A good example is entity coverage, which sometimes has failed to cover directors and officers with the coverage they thought they had, said Bill Cotter, chief underwriting officer for National Union, the New York City-based subsidiary of American International Group.

The entity as an insured under the policy uses the coverage, potentially at the expense of the directors and officers, said Tony Galban, vice president, D&O underwriting manager, Chubb Insurance in Warren, N.J.

“So were promoting that entity coverage be removed from the contract,” said Mr. Cotter, so that the D&O policy exists for the exclusive benefit of individual directors and officers. (Entity coverage provides insurance for the corporation in the event of a securities lawsuit filed by shareholders.)

Mr. Galban said entity coverage still has value for some customers, but shouldnt be provided at the expense of directors and officers.

When a corporation goes into bankruptcy, the trustees of the creditors estate have made claims against the D&O policy, stating its an asset of the estate and should benefit the creditors, said Mr. Cotter. Then as a result, he said, in certain circumstances, directors and officers dont have access to the coverage.

Underwriters are experiencing very heavy losses, especially in the securities liabilities coverage area, said Michael Cavallaro, director with ARC Excess and Surplus in Garden City, N.Y. “Underwriters are looking to find ways to limit the coverage other than continually increasing rates. They are looking to find ways to limit the coverage in order to maintain a market,” he said.

Although underwriters would like to return to simple indemnification of directors and officers and forget about providing entities coverage, risk managers may still want the coverage to protect the balance sheet of the company, Mr. Cavallaro said.

“Securities liabilities are a huge exposure to the company as well as to the individual directors and officers,” he said.

Whats the solution to the problem?

Mr. Cavallaro said there are a few different routes a risk manager can take.

“If you do buy a D&O policy with entity coverage, then you need to make sure there is an order of payments provision,” he said.

The order of payments provision prioritizes payment of loss under the D&O policy to first protect the individual directors and officers for non-indemnifiable claims.

“Bankruptcy court decisions in Enron and Adelphia exemplified the importance of order of payments,” he said.

Because such a provision existed for Enron, the bankruptcy court allowed some of the policy proceeds to be used for defense expenses of the directors and officers, he added. “In Adelphia, that provision didnt exist [and the] bankruptcy court took a much harder line in devoting policy proceeds to protect the directors and officers.”

Instead of buying entity coverage, risk managers can also buy pre-determined allocation, which apportions loss attributable to the insured directors and officers versus loss attributable to the uninsured corporation or entity, he said.

The policy could stipulate that the corporation wont be covered and that 100 percent of the loss will go to the directors and officers, which may help circumvent the freezing of policy proceeds in a bankruptcy situation, he said.

The third thing the risk manager can do is buy an “A-Side” policy to cover only non-indemnifiable claims against the directors and officers and do so as an excess policy above the D&O/entity coverage program the company has in place, he said.

Its important for the risk manager to carefully examine the A-Side wording to see if it drops down as primary coverage in the event the D&O/entity coverage policy is frozen in bankruptcy, he added.

“Different policies do different things.”

Theres a potential conflict of interest between the risk manager and the outside director, said Mr. Galban. The risk manager buys coverage for the company and is worried about the corporate balance sheet and the earnings statements. “The outside director is worried about his or her individual protection for liability. That conflict has existed for quite a while.”

Mr. Galban said there is a growing move on the part of insurance buyers to buy a combination coverage. “Theyll buy one tower for the entity and then theyll buy on top of that for the board,” he said. “So theyre trying to do the best for both worlds.”

However, he said, traditional D&O insurance was not intended to be a corporate financial buffer. “It was intended to be a policy to protect individual directors and officers and their personal assets.”

Reproduced from National Underwriter Edition, May 19, 2003. Copyright 2003 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.