Buyers Wary Of D&O Policy Restrictions
There are several policy restrictions creeping into the directors and officers insurance marketplace for buyers of insurance to be aware of–but the most widespread changes are also the least worrisome, policy experts say.

The most common change is the elimination of the waiver of retention, they say. The waiver, introduced in the soft market, essentially reimbursed an insured's deductible when the insured successfully spent money to defend a case, or the case was ultimately dismissed.

“The waiver of retention was designed to alter behavior,” said Tony Galban, vice president and D&O underwriting manager for Chubb Executive Risk in Simsbury, Conn. However, “in our experience, it didn't,” he added at the Professional Liability Underwriting Society's D&O Liability & Insurance Issues Symposium in February.

“The feeling was it would create a more aggressive behavior on behalf of the client defending themselves. The fact is, our clients take it that far anyway–to a motion to dismiss. And our experience has been that the pleading of a motion to dismiss ends up costing well beyond the deductible anyway. So we were giving dollars for nothing,” he said, explaining why insurers have stopped doing this.

Brokers interviewed by National Underwriter said the fact that this soft market “nicety” is going away–almost without exception–is something theyre not losing sleep over. They have more difficulty with the “failure to maintain insurance” exclusion, a pre-soft market exclusion that some carriers are reintroducing to D&O insurance policies.

The reintroduction “has to do with 9/11,” said Christopher Sparro, president of the Middle Market & Commercial Division of National Union in New York, giving the carrier perspective at the PLUS Symposium. “Not only is our market hardening, but many insurance products are hardening as well, and capital for our clients is becoming constrained,” he added, suggesting that tight insurance budgets force some buyers to eliminate some insurance coverages.

“The intention of the D&O policy is to pay for D&O losses, and to have it subsidized for anything other than that is not what the expectation of the contract should be,” he said.

There are two ways the exclusion can be worded, Jeffrey Lattman, managing director of Marsh's FINPRO Group in New York, told NU. If it says “failure to maintain insurance,” that would be triggered if someone simply nonrenewed a policy, he said. An alternate wording, “failure to effect and maintain adequate insurance,” is more subjective, he said.

But “how do you know what's adequate,” asked Carolyn Rosenberg, an attorney for Sachnoff & Weaver in Chicago. “If faced with that, you'd want to try to delete it, modify the wording, or get some kind of assurance beforehand that the insurance you have is adequate.”

Michael Cavallaro, a broker with ARC Excess & Surplus in Mineola, N.Y., had additional advice for risk managers. “You want to be able to demonstrate due diligence for all the different exposures your company had, and, to the extent insurance was available, that you went out and got quotes. You want to be able to do this anyway, but particularly if you have that exclusion on your D&O policy.”

In the past, he said that if D&O insurance buyers gave carriers “an acceptable schedule of insurance,” they could get the exclusion deleted. “Some carriers will still look at that today,” he reported. “Having the exclusion on the policy isn't the best thing in the world,” but it's not the end of the world, either, he said.

Bankruptcy exclusions, on the other hand, are totally unacceptable, brokers contend. Such exclusions say the policy will exclude any type of claim arising from a bankruptcy or insolvency–whether it's a shareholder claim, a claim brought by the creditors, or a claim brought by the trustee on behalf of the creditors, according to Mr. Cavallaro.

“Personally, I would not sell that to my clients. It makes little sense,” he said. “If you're buying the insurance to protect individual directors and officers, and the company goes bankrupt and there's no indemnification, the directors and officers hanging are out there personally” liable, he noted.

He said he is particularly troubled when insurers that wrote an insured for three years that “all of a sudden starts to turn bad,” try to throw bankruptcy exclusions on a renewal. “Now they want to jump off and not cover the greatest exposure to it? To me that's not fair.”

Mr. Galban said that “bankruptcy exclusions are enormously powerful instruments to use,” indicating that he would “attack with a number of other approaches before a bankruptcy exclusion.” For example, he might offer lower limits, or issue a policy with a shorter policy term, like six months.

“Because of what they do to a board, bankruptcy exclusions should be the instrument of very last resort,” he said.

Mr. Lattman told NU that bankruptcy exclusions are not a big issue in the D&O market yet. “There aren't that many that are being thrown on the policies right now. But they're being talked about–a lot,” he said.

Ms. Rosenberg said she didn't see evidence of bankruptcy exclusions being put on policies, either. But she does advise insurance buyers to look for some provisions that can be incorporated into policies or added by endorsement, specifically designed to provide coverage for directors and officers in the event of bankruptcy. They are:

An exception to the “insured-versus-insured” exclusion for claims brought by a trustee or receiver in bankruptcy.

A priority-of-payment provision

The waiver of the automatic stay in bankruptcy provision.

Explaining the exception to the “insured-versus-insured” exclusion, she said insureds have often argued successfully that when a trustee or receiver brings a suit, it is as if a third party is bringing a claim, rather than one insured bringing a claim against another. While insureds have been successful in coverage disputes on this issue, it's better to avoid litigation with your carrier in the first place, she advised, adding that carriers will typically agree to add this exception.

She also explained that an order-of-payment provision might help in a situation when claims covered under the policy are made against directors, officers and the company. In the event of insolvency or bankruptcy, the provision directs that the non-indemnifiable claims against directors and officers will be paid first. “In other words, if there's no money or you can't indemnify, and you've got these competing claims on the policy, the non-indemnifiable claims have first priority,” she said.

The waiver of the automatic stay in bankruptcy provisions, waiving a stay on litigation, reinforces the policy intent–”that the D&O policy is supposed to be used to defend and protect the directors and officers,” she said.

Although she noted that the last two provisions have not been tested in court, “if it has an opportunity to be looked at by a trier of fact, why not put it in to augment your argument?” she said.

“I have not seen cutbacks on those provisions in recent negotiations. If anything, those are provisions that I would request for any company, given the downturn in the economy, some of the dot-com busts, and some of the other prominent companies that have experienced financial difficulties,” she added.

On another topic that has implications as companies go bust, Fred Poldolsky, CEO of the Global Financial and Executive Risks Practice of Willis Group in New York, warns that the deletion of total severability provisions are making their way into the D&O market.

Severability takes two basic forms–one in the original application process, and one related to the exclusions, he said. Explaining the first, he said that when an insured first applies for coverage, there are a series of questions that are essentially warranties, asking if any proposed insured has any knowledge of any errors, acts or omissions that could give rise to a claim under the policy.

If the chairman of the company signs the application and answers no, the question becomes, “Are those warranties severable in nature?” If there's no severability provision in the policy “and something sneaks out later on, [indicating] that the chairman or someone else had knowledge, then everyone is responsible for not having reported that,” and everyone can have coverage denied.

Explaining severability with respect to exclusions, he highlighted the “dishonesty, fraudulence or criminality” exclusion. “The D&O policy typically provides defense coverage until there's been a legal finding or final adjudication of fraudulence, dishonesty or criminal actions. You can't insure against criminal actions. It's against public policy,” he said. “Within the broad exclusion, however, there is usually a severability provision, which essentially says that the innocent are protected. So if a securities case goes to trial and only one person is found to be guilty, then only that person is stripped of coverage.”

He said that “in the past, it was a lot easier to negotiate severability. Now, it's more of an effort. You can't automatically assume that you have it.”

Ms. Rosenberg said news of insurer attempts to rescind Enron's policy because of alleged misrepresentation in the application process has insureds paying attention to severability, and to “what's considered fair game in terms of being part of the application.”

“What really troubles me are attempts by insurers to incorporateanything that was publicly filed within the last year as part of the application,” she said. “The concern is that insurers could allege that there was some sort of misstated financial information” in a past filing with the Securities and Exchange Commission “that the carriers assert is relevant to the application for insurance,” using that as a basis for an attempt to rescind coverage.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, April 22, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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Buyers Wary Of D&O Policy Restrictions

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