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.
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.
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.
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.
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.
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.
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
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.
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.