Excess D&O insurance coverage – an important but often neglected part of your D&O insurance program
April 2015 | SPECIAL REPORT: MANAGING RISK
Financier Worldwide Magazine
Excess Directors & Officers (D&O) Liability Insurance policies are often referred to as “follow form” coverage. Despite the name, few excess D&O policies truly follow the terms and conditions of the primary D&O insurance policy. Instead, most excess policies will add various terms and conditions that have the potential to significantly impact the overall protection provided by the D&O program of insurance.
Notwithstanding the potential impact that these added terms and conditions may have, excess D&O policies are often neglected almost entirely. Insureds fail to analyse or negotiate their excess policies for many reasons. Sometimes, they assume the excess policies are all the same and simply pick the cheapest one. Often, they just run out of time to deal with the excess policies as the renewal date approaches.
This makes little sense because, once the limit of liability of the primary policy is exhausted, the excess D&O policies will be very relevant to whether a claim will continue to be paid. In fact, in a large D&O insurance program, the excess policies often constitute the vast majority of the limit of coverage.
Below are a few examples of how the failure to review and negotiate an excess policy may result in a loss of coverage.
The attachment/exhaustion provision
One of the most important provisions in an excess D&O policy is the ‘attachment/exhaustion’ provision. This provision determines when the coverage of the excess policy will begin. Some excess D&O policies state that the excess insurer’s liability for any covered loss will attach only after the insurers of the underlying policies have paid for loss equal to the full amount of the underlying limit. Such a provision could be interpreted to mean that payments by the insureds (or another source, such as a Side A policy) to settle coverage disputes would not count toward the exhaustion of the underlying limit of liability.
In fact, this is exactly what happened in Qualcomm, Inc. v. Certain Underwriters at Lloyd’s, London, 161 Cal. App. 4th 184, 73 Cal. Rptr. 3d 770 (Ct. App. 4th Dist. 2008). Qualcomm had a US$20m primary policy with AIG and an excess policy with Lloyds of London (Lloyds). In resolving the underlying lawsuit, Qualcomm incurred US$28.6m in defence and indemnity costs. In seeking insurance funding for the loss, Qualcomm settled a coverage controversy with AIG so that AIG paid US$16m of its US$20m limit. Qualcomm then sought to recover US$8.6m from its excess insurer, Lloyds (Qualcomm was willing to absorb the US$4m in costs between the US$16m paid by AIG and the US$20m limit). Lloyds refused to pay any of the excess loss based on its attachment/exhaustion provision. This provision stated that the “underwriters shall be liable only after the insurers under each of the Underlying Policies [i.e., the AIG policy] have paid or have been held liable to pay the full amount of the Underlying Limit of Liability”. Qualcomm sued and the court held in favour of Lloyds. According to the court, since AIG did not pay its full US$20m limit and since AIG was never held liable to pay that limit, the terms of the exhaustion provision in the Lloyds policy were not met and Lloyds would not be required to pay any amounts to the insured.
As the Qualcomm case demonstrates, strict attachment/exhaustion provisions have the potential to gut coverage. To avoid this unfair result, insureds need to negotiate excess insurance policies so that they recognise payments made by the underlying insurers, the insureds, or any other source.
Some D&O insurance policies require disputes between the insured and the insurer to be resolved by arbitration (as opposed to litigation). This can be problematic in large insurance programs if the excess D&O policies have separate arbitration requirements.
By way of a real life example, in one program, the primary D&O policy required AAA arbitration and applied the laws of the state of Florida. The first excess policy required UNCITRAL arbitration rules and applied the laws of Bermuda. A higher excess policy required controversies to be resolved in London under the Arbitration Act of 1996. In addition to applying different laws to any controversy, each of these arbitration provisions required the dispute to be heard in different locations.
This type of inconsistency could force an insured to fight multiple battles on multiple fronts with potentially inconsistent results. Obviously, this is not what an insured wants from its D&O insurance program.
To avoid this result, an insured should attempt to remove all arbitration requirements from its excess policies. If this is not possible, an insured should seek to have all of the insurers agree to one arbitration method with only one choice of law provision and one required venue to resolve any potential coverage disputes.
Some D&O insurance policies allow an excess insurer to appeal an adverse judgment against an insured even if the insured has no desire for the appeal. One reason an insurer may want to appeal a matter is if the insurer believes the jury awarded unreasonably high damages and that such damages might be reduced on appeal. By appealing the judgment, the insurer may be able to reduce its losses.
The insured, on the other hand, may have no desire to appeal the jury award – especially if the insurer is fully covering the loss. Instead, the insured may prefer to leave the matter resolved and remove the distraction of the litigation.
Perhaps the most troubling aspect of an appeal provision, however, is that most appeal provisions do not make the insurer responsible for any additional losses above the insurer’s policy limit incurred as a result of the appeal. Thus, if instead of reducing the jury award on appeal, the case is remanded and the new jury returns an even higher award – one that exceeds the insurer’s policy limit – the insured could potentially be required to pay for the increased award.
To avoid this result, an insured should delete the appeals provision from its program.
Taking the time to review and negotiate excess D&O policies is essential. Insureds that fail to do so may discover that they have unfavourable provisions in their excess policies that may result in a loss of coverage in a claim situation. Since most excess insurers are willing to make the changes discussed above (and other significant changes) upon request and for no additional premium, insureds must take an active role in reviewing and negotiating their excess D&O insurance policies.
Thomas H. Bentz Jr. is the leader of the D&O and Management Liability Insurance Team at Holland & Knight. He can be contacted at +1 (202) 828 1879 or by email: firstname.lastname@example.org.
© Financier Worldwide
Thomas H. Bentz Jr.
Holland & Knight