RISKVUE ARCHIVE | FEATURE STORIES

Director and Officer Insurance, Part 2:
Policy Coverage

By James W. Reuter and Raymond W. Faricy III,
Lindquist & Vennum P.L.L.P.

In last month’s column, we discussed indemnification of corporate managers in the event of alleged SEC violations. In Part 2 of our article, we provide an overview of D&O policy coverage.

Every state authorizes corporations to obtain insurance on behalf of directors and officers to cover liabilities incurred by corporate managers in their official capacities. With the expansion of director and officer liability over the past two decades, the D&O liability insurance marketplace has seen rising premiums, and policies have become more restrictive.

The Basics

The traditional D&O policy has two separate coverages. The first covers individual corporate managers for losses not indemnified by their corporation. The second reimburses the corporation for the amounts it spends indemnifying its corporate managers for their losses. In either case, traditional D&O policies cover the individual corporate manager as the “insured.” A newer form of coverage, called “entity coverage,” is also available. This coverage provides protection for the business or organization as well as for corporate managers.

D&O insurance is almost always written on a “claims made” basis, meaning the insured has coverage for claims made during the policy period regardless of the date the events or transactions underlying the claims occurred. However, a “retroactive” or “continuity” date may limit covered claims back to a specified date.

Most D&O policies now provide for advancement of defense costs by the insurer upon request by an insured. Typically, a D&O policy is a “wasting policy” because defense costs effectively reduce the policy limits.

In the traditional D&O policy, if an action against a corporate manager involves claims covered by the D&O policy and claims that are not covered, costs expended in settlement and defense of the action must be allocated between the covered and non-covered claims. Generally, an insurer is responsible only for those expenses that are reasonably allocable to the defense and settlement of claims against the insured corporate managers, as opposed to claims that are made against the corporation.

Defense costs are covered by the D&O policy if they are reasonably related to the defense of the insured corporate managers, even though they may also have been useful in the defense of the uninsured corporation. Allocation issues are not so prevalent under the “entity” coverage form. However, unless policy limits are increased, corporate managers have to share the same amount of coverage with the entity. Thus, coverage for corporate managers may be diluted when “entity coverage” is added to the D&O policy.

Exclusions

D&O policies contain an ever-increasing variety of exclusions that limit the insurer’s exposure. In addition to those exclusions that are explicitly labeled as such, exclusions are effectively created in the definitions used in the policy. For example, the definition of “loss” usually excludes fines, penalties and other matters deemed uninsurable by law. Similarly, a “wrongful act” may be defined to exclude coverage where the liability of the insured is not claimed solely by reason of the insured being a corporate manager.

Other typical exclusions found in a D&O policy include:

• Insured v. insured exclusion—Subject to a variety of exceptions, there may be no coverage when one insured sues another.
• Dishonesty exclusion—Excludes coverage when a corporate manager has acted dishonestly, criminally or in bad faith.
• Securities laws exclusion—Exclusions relating to certain violations of securities laws. Some D&O policies exclude securities liability completely, while others exclude specific types of securities liability. Broader securities coverage can often be purchased by endorsement.
• Regulatory agency exclusion—Exclusions for any loss arising from claims brought against the insured by or on behalf of any governmental or quasi-governmental body empowered with regulatory control or authority over the entity named in the policy. This exclusion often comes into play in government agency actions regarding labor and employee matters, safety, and failing financial institutions.
• Pollution—Like most policies, D&O policies have an exclusion for pollution.
• Other coverage exclusions—Exclusions for claims such as employment practices, employee benefits and bodily and personal injury that may be covered by other policies.

Endorsements

Numerous endorsements to D&O policies are available. They can change the body of the policy in just about any conceivable manner, including adding or taking away coverage. Endorsements can also add important rights, such as granting insureds the right to select defense counsel. Hence, it is important to know and understand endorsements, including what endorsements are available for purchase.

Insurance Expertise

It is important for businesses to know and understand the main body of a policy and the endorsements; the insurance purchasing process, including the financial strength or weakness of particular insurers; the claims process; and, coordination of insurance coverage. If a business does not have insurance expertise on staff, a competent commercial insurance broker or an attorney with business insurance experience should be consulted. Given the increasing importance and complexity of insurance, any business that does less is short-changing itself and its constituents and, likely, inadequately managing its risks. 

ABOUT THE AUTHORS

Jim Reuter is a partner in the Minneapolis law firm of Lindquist & Vennum and chair of the firm’s Insurance Coverage Group. He can be contacted at 612-371-3519; jreuter@lindquist.com. Ray Faricy practices in the firm’s Corporate and Business Department. He can be reached at 612-371-3507; rfaricy@lindquist.com.

Read Director and Officer Indemnification and Insurance (Part 1)

riskVue | The webzine for risk management professionals
March 2003