Policy Forms without a Specific Definition of Claim

It is interesting to note that some D&O insurers choose not to define claim. Absent a specific definition, a claim generally is considered to be a demand for relief or an assertion of a legal right, subject to the judicial or administrative interpretation of prevailing law. When the policy does not define claim, it may be possible to obtain from the insurer a letter of intent. However, even a letter of intent would be a form of definition and could be restrictive.

Policy Forms That Provide EPL Coverage

Both federal and state laws prohibit wrongful employment practices involving sexual harassment and discrimination. The Equal Employment Opportunity Commission (EEOC) is the federal agency responsible for enforcing federal employment law, including Title VII of The Civil Rights Act and its amendments, the Age Discrimination in Employment Act (ADEA) (for persons over 40), the American Disability Act (ADA), the Immigration Reform & Control Act (granting citizenship protected-class status) and one of the most recently enacted federal employment laws, the Family & Medical Leave Act (FMLA). The EEOC, and many state agencies, have the authority to investigate an employer to ensure compliance with the law even if there is not an employee pursuing a charge or a complaint. This type of investigation is often triggered when the administrative agency finds out that an employer has illegal policies or procedures. Such information could come from an anonymous disgruntled employee or from an unrelated administrative claim whereby the employer produced its documents to the agency.

When employment practices liability (EPL) coverage is also included under the D&O policy form, the definition of claim is usually expanded to specifically include actions filed by the Equal Employment Opportunity Commission or similar state or federal agencies. An example of such an expanded claim definition follows:

The wording of the claim definition in some D&O policies that provide EPL coverage clarifies that coverage does not apply as respects arbitration of issues subject to a collective bargaining agreement, as shown in the following example:

Arbitration may be individually agreed to under an employment contract, or made part of a collective bargaining agreement. An arbitration provision also may be contained in an organization's employee handbook. More restrictive definitions of claim exclude all forms of arbitration whether on an employee-by-employee basis or pursuant to a collective bargaining agreement, as in the following example:

An insured that has an arbitration provision in its handbook or in employment contracts, or has a collective bargaining agreement with a union providing for employee arbitration, should be aware that not all EPL insurance policies cover such arbitration.

Related Claims

How D&O coverage applies when more than one claim arises out of a single occurrence or wrongful act affects the policy deductible, coverage limits and even the insured's decision to purchase any available extended reporting period. A very broad definition of related claims is shown:

Often, a wrongful act is actually a sequence of related events that can involve or affect many people. For example, failure of a company's board of directors to comply with securities laws governing the disclosure of financial information may result in fines and penalties assessed against the corporation, as well as a decline in the company's market value. Such a situation could potentially result in the filing of a claim by each individual stockholder or claims against one or more of the directors.

If all related claims are considered to be a single claim, usually only one deductible will be imposed, regardless of the number of claims submitted. However, if there is no related claims definition in the policy, it may mean that the insurer intends to apply a separate deductible to each individual claim. Also, if there is no reference to related claims in the policy, and if such claims are made over successive policy periods, there may be a difference in coverage provided by the successive policies. To preserve uniform coverage when multiple claims are expected to arise from a single wrongful act, insureds must purchase an extended reporting period on the first involved D&O policy.

In contrast, there is a potential benefit from the insured's standpoint in having the insurer treat related claims filed over successive policy periods as separate claims. By spreading out the claims over more than one policy period, the insured may benefit from the coverage limits provided by two or more policies. However, because insurers would rather have all related claims applied to a single policy (thus limiting their total exposure), many D&O policies include a definition of related claims.

As with definition of any important policy term, it is preferred that the related claims definition be as broad as possible.

Potential Claim

Whether or not the policy defines claim, it is important that claims be distinguished from potential claims. Potential claims are facts and circumstances known by an insured that later may lead to claims under the policy. By the time a potential claim evolves into an actual claim, a policy may have expired or been cancelled. If the policy's definition of claim requires that the policy be triggered by a written demand to the insureds, and if this written demand occurs after policy expiration or cancellation, coverage would be precluded by standard claims-made reporting provisions. Such provisions normally require claims to be made against the insured and reported to the insurer during the policy period or within some limited time thereafter.

Fortunately, most policy forms contain potential claim reporting language, incorporated either into the definition of claim or as a policy condition specifically addressing this issue. Normally these provisions list specific information required of the insured in order to trigger the policy as to potential claims. When the insured can provide specific information as required by the potential-claim-reporting requirement, any actual claim that later is made against the insureds will be treated as a claim made during the current policy period.

The following examples illustrate potential-claim-notice provisions. The first clause requires specific information regarding the potential claim and further requires that such notice be made to the insurer in writing during the policy period or within sixty days from the date the insurer becomes aware of the potential claim.

Another example of a potential-claim-notice provision follows. While the language requires the insured to give information regarding the potential claim, the information required is less specific than required by the previous example.

Still another example, taken from a policy no longer in use, contains language that is somewhat vague in its requirement for the insured to submit “circumstances with full particulars.” This appears to impose a less-rigorous requirement on the insured.

In the absence of the receipt by the insureds of a claim that meets the definition requirements, it may be difficult or impossible to predict whether an event or circumstance might later result in a claim. If the insured chooses not to report a potential claim or if the definition of potential claim is overly restrictive (preventing the policy from being triggered) and a claim does arise later, in some situations the insured might be left without coverage altogether. If the insured is aware of a situation or knows of circumstances that might give rise to a future claim and fails to comply with the reporting requirements, the policy will not be triggered by a claim made after the policy period. This would not be a problem when a claim is made during the current policy year, or even in a subsequent policy year if coverage were renewed with the same insurer or on an identical or broader basis.

Problems could arise, however, if the insured were forced to or chose to change insurers. Usually a new insurer will include a warranty in the application that there are no known circumstances likely to give rise to a claim. While the specificity requirements of the expired policy may have prevented triggering of that policy, the new policy's warranty might preclude claims based on prior events likely to give rise to a claim. Unless the extended reporting provision (ERP) under the expiring policy was exercised, the insured might be without coverage. A similar situation occurs when coverage under a renewal policy is substantially more restrictive, or if the retroactive date is advanced.

Policy forms that contain clear and broad definitions of claim and provisions for reporting of potential claims are easier to interpret, less ambiguous, and preferable than policy forms that do not contain such definitions. When the policy does not contain a broad definition of claim, when the definition is restrictive, or if there is no claim definition, care should be exercised to ensure that the policy contains a broad potential-claim-reporting clause. A policy that does not contain a definition of claim but has a broad potential-claim-reporting clause usually is preferable to a policy that contains a restrictive definition of claim.

Defense Costs—Criminal Investigations

Most, but not all, D&O policies include coverage for defense costs incurred by insured persons in connection with criminal investigations and proceedings that are either against or involve an insured person (subject to the other terms and conditions of the policy), whether or not the company indemnifies the insured person for those defense costs.

However, coverage for defense costs incurred in connection with regulatory and other governmental investigations of the corporate entity should not be assumed. Some insureds have assumed there was full coverage for any investigation costs incurred by the company and were surprised when the D&O insurer denied coverage for some or all of those costs. While most D&O policies today afford full coverage for investigation costs incurred by insured persons, some afford no coverage for investigation costs incurred by the company.

When coverage for defense expenses has been the subject of a dispute, courts have generally based their investigation cost coverage rulings on the clear language of the applicable policy. However, the intended lack of entity coverage has been subverted by some courts under various situations. Consequently, some D&O insurers are now offering entity investigation cost coverage for an additional premium.

In recent years, investigation costs have increased dramatically due to a rise in the number of investigations and cost of responding to those inquiries. Many large organizations now identify regulatory and investigatory matters as the legal disputes of greatest concern to their companies. Not surprisingly, many companies retain outside counsel to assist in defending or responding to investigations, thereby further increasing costs. In addition, directors and officers often request separate counsel to represent themselves in interviews and to respond to document requests. Because of the potential costs associated with the hiring of oftentimes expensive counsel, the existence or lack of investigation cost coverage can be critically important for insureds.

From the insureds' perspective, this type of additional entity coverage benefits the insured organization. However, since the D&O policy limits typically include both loss and defense expenses, entity investigation cost coverage dilutes the amount of coverage available for the insured persons. As a result, and for companies that purchase very large amounts of D&O coverage, prudent risk management may dictate the purchase of entity investigation cost coverage in the first few layers of the D&O program but not including it in the higher layers, thereby protecting those higher layers (and any Side A layers) from potential erosion by this expanded entity coverage.