the organisation cannot indemnify executives any further.
2. Difference-in-conditions (DIC): additionally, stand-alone Side-A can provide difference-in-conditions coverage (DIC); whereby coverage can ‘drop down’ and indemnify executives if an organisation and/or the primary D&O policy cannot protect them. This is possible because Side-A DIC policies often provide broader coverage than primary D&O policies, as they deliberately include fewer exclusions.

Note: Many stand-alone Side-A policies include the benefits of both difference-in-limit (DIL) and difference-in-conditions (DIC).

D&O programmes

Any organisation requiring a large limit of liability will work with an experienced broker to develop a D&O programme. D&O programmes are constructed to allow an organisation to acquire its total policy limit from multiple insurers when its requirements are too high for any one insurer to satisfy.

Layering of indemnity limits

The panel of insurers that make up a programme are headed-up by the lead insurer. The lead insurer is typically experienced with D&O liability issues and is responsible for issuing the policy wording and handling claims. It is responsible for issuing the first layer of coverage, the primary layer, which means it is also the first insurer to pay out when claims arise.

Following the lead insurer, excess layers of coverage are acquired from other insurers and are stacked on top until the desired limit is reached. Excess layers are typically follow-form, in that they are subject to the same terms and conditions of the primary layer.

Any claims lodged against a D&O programme erode the limit liability from the bottom up. Once a claim exceeds the self-insured retention, the primary layer of coverage is eroded until the first excess layer is reached. The first excess insurer then pays up until to the second excess layer. This continues until the total programme limit is exhausted or the end of the policy period, whichever occurs first.

In practice, the lead insurer will usually incur the majority of losses, and is responsible for paying claim settlement and defence costs on its own. The excess layers often play a secondary role, existing for the purposes of covering claims that are large or that have aggregated to a significant level.

In relation to the underwriting of a programme, the lead insurer also invests the most time into negotiating the terms and conditions of coverage. As a result, it receives a much larger share of the premium than excess layer insurers. The amount of premium allocated to each excess layer insurers reduces as the overall programme limit increases; as higher layers are less likely to incur claims.

Co-insurance

An alternative programme structure to layering is proportionate co-insurance. Co-insurance requires that a panel of insurers share the risk equally, by agreeing to pay the same percentage of any claim made against a policy. In this arrangement, each insurer receives an equal split of the premium, because they all effectively share the same risk.

Conclusion

Selecting a limit of liability is arguably one of the most important insurance decisions for an organisation’s management. It’s a difficult process and it’s certainly not made any easier by the fact there are no hard and fast rules. Each organisation is different and will require different requirements for D&O policy limits, programme structures and executive protection products.