A-Side D&O Is Sleep Cover

Once asleep, the coverage also prevents the ultimate nightmare of directors and officers: a large judgment or settlement against them that the corporation cant or wont indemnify, combined with primary D&O insurance that cant or wont pay on their behalf.

Most D&O policies have at least two "sides," and some have three. Side A pays judgments and settlements on behalf of directors and officers in situations where the corporation does not indemnify them, either because it is financially unable or indemnification is prohibited by law. Side B "indemnity" coverage reimburses the corporation for judgments and settlements for which the corporation has indemnified the directors and officers. Side C, which is optional in some policies and not offered at all in others, provides "pay on behalf of" coverage to the corporation itself ("entity" coverage) for claims involving securities litigation.

Separate A-Side policies give added Side A protection in a variety of situations.

Steve Shappell, director of the financial services legal department at Aon Financial Services in Denver, Colo., noted that the major writers of A-Side D&O are ACE (including CODA, ACEs Bermuda company), XL, AIG and Chubb. "Premiums for A-Side policies are generally discounted 60-to-70 percent off of what a traditional D&O excess policy would cost," Mr. Shappell said.

He added that capacity is currently not a problem, as "more and more carriers have created Side A programs during the last 12-to-18 months."

The unintended consequences of the mid-to-late-nineties trend of adding entity coverage to D&O policies was the main impetus for developing the current crop of A-Side policies, according to William Cotter, chief underwriting officer of National Union, an AIG member company.

"Situations arose in which the corporation became a competing interest for the assets of the D&O policy," Mr. Cotter noted. "With settlement values in the $25 million range and average limits of about $20 million, the [primary D&O] policy just wasnt enough to cover all the insureds."

Hartfords Mr. Monteleone noted that A-Side policies provide directors and officers with D&O limits–for claims not indemnified by the corporation–that cannot be partially or wholly exhausted by amounts reimbursed to or paid on behalf of the corporate entity. Also eliminated is exhaustion that may occur when claims paid under employment practices or fiduciary liability coverage parts of blended D&O policies reduce or use up the single policy limit, he added.

"For example, an employment practices liability claim can reduce the blended policy limit, even though an outside director would ordinarily have no exposure to employment matters and not need coverage in that instance," he explained.

A-Side policies usually apply as excess over the Side A coverage in primary D&O policies, and can be written to "drop down" and become primary under certain circumstances, such as when the primary limit is exhausted or the primary carrier becomes insolvent," Mr. Monteleone continued. Policies that "drop down" in this manner are referred to as DIC (Difference In Conditions) policies, he noted.

Mr. Monteleone also pointed out that coverage under an A-Side policy may be triggered and drop down when a bankruptcy judge "freezes" the primary policy as an asset of the bankrupt corporation or when the primary insurer becomes insolvent.

Michael A. Rossi, president of Insurance Law Group, a Glendale, Calif.-based law firm specializing in providing insurance-related legal advice to risk managers, noted that another distinguishing feature of A-Side policies is that they provide broader "pay on behalf of" coverage than the Side A coverage in many standard D&O policies.

"For instance, even if a claim is one in which the corporation by law can indemnify the directors and officers–and is financially able to do so–but the corporation chooses not to indemnify (due to a change in control or other reason), then the A-Side insurer would pay the directors and officers and subrogate against the corporation," Mr. Rossi explained. He pointed out that standard D&O policies often will not pay directors and officers directly if the corporation can legally indemnify those individuals and make a claim under Side B of the primary D&O.

Aons Mr. Shappell pointed out that A-Side insurers are free to subrogate against the corporation because the corporation is not an insured under the policy.

"Watch out for A-Side policies with presumptive indemnity in them," Mr. Rossi warned. "These policies say that if a claim can legally can be indemnified, it is presumed by law that it was indemnified." This may result in the A-Side carrier being able to sidestep the claim because it is a Side B matter, he indicated.

Regarding exhaustion of limits, Mr. Cotter of National Union pointed to the securities-related entity coverage provided under Side C of many primary D&O policies as an example of how claims paid on behalf of the corporation can eat away at the primary D&O limits of individual directors and officers.

Carol Zacharias, senior vice president of ACE USA in New York, noted that other scenarios that can partially or wholly exhaust limits available to directors and officers include the "employee as insured" and "outside directorship" coverages now offered by many primary D&O policies.

"A situation where A-Side can benefit directors and officers is when there is fraud in the primary D&O application filled out by the corporation and the insurer rescinds that policy," Ms. Zacharias pointed out.

She explained that the primary policys severability provisionunder which coverage is kept in force for "innocent" insureds who didnt know about the fraudmay provide coverage to the directors and officers in such situations. "In addition, some A-Side policies are written to be nonrescindable," added Ms. Zacharias, "so what the officers and directors knew or didnt know would not be relevant to enforceability of the policy."

Severability and nonrescission are especially important to the outside directors, who usually had no hand in completing the application, said Tim ODonnell, executive vice president of ACE USA. "Outside directors want to make sure they have insurance coverage for themselves, and A-Side is one way to meet that need." Mr. ODonnell added that "outside directors have become much more educated buyers and are asking questions they never used to ask about their D&O insurance."

Large corporations are the ones buying A-Side policies, according to Mr. ODonnell. "Mostly it is the Fortune 500 or 1000 companies that are building these types of insurance towers," he said.

"A-Side policies are not new," Mr. Monteleone of Hartford pointed out. But he noted that the heightened interest in themespecially by outside directorsis new, given the recent bankruptcies, scandals and other corporate tumult. Also sparking interest in these policies, according to Mr. Monteleone, is outside directors increased obligations under the Sarbanes-Oxley law, such as their audit oversight duties.

Mr. Rossi, the attorney, noted in this regard that some A-Side policiescalled Independent Directors Liabilityare specifically designed to insure outside directors only.

Mr. Monteleone added that the recent rise in damages and settlements stemming from shareholder derivative actionswhich cannot be indemnified to directors and officers by the corporation in the many states that have adopted Delaware-type indemnification provisionscan substantially eat away at primary Side A limits, making excess coverage necessary.

(Derivative suits are brought by shareholders in the name of the corporation against directors and managers for alleged breaches of fiduciary duty.)

National Unions Mr. Cotter added that the Securities and Exchange Commission will sometimes require settling directors and officers to waive their right to corporate indemnity (Side B cover) before proceeding with the settlement, further straining the Side A limits and requiring excess coverage. The SEC, in such circumstances, wants a non-indemnifiable loss against directors and officers involved in fraud or other wrongdoing, he said.

"Directors, in general, are much more savvy about D&O in the wake of the corporate scandals," Mr. Monteleone said. "They are not just making cursory inquiries anymore." He also noted that corporations often need to have a separate A-Side policy in force in order to attract talented board members.

Merely raising primary Side A limits does not provide the same protection as having a separate A-Side excess policy, according to the D&O experts.

"One of the reasons for purchasing an A-Side policy is to have drop-down protection if the primary carrier becomes insolvent," Ms. Zacharias of ACE said. That protection wont be there without a second carrier writing the excess, she added.

"We have had some surprises in recent years regarding who is solvent and who isnt," Mr. Cotter of National Union said.

Ms. Zacharias added that another reason for having different carriers is if the primary insurer rescinds its policy. "Some insurers have tie-ins where they will write the excess only if they write the primary, yet the excess states it will only cover if the primary rescinds." The question then becomes why the same carrier would rescind one policy and then pay under another, she noted.

"If there is no primary/excess tie-in rescission language, and if you trust the financial integrity of the carrier, you can have the same carrier participating in multiple D&O layers, including A-Side policies," Ms. Zacharias indicated. But she stressed that those are big "ifs."

As for loss experience, Hartfords Mr. Monteleone, although he could not cite firm statistics, noted that A-Side loss experience is generally lower than primary D&O. The reason, he said, is that high-severity claims such as securities class actionsoften allocated in large part to the entityare taken out of the mix.

"With A-Side policies, past loss experience is not a good indication of the future," according to ACEs Mr. ODonnell. He explained that "this is because new liability events in the marketplace, such as [securities] analyst claims, mutual fund issues and the Sarbanes-Oxley Act, along with the increase in derivative lawsuits, will bring previously unforeseen loss scenarios, especially for outside directors."

National Unions Mr. Cotter noted that "there is now a push to remove entity coverage and have D&O policies get back to the basics of insuring directors and officers." What effect this trend–if it is a trend–will have on A-Side policies has yet to play out.

Shopping For A-Side Policies

By Gary S. Mogel

A-Side policy wording "varies dramatically" among insurer forms, according to Aons Steve Shappell.

He offers these pointers of what brokers should attempt to obtain for clients when placing this type of policy:

DIC (drop-down) coverage.

"Some have it, some dont," Mr. Shappell warned. Without this coverage, the policy would only apply as excess and would not pick up claims that the primary insurer cant or wont pay, he noted.

"Final adjudication" language for personal conduct exclusions such as fraud and profit/advantage.

"Otherwise, a mere allegation of misconduct can negate coverage." Mr. Shappell noted that this is important in all D&O policies, but it is especially critical for A-Side D&O because the policy is the "last line of defense between the directors and officers personal assets and the hands of the plaintiffs attorneys."

Insured versus insured exclusion modified so that it is limited to suits brought by specified top corporate officials.

"This would provide some degree of coverage in situations where you have old management suing new management," he said.

Also critical is the financial security of the insurer writing the coverage, Mr. Shappell added.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, November 26, 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.