Policy Limits, Retentions, and Coinsurance
February 1, 2010
Policy Limits
Most D&O policy forms are subject to a single annual aggregate limit, applicable to both the individual-liability and the corporate-reimbursement coverage parts. This provision is illustrated in the following sample policy language.
The most we will pay for all “loss” under Coverage A or Coverage B or both, resulting from all “claims” first made during the “policy period” and Extended Reporting Period, if applicable, is the aggregate Limit of Liability shown in the Declarations.
If the aggregate Limit of Liability is exhausted by the payment of “loss”, we will have no further obligations or liability of any kind under this Policy.
ISO Properties, Inc., MP 00 01 04 03
Notable exceptions are policy forms that provide only individual-liability coverage or policies that have multiple coverage parts that may stipulate separate limits for employment practices liability, fiduciary liability, or other coverage extensions such as for securities claims or investigative expenses. This approach is illustrated in the following example.
The Limits of Liability and Retentions for each Coverage Section are separate Limits of Liability and Retentions pertaining only to the Coverage Section for which they are shown. The application of a Retention to Loss under one Coverage Section shall not reduce the Retention under any other Coverage Section and no reduction in the Limit of Liability applicable to one Coverage Section shall reduce the Limit of Liability under any other Coverage Section.
Westchester Fire Insurance Company, PF-15191NFP (07/05)
Most policy forms clearly state that costs and expenses associated with defense of claims are included in and are not in addition to the overall limit of liability. Coverage for such expenses normally applies in the same fashion as indemnity for liability, subject to the applicable deductible or retention.
The overall aggregate limit of liability also normally applies if the insured actuates the policy's Extended Reporting Period (ERP). Aggregate limits are not usually reinstated or increased by purchase of the ERP. However, reinstatement of full or partial limits may be available in limited circumstances for additional premium.
Retentions
Most D&O policies contain a retention, deductible, or some other provision that requires the insureds to first bear a portion of loss before the insurer pays any loss. When the deductible or retention applies as respects claims against the individual directors and officers, the clause may provide for a specified amount to apply per individual insured for each claim. The clause also may provide for a single retention applicable to claims made against several insureds for the same or related wrongful act(s). When the sum of the individual-insured retentions exceeds the individual-insured aggregate deductible, only the aggregate retention normally applies.
Retention or deductible amounts that apply to the individual coverage part generally are quite low; it may not be unusual to have per-insured retentions of $500, $1,000, or $5,000 with the aggregate retention being between $25,000 and $50,000. The trend in recent years, however, has been for the individual coverage part to have a small flat deductible or no deductible at all.
The trend toward elimination of the individual deductible, while beneficial to the individual insureds, may be more the result of changes in attitudes toward indemnification than any deliberate improvement in the policy forms by insurers. Most claims paid by D&O insurers are under the corporate-reimbursement section when the corporation is allowed to provide and/or has provided indemnification to its executives. Removal of the already-low deductible probably has little impact on overall loss costs to insurers. This is especially true considering that claims are infrequently paid under the individual-coverage section.
Some recent D&O policies contain a creative provision that applies the retention applicable to securities claims (or under a few policies, all claims other than employment practices claims) only to defense costs, not to any settlement or judgment. In addition, this type of provision frequently provides that the retention does not apply to defense costs if all defendant insureds successfully defend the claim without the payment of any settlement or judgment. This type of provision appears to be intended to encourage insureds to define an exit strategy early in the D&O litigation process. If the insureds believe they must ultimately settle the case, this type of provision may encourage an early settlement, thereby triggering coverage sooner, and thus avoiding needless defense costs that are otherwise payable by the insureds within the retention. However, if the insureds believe they can successfully defend the case, this type of provision rewards such success by waiving the retention entirely.
Retentions under the corporate-reimbursement section of the policy often are substantially larger, reflecting both the organization's greater capacity to bear risk and the frequency of claims paid under this section. For even medium-size corporations, the retention can be into six figures.
Presumptive Indemnity
Some policies may contain what are referred to as presumptive-indemnity clauses, which can include language that
•Deems that the corporation's bylaws, articles of incorporation or resolutions have been amended to allow or require the corporation to provide indemnification to the fullest extent permitted by law.
•Provides that claims paid directly to the individual insureds will be subject to the corporate-reimbursement deductible when the corporation is allowed by law but chooses not to indemnify its directors or officers.
The following sample policy language illustrates presumptive-indemnity.
If the Organization:
(1)is permitted or required by common or statutory law to indemnify the Insured Persons for Loss or to advance Defense Costs on their behalf; and
(2)fails or refuses, other than for reason of Financial Impairment, to indemnify the Insured Persons for such Loss or to advance such Defense Costs,
then any payment of such Loss or advancement of such Defense Costs by the Insurer shall be subject to the applicable Coverage B Retention amount stated in Item 4 of the Declarations.
For purposes of this Section VII, the Organization shall be deemed to provide indemnification to the Insured Persons for such Loss or advancement of such Defense Costs to the fullest extent permitted or required by law, and hereby agrees to indemnify the Insured Persons for such Loss and to advance such Defense Costs to the fullest extent permitted or required by law, including the making in good faith of any required application for court approval.
Arch Insurance Group, Inc., 00 ATL0003 00 04 05
Provisions like this prevent insured organizations from avoiding the corporate-indemnification retention by simply not providing indemnification to the directors and officers. Without such a provision, a claim or claims could then be made under the individual-liability section, subject to little or no retention.
An inherent problem with presumptive indemnity clauses is that while the corporation may be able to amend its bylaws or certificate of incorporation to provide indemnification to the fullest extent allowed by law, it is possible that they have not been so amended. The board of directors also may feel that it has the discretion to indemnify in certain situations and may choose not to do so. In either of these situations the corporate retention that would apply to the unfortunate director or officer could be well beyond his or her financial means. It is possible the insurer would pay the claims not subject to the deductible and attempt later to recoup its costs from the corporation, but in many instances the burden of paying the deductible rests with the individual insureds.
In the past some policy forms have excluded coverage completely for individual insureds when indemnification is legally permitted, and some expanded this limitation to preclude coverage whether or not indemnification was actually made.
In recent years some insurers have addressed the issue of retention for individual insureds where the organization is unable to indemnify the insured due to financial dislocations by waiving the retention regarding loss and defense costs. This is illustrated in the example below.
While the Organization is unable to indemnify the Insured Persons for Loss or to advance Defense Costs for reasons of Financial Impairment, no Retention shall apply to such Loss or Defense Costs; provided the Insureds shall take all action reasonably required to obtain court approval or other authorization for any such indemnification or advancement.
Arch Insurance Group, Inc., 00 ATL0003 00 04 05
Not all policy forms contain presumptive-indemnity language. Those that do may not specifically identify the clause under a separate caption, or the language may be contained in other parts of the policy, such as in the insuring agreement. Where such clauses are found, policies that apply a retention or deductible are preferable to those that exclude coverage altogether. In either case, some policies contain language that either does not prevent coverage or imposes the corporate-reimbursement deductible in situations where the corporation is unable to indemnify due to financial insolvency. These are desirable features.
Coinsurance
Some policy forms may contain “coinsurance provisions,” which require the insured to bear a percentage of any loss that is in excess of the retention or deductible amount. Such policies often set the retention at from 5 to 10 percent, but usually the insurer can be persuaded to remove the coinsurance provision altogether. However, some states, such as New York, have laws that require D&O insurance policies to contain coinsurance provisions, although certain exceptions from this requirement may apply. As a general rule, many newer policy forms and many not-for-profit forms do not contain any type of coinsurance wording, and when a coinsurance retention is mandatory, it is often accomplished by endorsement. When insureds have negotiated reduced retentions or have removed them from the individual-liability section, it is prudent to also attempt to remove any coinsurance requirement altogether.