D&O policies include a range of exclusions for risks that an insurer does not wish to cover. Close attention should be paid to these excluded circumstances and events, so you aren’t caught out in the rain without a jacket.
D&O is designed to provide broad and thorough protection for policyholders. However, it doesn’t cover everything.
Policies contain a range of exclusions for situations and types of losses that insurers consider unfavourable, and do not wish to cover. Some are commonplace and exist in all policies, whilst others may only appear occasionally.
Some are commonplace and exist in all policies, whilst others may only appear occasionally. Below we outline the various forms of exclusions which exist in the marketplace.
Known claims and circumstances
Due to the claims-made and notified’ nature of D&O a policy will not cover known claims and circumstances; in other words, claims that should have been notified in past policy periods. For this reason, all claims and circumstances which directors and officers are aware of prior to the inception of a policy, are excluded.
By definition, insurance aims to protect policyholders from unforeseen risk. Hence, there is no reason for an insurer to cover a loss or potential loss which will certainly occur. This is clearly understandable from an insurer’s perspective, as they do not wish to issue coverage and receive their premium, only to then to immediately pay it back out in claims.
For example, if a new D&O policy is incepted today, it will not cover a potential employment dispute that an organisation’s management was aware of prior to today. In this scenario, the employment dispute in question will have to be covered under a past D&O policy, or not be covered at all.
Prior or pending litigation
A prior or pending litigation exclusion removes coverage for a claim if that claim has commenced before the prior or pending litigation date. This date is specified in the policy schedule and usually represents the date an organisation first acquired D&O coverage or most recently transferred insurers.
The purpose of a prior or pending date is to exclude cover for claims that may have already commenced and therefore, should have been notified under a past policy. It takes the form of an absolute exclusion, meaning that a claim will be not covered if it has commenced in any respect – even if management aren’t aware of it – prior to the specified date.
A typical example of where prior or pending litigation issues arise is when an older lawsuit against the organisational entity is later amended to implicate its management, after the prior or pending date. Policyholders can also be exposed if a lawsuit is filed with courts before the prior or pending date, but management don’t find out about it until afterwards.
Both these instances would see a claim be excluded, as the litigation proceedings technically began before the prior or pending litigation date.
D&O does not intend to cover risks which can be covered by other classes of insurance. These types of exclusions have two objectives; firstly, so underwriters can accurately measure the potential exposures of D&O liability, and secondly, so the chances of double insurance are minimised.
For example, any professional services provided by an organisation, such as accounting services provided by an accounting firm or engineering services provided by a civil engineer, are generally not covered as professional indemnity insurance is designed specifically for this purpose.
Other common exposures not covered by D&O are those relating to personal injury and property damage; as most organisations carry general liability and workers compensation insurance to cover these risks.
There may be some occasional exceptions to this, however, particularly in relation to employment claims involving mental anguish, humiliation and emotional distress; where some coverage may be added back in using a coverage carve-back.
D&O policies are likely to exclude hazards that are deemed to be catastrophic for an insurer’s own financial position. A catastrophic hazard is a situation considered so destructive, that an insurer could not realistically cover the cost of payouts in the event that it occurred.
Examples include losses resulting from nuclear events, war, terrorism and instances of environmental damage. While some more modern policies may not explicitly exclude some of these risks, the existence of catastrophic loss exclusions are not just limited to D&O policies. In fact, they often appear in other insurance classes too!
When catastrophic hazard exclusions are included, some, particularly those related to environmental damage, also include a carve-back to add back in Side-A coverage for the benefit of executives. In these situations, despite environment-related coverage not existing for Side-B and Side-C claims, individuals will remain protected if indemnification from the organisation is not available.
Insurers are legally prohibited from covering criminal or fraudulent conduct, because any attempt to do so would undermine the fundamental principals of the law. Dishonest acts by any individual, resulting in illegal profit or remuneration such as those generated by insider trading or embezzlement, are excluded.
While conduct exclusions aim to discourage inappropriate behaviour, it’s important to note that an insurer will generally advance defence costs to an individual accused of these offences. This is done so on the presumption of innocence, as a formal court ruling or admission of guilt is required to decline coverage completely.
Insured vs. insured
D&O traditionally excludes claims brought against directors and officers by others insured under the same policy. This discourages infighting among senior management by removing an insurer’s backing and also removes any incentive for collusive behaviour.
While this behaviour is generally uncommon, directors or officers have been known to concoct claims against themselves in order to recover losses resulting from an organisation’s poor performance.
Insured vs. insured exclusions are for the most part, standard. However, there are a range of common carve-backs. These include adding coverage back in for derivative claims, cross-claims, bankruptcy claims and employment-related claims.
Modern policies may contain a more favourable consensual claims exclusion, which only excludes claims when it can be ascertained that management has deliberately invited or solicited litigation, rather than excluding all claims that are brought by those who are also insured.
Major shareholder exclusion
Another type of exclusion, that is a slightly different take on the insured vs. insured exclusion, is the major shareholder exclusion. The major shareholder exclusion aims to exclude coverage for any claims by a claimant who owns more than a certain percentage of a company, typically 10-15%.
The rationale behind this form of exclusion is to remove any incentive for collusion and infighting between shareholders and management. It also encourages shareholders who hold a significant stake in a business, to take a proactive approach in staying informed of their investments.
During the underwriting process, an insurer may identify a specific circumstance, event, or risk, which they are not willing to accept. As a result, they may offer coverage to an organisation on a restricted basis.
Often referred to as laser exclusions, specific exclusions are applied on a case-by-case basis and refer to any risk that an underwriter wishes to avoid, such as excluding coverage for specific entities, individuals, events, activities, or jurisdictions.
Specific exclusions may also be used where an organisation has disclosed a serious claim or circumstance occurring in a past policy period. Although any claim that materialises out of this notification will automatically be excluded by any new policy (because it is a known claim), an underwriter may prefer to explicitly state this fact. That way, the insurer’s intention is clear for all parties involved.
That way, the insurer’s intention is clear for all parties involved.
Important! Specific exclusions are reasonably common, but if possible, an organisation should attempt to acquire D&O coverage without them.
Private company exclusions
The insurers of private D&O policies do not intend to cover the risks associated with public companies. Public companies are generally higher risk as they attract larger and more frequent claims. Private organisations, on the other hand, have simpler structures and therefore, their policies typically exclude capital raisings and the public trading of securities.
If a private organisation wishes to raise funds by undertaking an initial public offering (IPO), additional coverage must be applied for. An organisation will need to provide specific details of the offering, such as how many shares are available, to whom, and the type of prospectus documents involved. Based on this information an underwriter can add coverage by endorsement, provided that an extra premium is paid to account for the increased risk.
Based on this information an underwriter can add coverage by endorsement, provided that an extra premium is paid to account for the increased risk.
In addition to those listed above, there are other more unusual types of exclusions. Three of the most common include the failure to maintain insurance exclusion, the commissions exclusion and exclusions relating to bump-up costs. A summary of each is included below:
Failure to maintain insurance: The failure to maintain insurance exclusion excludes any claim which alleges the mismanagement of an organisation’s insurance programme.
Commissions: The commissions exclusion eliminates coverage for any directors or officers who are found to have made financial payments to employees or representatives of foreign governments.
Bump-up costs: In claims involving mergers & acquisitions, bump-up related expenses are excluded. Shareholders may claim bump-up costs when they believe that management has undervalued the value of their investment in a transaction. The ‘bump-up’ represents the claimed difference between the transaction price and the alleged fair price of a company’s shares.
As you can see, despite the broad coverage offered by D&O insurance policies, not all risks are covered. While many may consider this to be a downside of acquiring coverage, each exclusion has a specific purpose and for the most part, they intend to discourage any deliberate, immoral or illegal behaviour.