Exclusions play an important role in determining a policy’s coverage. They have serious implications for an organisation and its management, as they eliminate coverage for particular types of events and losses. They exist for a range of purposes, so it is important to be aware of their far-reaching consequences.
In this article, we will explore exclusions in the context of the following coverages:
- Directors and officers liability insurance
- Employment practices liability insurance
- Management liability insurance
- D&O insurance for nonprofits
You may also find that similar concepts apply to a broad range of financial lines insurances, such as professional indemnity insurance, cyber insurance, and even crime insurance to a certain extent. Keep in mind, however, that each policy is strictly interpreted according to its own terms and conditions.
Exclusions: A definition
Exclusions aim to eliminate coverage for a particular risk or exposure. They are typically applied by an insurer to any situation, event, activity, or loss, which is deemed to be undesirable. Some exclusions are included as standard within a policy wording, while others may be applied by endorsement during the underwriting process.
Insurance, by definition, intends to cover any unforeseen loss. As a result, an insurer will look to exclude any risks and exposures that are obvious or where there has been no attempt to mitigate them. By doing this, an insurer is able to provide an organisation and its management with a reasonable level of coverage, while also maximising its chances of making an underwriting profit.
An exclusion may exist on its own, or may interact with a policy’s extensions and conditions. Crafting coverage this way can allow an insurer to achieve a particular outcome by overlapping its intentions. For example, an exclusion may eliminate coverage for a specific type of claim, but a corresponding extension could write-back defence costs (but nothing else) in the event of such a claim.
Common standard exclusions
Some exclusions are considered to be relatively standard and are typically built into an insurer’s wording.
Common standard exclusions include:
Prior notice exclusion
A prior notice exclusion intends to exclude claims that should have been notified in a prior policy period. The only exception to this is when a policy includes a continuous coverage benefit – whereby an insurer may accept a notification that should have been made in a prior policy period (but was not), as long as there has been uninterrupted coverage with the same insurer over this period of time.
Pending and prior litigation exclusion
A pending and prior litigation exclusion intends to exclude claims arising from litigation that existed in any way prior to a specified date. It is typically represented by a pending and prior litigation date, which is listed on the policy schedule. The pending and prior litigation date usually represents the date in which an organisation first incepted coverage with its current insurer.
A retroactive exclusion, also known as a prior acts exclusion, can be used to restrict a policy’s prior acts coverage. It is typically represented by a retroactive date listed on the policy schedule. A retroactive exclusion will usually state that no claim will be covered if it arises from a wrongful act occurring prior to the specified date. That said, many policies may include unlimited retroactive coverage.
Dishonest conduct exclusion
A dishonest conduct exclusion intends to exclude deliberate, fraudulent, or malicious acts conducted by an organisation or its management. This exclusion aims to reduce any incentive for moral hazard, by excluding coverage for deliberate dishonest acts. It is worth noting that an insurer’s reliance on such an exclusion is usually subject to final adjudication by a court of law.
Catastrophic hazard exclusions
Catastrophic hazard exclusions intend to exclude exposures that are deemed by an insurer to be too significant for its own viability, or where the potential losses of a particular hazard cannot easily be quantified. A range of these hazards exist, and their practical impact on coverage will depend on an organisation’s specific activities.
Common catastrophic hazard exclusions include:
- Pollution exclusion
- Nuclear and radioactivity exclusion
- War and terrorism exclusion
- Asbestos exclusion
Other insurance exclusions
Other insurance exclusions intend to exclude risks and exposures that are better covered by other classes of insurance. That way, a policy can be narrowed to capture purely managerial risks, where at all possible. At the very least, an other insurance clause may explicitly state that a policy will sit in excess of other insurance classes in the event that their coverages overlap.
Common other insurance exclusions include:
- Bodily injury and property damage exclusion
- Professional services exclusion
A sanctions exclusion intends to exclude any activities or losses that are in violation of trade and economic sanctions. The applicability of such an exclusion will largely depend on the jurisdictional limitations of an insurer. For example, an insurer subject to United States regulation will have little room for negotiation, while an insurer domiciled in another jurisdiction may be more flexible.
Common context-specific exclusions
Other exclusions are applied to address a specific exposure or concern of an organisation and its management. These are most likely (but not always) applied by endorsement.
Common context-specific exclusions include:
Financial impairment exclusion
A financial impairment exclusion, also known as an insolvency exclusion, may be applied if an organisation is displaying signs of financial weakness. This exclusion intends to exclude any claims arising from a failure to meet debts as they become due. Its removal may be considered if an organisation’s position – as represented by its financial statements – shows material improvement.
A major shareholder exclusion is likely to be applied if any one investor owns a significant portion of an organisation’s shares – usually over fifteen percent. The rationale is that the exclusion will remove any incentive for a shareholder to rely on insurance coverage to recover losses that may arise from their lack of involvement in governance matters.
Securites offering exclusion
A securities offering exclusion intends to exclude coverage for any claim arising from the offer, sale, or purchase of an organisation’s securities. These types of activities are inherently risky, and an insurer may not be willing to effectively underwrite the assertions made by management to prospective investors – who rely on this information to make decisions.
Absolute exclusions may be applied when an insurer is particularly risk-averse to an aspect of an organisation’s activities or exposures. They intend to eliminate a type of loss in the broadest possible way – often worded as follows:
directly or indirectly caused by, arising from, or in any way connected with…
Common absolute exclusions include:
- Absolute bodily injury and property damage exclusion
- Absolute professional services exclusion
- Absolute pollution exclusion
When do exclusions come into play
An organisation and its management will first encounter exclusions during the application process. All exclusions serve a purpose, so special attention should be paid to gain an appreciation of their overall effect on coverage. Whether included in a policy wording or added by endorsement, exclusions should carefully evaulated and discussed prior to binding.
The next time exclusions are likely to become a topic for discussion is during claim notification. If it appears that a claim may be subject to an exclusion, an insurer will often issue a reservation of rights letter – as not to prejudice its position. However, this will not typically relieve it of its obligation to advance defence costs to an insured, or its duty to defend an underlying claim.
By the time there is an opportunity for claim settlement, if part of the claim (or the act which led to the claim) infringes on an exclusion, an organisation may be liable for incurring any uncovered aspects by means of cost allocation. Or, in a worst-case scenario, an insurer may decline a claim altogether – requiring repayment of any costs that have been previously advanced.
Exclusion imputation and severability
A policy will usually outline how actions will be imputed between an organisation and its management when interpreting exclusions.
Imputation of exclusions onto the entity
There will be certain senior managers within an organisation – such as the chief executive officer, chief financial officer, and chief operating officer – who will have their actions imputed onto an organisation. This means that any actions by them infringing an exclusion will have a material effect on the coverage of the organisation as a whole, not just their own.
Severability of exclusions between individuals
A policy is also likely to address the severability of actions between individuals. Often, with respect to exclusions, the actions of one individual will not be imputed onto another. This means that one person’s knowledge or behavior will only affect themselves, and not an innocent person – with the exception of those whose actions are imputed onto an organisation.
Exclusions: An example
Now that we have explored exclusions and the influencing factors, we can tie it all together.
An organisation wishes to purchases an insurance policy to protect its management from board of directors liability. It is seeking a policy period of twelve months, from 31 December this year to 31 December next year. Its desired limit of liability is $1 million any one loss and in the aggregate, with a self-insured retention of $10,000 for Side B coverage, defence costs inclusive.
The organisation has been operating for many years in the book publishing industry. Its chief executive officer completes a proposal form and submits this to his broker – along with the organisation’s most recent financial statements and an ownership structure diagram. There are no claims or circumstances declared.
The broker provides the submission to an insurer. Following review, the insurer issues a quote for an annual premium of $10,000. However, because organisation’s financial position is relatively weak, a financial impairment exclusion is applied – in addition to the standard exclusions. After a few days of consideration, coverage is bound and policy documents are issued.
Exclusions play an important role in determining a policy’s coverage. They have serious implications for an organisation and its management, as they eliminate coverage for particular types of events and losses. It is important to be aware of their far-reaching consequences because they exist for a range of purposes.