THE TERM “continuity” is frequently used when discussingdirectors and officers liability insurance, employment practicesliability insurance and other claims-made products. Yet, theconcept is often confusing to many insurance professionals. Thedictionary defines continuity as “uninterrupted succession orflow.” That accurately describes the purpose of continuity ininsurance policies. The objective is to see that the originalcoverage is maintained, without gaps, as insurance is renewed fromyear to year.

Three matters must be addressed when trying to ensurecontinuity. One, pertaining mainly to D&O policies, is thewarranty of the initial application. Another is the policy'spending or prior litigation exclusion date, and the third is theprior-acts exclusion and retroactive date.

The chain of continuity begins when coverage is first writtenfor an insured. If coverage renews with the incumbent insurer,continuity is maintained at the anniversary of the first renewaland thereafter, as long as coverage is maintained with the sameinsurer. However, if the insured opts to renew with anotherinsurer, continuity may or may not be maintained, depending on thenew insurer writing the coverage.

Ideally, to maintain “full” continuity, the insurer issuing therenewal policy should allow the use of a short- form (renewal)application and backdate the pending or prior litigation date toinitial date coverage was written. (Be careful. Not all renewalapplications provide continuity.) The insurer also should providefull prior-acts coverage. Any departure from this process couldadversely affect an insured's coverage. Let's examine each step inmore detail.

When a D&O or EPL policy is initially written, the insuredcompletes a long-form application, which includes warrantyquestions. A warranty question reads something like this: “Is anyperson or entity proposed for this insurance aware of any fact,circumstance or situation which may result in a claim against theorganization or any of its directors, officers or employees?”

Once the corporation's chairman, CEO or president signs thecompleted application, it becomes part of the policy. The insurermaterially relies on the warranties in the application to issuecoverage, and breach of the warranties can affect the outcome of aclaim settlement. Each insurer uses its own long-form application,and the contents of applications vary widely among carriers.

When coverage is renewed with the incumbent insurer, the insuredcompletes a “short form,” or renewal application. If for somereason a long form must be used for the renewal, the incumbentinsurer often allows the insured to strike the warranty questionsin it. That way, continuous coverage from the original policy'sinception date cannot be jeopardized by knowledge an insurercontends the insured later acquired but failed to disclose when theinsured signed a subsequent set of warranty statements.

If coverage is renewed with an insurer other than the incumbent,a broker should negotiate the use of a renewal application or along-form application without the warranty questions. This is notalways acceptable to an underwriter. If a new long-form applicationwith warranty questions is the only option, then continuity isbroken.

The “severability” of the insurance application also needs to beconsidered when changing insurance companies. Severability willprotect those insureds who do not sign the application if asubsequent claim leads a carrier to conclude the warranty questionswere not answered accurately. This is an important factor in thedetermination of whether the policy will protect “innocent”directors, officers and employees. Some policies provide fullseverability; others do not. An examination of the actual policy isrecommended, since severability is not always addressed in theapplication. Provisions differ too. Sometimes coverage is voidedeven for innocent insureds if persons signing the applicationknowingly make false or misleading state ments.

Pending or prior litigation date

Insurance brokers often confuse the pending or prior litigationexclusion with the prior-acts exclusion. A typical pending or priorlitigation exclusion bars coverage for “any prior or pendinglitigation that is known, including any facts, incidents orcircumstances the insured had knowledge of with respect to any'claims' or 'wrongful acts,' including administrative or regulatoryproceedings, prior to the time the policy was written and/or ofwhich any notices were given to any prior insurers.”

It's important to check a policy's definitions of claims andwrongful acts. A claim may or may not include a non-monetarydemand, as well as a monetary demand, against the named insured. Aclaim may include written demands in one policy, or both oral andwritten in another. The definition usually includes administrativeor regulatory proceedings, such as matters involving the EqualEmployment Opportunity Commission or the Securities and ExchangeCommission. If a complaint is filed against an insured with theEEOC, the insured may not realize the insurer considers this a“claim.” More to the point, if the insurer failed to report thecomplaint to the incumbent insurer, the carrier might not respondto a lawsuit that arises after its policy expires. Meanwhile, thenew insurer could deem this to be “pending or prior litigation” andalso deny coverage for any subsequent litigation.

The term “wrongful act” also may be given different definitionsin different policies. A D&O wrongful act may mean any actualor alleged act, error, omission, misstatement, misleadingstatement, neglect or breach of duties by a corporation's directorsor officers of the corporation. The definition may or may notinclude “wrongful employment acts.” Such an act may be defined asany actual or alleged act of discrimination, harassment,retaliation, wrongful discipline, employment relatedmisrepresentation or wrongful termination committed by the insuredentity's directors, officers or employees.

The reason for the pending and prior litigation exclusion dateis to ensure that a new insurer does not have to pay a claimarising from active or pending litigation that an insured knewabout before the effective date of the new coverage. After all, theinsured should have notified the previous insurer of all suchlitigation or incidents that could lead to claims.

Ideally, to maintain coverage continuity, a new insurer shouldagree to use the inception date of the insured's initial D&O orEPL policy as the new policy's pending or prior litigationexclusion date. In practice, however, the great majority ofinsurers use the date their policies take effect. Depending on thestate of the insurance market, a new insurer may agree to keep theexpiring policy's pending or prior litigation date, if the insuredprovides copies of all notices or claims given to previousinsurers. Additional underwriting criteria may have to be met aswell.

Retroactive date

A common misconception is that D&O and EPLI policies haveprior-acts exclusions. In reality, the policies themselves affordfull prior-acts coverage for wrongful acts, includingemployment-related acts, as long as the insured had no knowledge ofthem. Some insurers restrict this coverage, however, by addingprior-acts exclusions and accompanying retroactive dates viaendorsement. For EPLI policies, the exclusion most often is addedwhen there has been no prior coverage. D&O policies may haveprior-acts exclusions, as well. For insureds that have beeninvolved in mergers and acquisitions, the insurer may want torestrict coverage for past wrongful acts of an acquired entity.

If the previous policy provided full prior-acts coverage, andthe new policy has a prior-acts exclusion, with the retroactivedate set at the new policy's inception date, continuity is broken.Of course if the new insurer uses the same retroactive date as theprevious policy, then continuity remains intact. Sometimes a newinsurance company will provide full prior-acts coverage (i.e., notuse a prior-acts exclusion endorsement.) In those cases, however,the carrier likely will require a new long-form application to becompleted, which of course also breaks continuity.

Weighing the implications

As we've seen, coverage continuity can be broken in severalways. Whether a break is good or bad depends on one's perspective.The reality is that insureds most likely will not be able tomaintain full continuity of coverage when moving from one insurerto another. Most often, a new long-form application (with warrantyquestions) will have to be completed, or a previous policy'spending or prior litigation date will not be honored. Theworst-case scenario, however, is having a new insurer impose aprior-acts exclusion. An insured should resist this outcome unlessno other options are available.

Because of threats to coverage continuity, it is usuallydesirable for an insured to maintain coverage with the incumbentinsurance company. Unfortunately, insureds often give a lot ofweight to price and may not attach much importance to continuity. Agood insurance broker, however, will make sure the client fullyunderstands the implications of a loss of continuity.

Wayne Bernstein is a managing director and founding memberof Executive Perils Inc., a national wholesale insurance brokerspecializing in EPLI, D&O, professional liability, crime,fiduciary liability, intellectual property and technology liabilityinsurance. He may be reached at (310) 444-9333 or [email protected].