The Pitfalls of D&O Insurance Excess

How many insurers use a standardized policy form for Directors & Officers Liability? None!  Each carrier develops their own policy and problems can arise when the terms of the primary and excess policies aren’t the same. Ideally, the primary policy outlines the terms and conditions of the entire D&O program and the excess policies would follow the primary policy without deviation. Rarely does this happen. Definitions, exclusions, and conditions stated in the excess policy nearly always conflict with coverage in the primary. “Follow form” does not always mean “follow form.” Without careful review and negotiations, you can have significant coverage gaps in your excess layers—a potential disaster for a company facing a D&O lawsuit.

The Attachment Pitfall

One troublesome gap in coverage stems from a very basic feature of the policy—the attachment point, or when the excess policy will begin to pay. In recent years, the courts have decided this “basic” question many times. The following case study illustrates this gap:

NaiveCo buys a primary D&O policy with a $10Mil limit and excess coverage above this.  NaiveCo is sued by its shareholders.  The claim is reported to all insurers and NaiveCo’s primary insurer disputes coverage under the policy.  After spending $1.3 Million in defense, the shareholder action is settled for $11 Million, for a total loss of $12.3 Million.  NaiveCo also settles the coverage dispute with their primary insurer with the carrier paying $7 Million.  As part of the coverage settlement, the primary policy is deemed fully exhausted.  NaiveCo contributes $3 Million as part of the settlement, plus their $1Million deductible for a total of $4 Million.  NaiveCo plans to recover the additional $1.3 Million from the excess carrier. However, the excess carrier declines to pay and, after filing suit, the courts agree with the excess carrier.

This scenario has been repeated many times in recent court cases involving Comerica, Qualcomm, Citigroup, JP Morgan, and Goodyear. In all of these cases, the courts confirmed that the excess policies had not been triggered because they required the underlying limits to be exhausted by the actual payment of losses by the underlying insurer. You’re caught in a lose-lose position.  Your excess policy won’t pay until your primary is completely exhausted, yet your primary carrier has closed their files and will pay no more. You are now self-insuring any further losses.

Other Pitfalls

Some excess policies have different definitions of a “claim,” limiting coverage for some actions that may be covered under the primary policy. Others have different cancellation provisions, which may leave you exposed if a primary carrier’s financial rating falls below a specified threshold. If a primary policy has sublimits, it’s important to make sure that the excess carriers understand the primary policy structure. They likely won’t provide excess coverage above those sublimits. Structured properly, the excess policies will acknowledge erosion of the underlying limits if those sublimits are paid.  Finally, check for any other definitions, conditions or exclusions in your excess policies and understand what impact they could have on coverage.

What Can Be Done?

The best thing you can do is work with a broker who understands management liability.  They can help you:

• Assess Your Needs.  Needs will vary by ownership, structure, size, where you are in your life cycle and corporate objectives.  More insurance isn’t always the solution.
• Find The Right Insurer.  Not all insurers will be a fit for your company. Consider how you would feel about working with them through the multi-year lifespan of a claim.
• Negotiate Broad Primary Coverage.  A wide range of coverage is available.  Understand the pros and cons of each offering and find the best coverage for your company.
• Layer Strategically.  Know when to layer and when to consolidate.
• Avoid Excess Layer Gaps.   Excess coverage should dove-tail with primary coverage, deviating only where necessary.  Anything else could cost your company dearly.
• Pre-Negotiate Defense Counsel.  Work with your broker and insurer now to appoint mutually approved counsel to save time and money when there is a claim.
• Coordinate Claim Communication.  Keep your insurers informed of developments, ensuring everyone is on the same page.
• Advocate Fiercely For Coverage.  Your broker should have the skills and expertise to advocate strongly for you and maximize your recovery.

Be informed, stay vigilant and work with a broker you trust. Our Management Liability experts can help if you have questions or would like a review of your program.

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