Exclusions—Archived Article

October 2004

Exclusions are policy provisions that eliminate or restrict coverage for specific claims or losses. Their purpose is to clarify the grant of coverage.

Theoretically a policy could be drafted to contain no exclusions at all, perfectly expressing the insurer's intent of coverage so that it could be interpreted in no other way. Such a policy has yet to be developed and probably never will be. In fact, all D&O policies contain many often convoluted and ambiguous exclusions as well as exceptions to exclusions, and exceptions to exceptions to exclusions.

When asked how he would respond to a client considering the purchase of D&O insurance, a prominent Yale law professor had this to say about D&O policy exclusions:

I believe I would tell him two things I do not know. First I do not know what the coverage is because I cannot tell what the exclusions mean . . . secondly, especially because I do not know what the coverage is, I would find it almost impossible to tell him whether the premium bore any reasonable relation to the actual size of the risk.

(Professor Joseph W. Bishop Jr., quoted in October 1969 in Rather Lillian, ed., “Protecting The Corporate Officer and Director From Liability,” Corporate Law and Practice Transcript Series, Number 9 ( New York City : Practising Law Institute, 1970).

Although this comment was made over thirty years ago, it is still valid of some modern policy forms.

This section of The D&O Book discusses some of the most common exclusions found in the “Exclusions” section of the basic D&O policy form or which are frequently added by endorsement. It does not address all exclusions, and some exclusions contained in the basic policy form may not be referenced in the policy charts contained in this book.

Exclusionary language apart from that contained under the “Exclusions” heading can be found throughout many D&O policies. For example, definitions frequently exclude some types of claims. Consider the following.

     Loss: Frequently excludes fines, penalties, punitive or multiplied damages, and taxes.

     Claim: May not extend coverage to administrative or regulatory actions or for proceedings seeking equitable or other relief.

     Wrongful act: Can be interpreted in some instances to preclude coverage for intentional actions or wrongful acts not committed solely in the discharge of the individual insureds' duties as directors and officers.

     Insureds: Can limit coverage to specified persons or classes of people.

Exclusionary language is also sometimes found in the “Conditions” section of the policy. For example, the “Other Insurance” condition frequently precludes coverage if there is other available insurance or indemnification to pay for a loss covered by the D&O policy. Some policy forms apply this exclusion only to the extent of payment under the other policy, only to other “valid and collectible” insurance, or only up to the amount of such other insurance (thereby making the D&O insurance excess of the other insurance). The coverage application may also impose a broad exclusion of prior acts or known circumstances that are likely to give rise to a claim.

Prefatory Language

Most exclusion sections of D&O policies begin with a prefatory or introductory phrase that can affect the scope the exclusion. One approach underwriters use is to simply state that the policy does not apply to claims “for” the specifically enumerated item being excluded. An example of this approach is the following:

(B) No coverage will be available under INSURING AGREEMENTS (A), (B) and (C) of this Policy for…

Executive Risk Specialty B24775 (8/97)

Another approach used by underwriters is to not only refer to that which is specifically excluded, but also to exclude any other claims that might arise out of or in consequence of the excluded item. The following is an example of this approach:

     The insurer shall not be liable to make any payment for loss arising from, by reason of or in connection with:

(K) the fraudulent, dishonest or criminal acts of the assureds;

Home H36667F (10/91)

The effect of the introductory language contained in the second example is to broaden the exclusion so that it applies not only to the specifically excluded item, but conceivably to claims that may only be loosely attributable to the excluded item. Because such prefatory language can further reduce or eliminate coverage, care should be taken to avoid such modifying clauses if possible.

It is also important to note that while some policies take the approach of stating the introductory language and then have it apply on a blanket basis to all exclusions, other policies contain introductory language for each exclusion. Where the introductory language is stated within the individual exclusions, that language sometimes varies between each exclusion. It is possible that some exclusions will be subject to the narrower version, while other exclusions are subject to the broader version of prefatory language.

The following examples further illustrate the limiting effect introductory wording can have on coverage. Both of the exclusions preclude coverage for bodily injury. However, due to the broad introductory wording contained in the first example, the coverage provided by that policy is severely impaired.

Broad Introductory Language

arising out of, based upon, attributable to, or in any way involving, directly or indirectly, bodily injury, sickness, disease or death of any person…

National Union 68462 (8/97)

Limited Introductory Language

for bodily injury, sickness, disease, death or emotional distress of any person, or damage to or destruction of any tangible property, including the loss of use thereof, or for injury from libel or slander or defamation or disparagement, or for injury from a violation of a person's right of privacy;

National Union 62335 (5/95)

The broad introductory wording in the first example likely would exclude not only the actual bodily injury contemplated by the exclusion, but also any other damages (such as lost wages) that occurred as a result of the bodily injury. On the other hand, the more limited prefatory wording shown in the second example would probably not broaden the exclusion to preclude coverage for the lost wages resulting from the bodily injury.

Severability/Nonimputation of Liability Provisions

When evaluating policy exclusions, special attention should also be given to the policy's severability or nonimputation provisions as they apply to the exclusions. Actions based on the actual or alleged wrongful acts of one or more individual insureds often are brought against a group of insured individuals or against the entire board of directors. Without some type of severability or nonimputation provision, exclusions that apply to a particular actual or alleged wrongful act might automatically apply or be imputed to all insureds on a blanket basis. For example, coverage for an action claiming damages based on fraud or dishonesty of the board might be precluded as respects all directors or officers by the dishonesty exclusion, even if only one of these persons are found guilty of such action. Even then coverage for a successful defense by an innocent insured might be excluded.

Fortunately, many D&O policy forms include some type of nonimputation provision that applies either to specific enumerated exclusions or on a blanket basis to all of the policy exclusions. Examples of both types of provisions follow.

The WRONGFUL ACT of any DIRECTOR or OFFICER shall not be imputed to any other DIRECTORS or OFFICERS for the purpose of determining the applicability of Exclusions A. or J.

Progressive Casualty 5775 (7/94)

No fact pertaining to or knowledge possessed by any Insured Person shall be imputed to any other Insured Person for purposes of applying the exclusions set forth in this section IV…

Zurich Ins. Co. U-DU-111A (CW) (2/97)

As a general rule, nonimputation exclusion provisions only apply to one or more of the following exclusions:

·     Dishonesty/willful-violation-of-laws exclusion

·     Personal-profit or advantage exclusion

·     Return-of-remuneration exclusion

·     Short-swing profits exclusion

When exclusions are added by endorsement, whether at or after policy inception, care should be taken to ensure that nonimputation language applies where applicable.

Categories of Exclusions

Although no longer a common practice, some insurers would have certain exclusions apply only to the individual-liability coverage part of the policy. This practice appears to have been intended to preserve coverage under the corporate-reimbursement section when the corporation can and does indemnify the directors and officers. Other insurers developed policy forms that contained two sets of exclusions—one set applicable to both the individual-liability and corporate-reimbursement insuring agreements and one set applicable only to the individual-liability coverage. However, since corporate bylaws and state statutes that govern corporate reimbursement plans commonly impose many of the same restrictions found in the directors and officers coverage exclusions, many D&O policy forms now contain only one set of exclusions.

The exclusions found in D&O policies may generally be classified into one of five categories. The first category of exclusion is a “conduct” exclusion. Conduct exclusions seek to eliminate coverage for certain conduct which is deemed to be sufficiently self-serving or egregious that insurance protection is considered inappropriate. Such conduct is generally felt to be uninsurable. Examples of conduct exclusions are:

·     Personal profit and advantage

·     Dishonest acts of directors and officers

·     Willful violation of law

·     Return of remuneration without previous approval of the organization or its stockholders

The second category of exclusion is the “other insurance” exclusion. This type of exclusion in essence makes the D&O policy the ultimate “backstop” protection for directors and officers. If a corporation can purchase another type of insurance to cover a specific D&O risk, the D&O insurer expects the insured to purchase that other insurance and therefore the D&O policy will not cover that risk. Examples of exclusions in this category include:

·   Bodily injury/property damage

·   ERISA liability

·   Libel and slander

·   Loss insured by prior policies

·   Pollution

The third category of exclusion is the “claimant” exclusions. Claimant exclusions eliminate coverage for claims by certain types of claimants who for various reasons are viewed as presenting litigation risks which the insurer does not want to cover. Examples of claimant exclusions are:

·   Certain types of claims made by one insured against another insured (although an exception is often made for employment-related claims)

·   Certain types of claims by industry or government regulators

The fourth category of exclusions are sometimes called “laser” exclusions. Laser exclusions are intended to address specific risks unique to the insured which the insurer has identified as inconsistent with its underwriting principles. Examples of laser exclusions include:

·   Claims against the company for breach of contract

·   Taxes

·   The costs to comply with non-monetary relief

·   Claims related to a public offering of securities

·   Rendering or failure to render professional services

The fifth category of exclusion is the type of exclusion that is sometimes removable or modifiable. Examples of removable/modifiable exclusions are:

·   Illegal payments and gratuities

·   Claims by regulatory agencies

·   Failure to maintain insurance

·   Prior/pending litigation

All D&O policy exclusions should be reviewed carefully and consideration given to how each exclusion affects coverage. Where coverage appears overly restricted by an exclusion, an attempt should be made to remove or modify the exclusion. Exclusions that are not applicable and have no impact on desired coverage should be removed whenever possible.