How do D&O insuring agreements operate?

The insuring clauses of a D&O policy perform a pivotal role in laying out coverage for an insured organisation and its management team. Below we take a look at the key terms which define the scope of a policy’s protection.

The insuring agreements of a D&O policy specify the scope of its coverage. Each one outlines the promise of the insurer to protect the policyholder, also known as an ‘insured’, in accordance with the terms and conditions of the policy.

While the exact structure of insuring agreements varies between policies, they typically follow a common format; covering an insured from loss arising from claims-made alleging wrongful acts during the policy period.

For a real-world example of what this may look like, consider the insuring clause for individuals on page 6 of AIG UK’s CorporateGuard policy:

The insurer shall pay the loss of each insured person except to the extent that the insured person has been indemnified by the company for such loss.

While this example doesn’t follow our template exactly, a quick look into the definitions of ‘loss’ and ‘insured person’ show that our highlighted terms eventually play a very important role.

A D&O policy usually includes separate insuring clauses for Side-A and Side-B coverage, as well as any entity coverage that may apply; such as Side-C, employment practices liability, or management liability.

Because insuring agreements are at the core of a policy’s function, it’s important to understand how to read and interpret them correctly. This is not only essential for placing cover but also handling claims, as they are often the subject of much scrutiny when determining whether an incident shall be covered or not.

Outlined below are the main components of an insuring agreement. In practice, these should be read in conjunction with coverage extensions, exclusions and conditions.

Key term definitions

D&O insurance, like other policy classes, relies on a range of key terms with special meaning. These terms are contained within the policy wording and play an important role in determining how a policy will respond to any specific claim or circumstance.

To assist with a policy’s interpretation, key terms are generally denoted throughout the document with bold, underlined or capitalised text. In AIG’s policy mentioned above, they are italicised.

Despite there being literally dozens of key terms scattered throughout a policy, none receive more attention than those within the insuring agreements; the definitions of insured, loss, claim, claims-made and wrongful act.

Insured

The definition of an ‘insured’ determines who is covered by a policy. For any individual or organisation seeking coverage for a claim, they must first fall within this predefined description.

The definition is usually broadly drafted, to ensure all those within an organisation who are exposed to managerial risks, are protected. A typical definition includes all directors, officers and corporate entities of the named insured.

Coverage is generally extended to protect the directors and officers of an organisation’s subsidiaries as well, provided that the parent entity has controlling ownership.

As some incidents can take years to materialise into a claim, all past, present and future directors and officers of an organisation are automatically covered. This retrospective coverage ensures that former managers remain protected for actions undertaken during their period of service, as long as their organisation continues to purchase ongoing D&O coverage.

For the actions of a person to be covered by a D&O policy, they must have been acting in their status and capacity as director or officer of the insured organisation. To satisfy this requirement, they must have been elected or appointed to their position, and been acting in their official capacity at the time of the alleged offence.

To ensure that adequate coverage exists for all managerial personnel, many policies broaden the insured person definition to include middle and front-line managers, as well as employees with supervisory functions.

If there is any uncertainty about whether a particular individual falls within this description, they may also be specifically noted on the policy as insured.

Loss

The definition of loss specifies what claim costs will be paid for by a policy. As D&O is a form of liability insurance, it intends to indemnify the policyholder from the financial implication of claims, which would otherwise be incurred by an organisation or the individuals themselves.

The definition of loss usually includes many of the typical expenses faced by defendants when involved in litigation, including investigation costs, legal fees, and the costs of settling any claim to make the whole thing go away.

It is also likely to include court awarded judgements such as damages, as well as civil fines and penalties as long as there has not been any intentional, deliberate or reckless breach of the law.

It’s important to note, however, that not all claim costs are covered. Of course, each policy is different, but many of the typical costs that are not included in the definition of loss include:

• Criminal fines and penalties
• Taxes
• Employment-related benefits such as retirement fund contributions
• Restitution and a host of others

Claim

In order for an insurer to indemnify an insured from a loss, the complaint against them must first fall within the definition of a claim. A typical definition will include any written demand received by an insured, as well as any civil, regulatory or administrative proceeding arising in the line of their corporate duties.

The definition of claim is also likely to include any criminal proceeding brought against an organisation or its managers, which may occur on its own, or alongside any pre-existing civil litigation.

And while any fines or penalties resulting from criminal prosecution cannot be covered, D&O will provide a policyholder with the resources to contest the allegations.

Allegations against an insured must generally be formal in nature to be covered, such as physically receiving a letter of demand from an aggravated third party claimant. However, some informal proceedings may also be included.

These slightly more informal claims may comprise of investigations, examinations, inquiries and formal hearings by regulatory authorities, including official requests for documentation. They can also involve mitigation processes to reduce the chance of a claim arising in the future, such as mediation, arbitration, and other forms of alternative dispute resolution.

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Claims-made (and notified)

D&O policies operate on what is known as a ‘claims-made and notified basis’. This means that a policy provides coverage for claims that are made against an insured and notified to the insurer during the period of insurance. Therefore, for a claim to be covered it must satisfy the following requirements:

1. Management must first become aware of the claim or circumstance during the policy period; and
2. The claim or circumstance must be notified to their insurer within the same policy period

As most policies provide some form of retroactive coverage, it may not be so important exactly when the alleged act took place, as long as the insurer is notified as soon as management become aware that a claim may materialise sometime in the future.

In practice, this means that a claim or circumstance is likely to be covered by the policy active at the time management become aware of the incident, and not necessarily policy period in which the alleged wrongful behaviour occurred.

For more information on claims-made reporting, I recommend taking a look at this post.

Wrongful act

The definition of a wrongful act specifies what type actions by an insured person will be covered by a policy. Once again, this term is often broadly defined to ensure that directors and officers are protected against the myriad of potential claims in existence.

Generally speaking, a wrongful act is considered to be any actual or alleged:

• Act: an action or decision that others deem to be wrongful, including breach of contract, intellectual property infringement, libel and slander
• Error: an honest mistake, poor and careless decisions, incorrect reporting and compliance
• Omission: omitting, or not presenting important information, relied on by others to make informed decisions
• Misstatement: making incorrect and false statements, whether innocent or deliberate
• Misleading statement: a statement that is unclear, deceptive or creates a false impression by remaining silent or telling part-truths
• Breach of duty: a failure to perform managerial duties with care and diligence
• Breach of trust: failure to perform adequately as a fiduciary. Claims may allege an abuse of power, misappropriation or other act, which violates the confidence of others
• Neglect: general carelessness, a failure to seek professional advice when required, or failing to satisfy the duty of care owed to stakeholders
• Breach of warranty of authority: performing acts on behalf of an organisation when unauthorised to do so

Covering allegations

The ability for a D&O policy to cover alleged acts, in addition to actions that are known to have occurred, ensures that management has protection for even the most obscure situations. This is important because claims often feature many details, recounts of actions, opinions and conflicting interests, for which the true position of liability is unclear.

Conclusion

The function of a policy’s insuring clauses is central to the operation of D&O insurance. A policy wording contains dozens of terms that have special meaning, including those terms which are absolutely critical to the interpretation of the insuring clause; insured, loss, claim, claims-made and wrongful act.