Understanding D&O insurance cover
December 2013 | SPOTLIGHT | RISK MANAGEMENT
Financier Worldwide Magazine
Directors’ and officers’ liability insurance (D&O) has long been instrumental in paying large losses arising from the tough and complex calls business leaders have to make on a daily basis, often on limited information. Originating in the 1930s in response to the American Securities Laws, which were introduced in the wake of the global economic crisis of that era, it has evolved considerably since and today helps preserve the personal assets of many company directors.
In the aftermath of another financial crisis – arguably greater than that of the 1920s – demand for D&O has understandably reached a high watermark. But a paradox lies in the fact that underwriters are still offering lots of capacity despite the recent spike in loss history. And this confluence of overheated supply and demand means premiums are lower than ever, coverage is extremely broad and, for certain types of company, buying D&O online is now extremely easy, affordable and quick.
For buyers of D&O, this would appear to auger well and in many respects it does. However, it should be remembered that a D&O policy remains a complicated legal contract – despite the advances and regardless of price, alleged breadth of cover and ease of purchase, risk managers and buyers must still subject it to stringent review.
Four areas warrant focused consideration: disclosure duty upon application; notification requirements under the cover; selection of appropriate liability limits; and claims management.
Get it right at placement
Despite the fact many insurers no longer ask for detailed proposal forms with exhaustive questions, it is essential that all proposers carefully consider their responses. The D&O policy is designed to cover all individual directors of a company severally. Therefore, if confirming to underwriters that you are not aware of any claims issues, it is crucial to first canvass your fellow directors to ensure there are, indeed, no issues. This will hopefully uncover any potential concerns on a timely basis and prevent insurers – at a later point in time – alleging non-disclosure of material information.
In fact, the duty to disclose is arguably the most vital aspect and one which must be paid close scrutiny at the outset. Without taking note of certain essential elements, policyholders run the risk of the contract failing at the point of claim.
First, be sure to disclose all material facts – these are facts that would affect an underwriter’s decision making and include matters that a proposer ought to know in the ordinary course of business. Second, remember that the window for disclosure remains open until the coverage is ‘bound’, the date of which may well be after inception. It may also include modification to the insured risk, although disclosure would be limited to the modification.
Equally, bear in mind that the parties responsible for disclosure will include each individual director, officer or manager – whether or not they are a signatory to the proposal form.
The consequences of failing to disclose may be the loss of cover for certain individuals. In order to avoid this scenario, the individual responsible for the D&O policy ought to ensure that all those who would fall to be covered by the policy know – on a timely basis – that cover is being sought or renewed and that they too have a duty to disclose material facts.
So despite the ease with which D&O insurance can now be purchased, the application for it should never be treated lightly. This becomes even more critical when we consider certain extensions that are now commonplace in the market.
Understanding the extent of cover
As insurers compete aggressively for market share their premiums have fallen and the coverage they are prepared to offer has broadened. The most recent illustration of this is the ‘pre-claim’ or ‘self-report’ cover that was introduced in the wake of the Bribery Act 2010, which came into force in the UK on 1 July 2011. This extension made it clear that if a company became aware it had breached a regulation and had reported it to the relevant authority, then certain costs would be covered. This would not have been the case previously, as the traditional definition of claim would not have been triggered. Such an extension of the boundaries of cover is to be applauded but equally raises an interesting point.
When a company becomes aware of such a breach, when do they report to insurers? Such matters are rightly treated with a high degree of confidentiality and, while the matter is purely internal, a company is usually very reluctant to divulge details to an insurer. Nevertheless, failure to notify in a timely manner may mean that, at a later date, insurers consider themselves to have been prejudiced and refuse to contribute to any subsequent legal costs.
The manner of addressing this issue is either to introduce a ‘no penalty’ clause for later notification or for all parties managing the claim to be bound by a non-disclosure agreement.
Limit of liability
In contrast to some of the simplified purchase procedures, the art of selecting the appropriate limit of liability is becoming a more complicated one. Traditionally, D&O limits have only been available on an aggregate basis, which meant clients selected a limit that would serve a maximum loss/losses scenario. The introduction of limits available on an ‘any one claim’ or ‘each and every claim’ basis theoretically means that concerns about exhausting a limit by multiple yet unconnected claims have dissipated. But the reality is not so far removed from the days before such cover was made available.
This type of cover is generally only available to commercial – that it to say, non-financial institutions – risks and it is therefore hard to envisage a situation where a series of totally unrelated claims are made. Furthermore, the policy language used by insurers to define ‘interrelated wrongful acts’ may well be draconian, rendering it difficult to see how such a limit structure would benefit clients. The prudent and cautious advice would be to continue to buy a vertical tower of coverage that you consider can envisage a disaster situation.
The final area requiring close scrutiny when purchasing D&O is claims management; it is self-evident that the true test of a policy comes when a claim is notified. However, typically little or no planning goes into the management of what will invariably prove a stressful scenario for individuals and corporate crisis.
The risk manager or appropriate person should circulate guidance about what potential matters need to be notified and via which conduit. This needs to align with policy requirements. The purpose of claim notifications is to obtain an underwriter’s confirmation of attachment of a claim or circumstance to the policy in force at the time, along with confirmation of coverage. Furthermore, proactive claims management will allow underwriters to participate in or control the defence and/or settlement of any matter.
In order to ensure claims management is efficient, a full understanding of policy requirements about when and what to notify is essential – ahead of any potential crisis. Once a claim has been notified the relationship between insured, broker and underwriter should be collaborative to ensure all interests are aligned.
In a claims situation, it is quite likely that not all of the interests of involved directors and the company will be aligned and that each party will, therefore, require separate legal representation. So, when considering their choice of broker and/or underwriter, an insured needs to be satisfied they have the capability to manage these conflicts and erect appropriate conflict screens.
In summary, while D&O cover is now readily available at very competitive pricing it is vital the policy form is fully understood and that all appropriate measures are taken to ensure it responds at the point it is most needed.
David Walters is Executive Director of Financial and Professional Risks at Arthur J. Gallagher. He can be contacted on +44 (0) 20 7204 6237 or by email: firstname.lastname@example.org.
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