In brief - Make sure you understand the definitions, exclusions and policy limits before buying D&O insurance
When buying directors' and officers' (D&O) insurance, you should check the definitions of "director", "claim" and "loss"; the exclusions, severability clause, allocation provision, defence costs provision and the territory and limits of the policy, as well as any deductible (excess) that will apply.
Directors and officers should look beyond the premium when choosing D&O liability cover
The size of the premium is often viewed as the most important consideration when it comes to purchasing insurance. However, when price is paramount, policy terms and some of the most important questions can be overlooked.
Below is a list of questions that you should ask your insurance broker when buying D&O liability insurance to ensure that you are getting the best possible value for your premium dollar.
1. What are the standard insuring clauses?
Standard D&O policies generally contain three insuring clauses - Side-A, Side-B and Side-C clauses.
Side-A insurance clauses
The Side-A insurance clause is commonly referred to as the "directors' and officers' liability clause". It provides coverage for individual directors in respect of loss for their wrongful acts carried out in their capacity as a director of the company in circumstances where the company is unable to indemnify the director. For example, an insolvent company is unable to indemnify the directors.
It is normal practice that a deductible will not apply to the Side-A insuring clause.
Side-B insurance clauses
The Side-B insurance clause is commonly referred to as the "company reimbursement clause". This clause operates in circumstances when the company can indemnify the directors in respect of loss arising from their wrongful acts.
If this clause is invoked then a claim is likely to be subject to the applicable deductible under the policy.
Side-C insurance clauses
The Side-C insurance clause is commonly referred to as the "corporate entity clause". This clause will provide coverage for the company in respect of its corporate liability. Historically this clause would only cover the defence costs associated with securities claims. This insurance clause has now been broadened to include coverage for loss and defence costs for securities claims.
Corporate entity coverage will dilute the policy limits which are for the benefit of the directors. Be careful what you ask for, because it may not be beneficial for a director to have Side-C coverage.
Other insurance clauses - investigative costs, employment practices liability and Side-A DIC cover
This insurance clause provides coverage for formal investigations directed against directors. Always check the definition of "formal investigations" and assess how narrow or broad it might be. It is common for this insuring clause to be sub-limited and it will form part of the policy limit.
Employment practices liability
This insurance clause will provide coverage for both the directors and the company in respect of loss that arises from a wrongful act which has an employment liability base. The types of claims that would be covered would include claims brought by an employee for:
• Wrongful termination
• Wrongful interference
• Wrongful deprivation of career opportunity
• Employment related defamation
As employment claims are more frequent, it would be prudent to obtain a separate employment practices liability policy to avoid dilution of the directors' and officers' liability policy limits.
Side-A difference in conditions (DIC) cover
This insuring clause provides an extra layer of protection to directors. This cover is usually stand alone from the other insuring clauses. It is reserved specifically for the directors and will not be exhausted by other claims under Side-B and C.
If purchased, the DIC option will also provide coverage in circumstances where an underlying insurance carrier is unable to or refuses to indemnify a director or officer for an otherwise covered claim.
This cover is usually sub-limited and will sit on top of the D&O liability policy.
2. Who should be covered?
The definition of director should be broad but carefully drafted to capture the relevant persons who make decisions within the company. It is standard in most policies for the definition of director to include a natural person who is duly appointed or elected as a director, shadow director, secretary or executive officer.
Some insurers in the marketplace extend the definition of director to include a person who may make or participate in making decisions that affect the whole, or a substantial part of the business and who has the capacity to affect significantly the corporation's financial standing. Coverage may also be extended to employees who are named defendants to any securities claim.
3. How broad is the "claim" definition?
The "claim" definition should be carefully reviewed. When determining whether a D&O liability policy affords coverage, the first step is to assess whether a claim has been notified and if so, when the claim was made.
The "claim" definition should clearly pick up demands for compensation, demands for non pecuniary relief and legal proceedings, including civil, criminal, administrative, regulatory investigations and prosecutions. You should consider seeking coverage for mediations and arbitrations. Some policies may also extend the definition of a claim to include extradition proceedings.
Most "claim" definitions also have the requirement of a "wrongful act" committed by a director in their insured capacity. Accordingly, the D&O liability policy will only respond to claims which contain allegations of wrongful acts committed by the directors in their insured capacity and will not cover wrongful acts taken in a personal capacity or on behalf of a corporate entity which is not the insured company.
4. How broad is the "loss" definition?
The policy definition of "loss" can limit the scope of coverage under the policy.
It is standard for the "loss" definition to include coverage for awards of damages, judgments, settlements and defence costs. It is also common for fines, penalties, taxes, punitive, exemplary and aggravated damages to be excluded from coverage.
However, it is becoming increasingly common for the "loss" definition to include civil penalties and punitive damages awarded against a director where a company is not prohibited from indemnifying a director in respect of civil penalties or punitive damages in the jurisdiction where the claim is determined and where such damages are insurable by law.
5. What are the most applicable exclusions?
There are a number of exclusions which restrict coverage under a directors' and officers' liability policy. Without being exhaustive, the following exclusions are some of the most commonly referenced by insurers.
The fraudulent conduct or dishonesty exclusion is usually only applicable when there is an actual finding of dishonesty against a director.
It is important that you check to see that this exclusion contains "final adjudication" language as this allows for the advancement of defence costs until there is a final adjudication of dishonesty and/or fraud against the director.
Personal profit exclusion
Most insurance policies will exclude coverage where a director has received a personal profit or advantage or remuneration to which he or she was not entitled. Check to see whether this exclusion allows for the advancement of defence costs in respect of these allegations prior to admission or final adjudication. If the exclusion clause contains "in fact" language, it may have broader application.
Insured v Insured exclusion
This exclusion operates to exclude claims brought by either a director or company against each other. The purpose behind this exclusion was to prevent a company from filing suit against its own directors to secure the benefits of the directors' and officers' policy.
The Insured v Insured exclusion may also include a number of exceptions or "carve outs" including:
• Employment practice claims
• Derivative shareholder claims
• Former director claims
• Any claims brought by a receiver, administrator or liquidator
Professional indemnity exclusion
The professional services exclusion operates to exclude coverage for errors and omissions committed by directors in their performance or non-performance of professional services. Check to see whether the policy contains a broad definition of "professional services" or whether it is limited to services pursuant to a written contract for a fee.
Prior or pending litigation exclusion
This exclusion operates to exclude claims involving facts, situations, or occurrences that were the subject of demands or litigation pending on, or prior to, the inception date of the current policy or an early specified date.
Prior acts exclusion
This exclusion operates to exclude claims arising from any acts occurring before a specific date, which is often the first date on which the policy is issued by the current insurer.
6. Does the policy contain a severability clause?
D&O liability policies should contain a severability clause. A severability clause provides protection to innocent directors who have not been involved in misrepresentations or misconduct, committed by other directors, which could potentially remove coverage.
A broad severability provision is clearly advantageous to the directors. Most insurers in the market are now offering broad severability provisions that apply to both the proposal/application and relevant misconduct exclusions.
Consideration should also be given to whose knowledge will constitute the knowledge of the company. Most insurers are prepared to consider limiting such knowledge to a small number of top level executives.
7. Is the allocation provision appropriately worded?
Typically allocation will arise when a claim is made against a director and also the company or an unrelated third party and where certain of the allegations in a claim relate to matters with respect to which coverage is excluded. Insurers will insist on an allocation between covered and non covered claims and between covered and non covered parties. Accordingly, the policy will only respond to the defence and indemnity of covered claims and covered parties.
The allocation provision should clearly set out the manner in which the insured and insurer shall use their best efforts to determine a fair allocation of loss and that loss must be allocated based on the relative exposures and legal liability of the parties.
Allocation will arise in respect of defence costs and settlement costs (indemnity).
Some policies may contain predetermined allocation for defence costs. Allocation for settlements and judgments is not usually predetermined.
8. How are defence costs advanced?
Most policies in the market place offer to advance defence costs to the directors as the case progresses. Avoid policies that are silent or that clearly state that defence costs will be reimbursed once the claim is resolved.
Some policies in the marketplace even offer payment of the defence costs within a specific time period once the bills have been received.
It is important that the policy contains a provision which advances defence costs on a current basis.
9. What is the territory, choice of law and jurisdiction clause?
A director should be concerned that the policy territory should extend to all jurisdictions where the company's business may operate. Most US insurers are prepared to offer worldwide coverage.
It is also important for a director to identify what laws shall be applicable as to the construction and enforcement of the directors' and officers' liability policy. It is often standard practice for the laws of the country or state where the policy is issued to apply. However, in the United States alternatives may be the jurisdiction where the company is incorporated or has its principal place of business.
Some D&O policies may provide for coverage disputes to be addressed before an arbitrator. Arbitration may not be the most appropriate forum for a coverage dispute to be addressed.
10. What are suitable policy limits and deductible?
When determining the policy limits and calculating what policy limits may be adequate, including whether excess coverage may be warranted, you are trying to predict the types of claims that might arise against the directors of the company.
The analysis by the broker must take into account the organisation's size, its ownership structure, its business activities, its current investment activities and future investment strategy and the location of business operations. The analysis may also take into account the types of possible claims and the cost of defending such claims, as defence costs will erode the policy limits.
When determining the applicable deductible, the company should not retain a payment obligation greater than it can afford to pay without materially impacting earnings or cash flow. Consideration should also be given to potential claim frequency, as a fresh deductible applies to each unrelated claim. Deductibles in the market are trending downwards. Ask the broker for guidance on this point.
It should be noted that a higher deductible will reduce the premium charged by the insurer. In the case of a tower of insurance, the different options for structuring that tower should also be investigated to reduce premiums.