When you shop for home insurance, you tend to think about the coverage you’ll need if the house burns down, or in other words, the worst-case scenario. Companies need to apply that same mindset to directors and officers insurance — and whether their burning house is a bankruptcy, an acquisition or a lawsuit, they’re going to be glad they negotiated the best terms when the company was thriving.
Organizations should be prepared if conditions significantly worsen - like during the pandemic - and put the business under sudden financial strain. That’s why Nan Murphy, vice president of management liability for QBE North America, believes it’s vital to determine risk scenarios, and what you need from the coverage, at the outset.
“If you’d asked anybody even a year ago if they were worried about a pandemic driving restaurants and hotels out of business, people would have laughed at you,” Murphy said. “But here we are, looking at all the hotels and restaurants and wondering which ones are going to survive this.”
Privately owned companies’ D&O insurance should have full entity coverage, which is what is needed in the case of a bankruptcy. Unlike a publicly traded company where most of the coverage is just for the directors and officers, when a private company goes bankrupt, the entity is covered and its creditors will look for any avenue to find money and pay off debts.
Attorneys get creative, Murphy noted, and when they find a source of funds, they figure out how to file claims that can access the insurance policy — a feat that’s “a bit easier when there’s entity coverage because they can name the entity versus pointing to a director or officer and saying specifically, ‘You, the CEO, did this wrong.’” Another difference for private companies is that entity coverage limits tend to get exhausted quickly.
There are some provisions in D&O policies that companies should verify whether they’re facing hard times now or not. One example is the insured versus insured exclusion — it’s usually there to prevent collusion or insurance fraud, but there are certain carve backs for bankruptcy, for example. Companies should check to make sure that, in the worst-case scenario of bankruptcy, they have the right carve backs to that provision.
What Murphy is seeing a lot of in the market lately is carriers putting bankruptcy or creditor exclusions on companies that are financially challenged, to try and avoid the typical claims filed when a company goes bankrupt, especially from creditors.
“Unfortunately, by the time those exclusions are going on to a policy, it’s probably too late to negotiate them off, but it’s something to be aware of,” she said. “If that’s what the renewal terms come in on, that’s a pretty hefty exclusion. If they turn the corner and are getting better financially, they should negotiate to get that exclusion removed.”
In times like this, one key coverage to check for is if the D&O policy includes an additional side A limit, which is for claims where there is no indemnification. It’s an additional limit, in most cases $500k or $1 million, that’s set aside just for the directors and officers.
“I call it the emergency limit,” Murphy says. “In case your D&O policy is exhausted, there’s still this additional limit sitting there to help in the worst-case scenario.”
Companies should also pay attention to allocation provisions. If you have some claims that are covered and some that are not, how much of the defense expenses does insurance pay versus the directors and officers? What’s standard in most private company policies is the 100% defense cost allocation that basically says that if at least one piece of the claim is covered, the insurance company will defend all of it.
“Different carriers have different wordings, some have carve backs to that, some don’t, but allocation provisions could be critical if a company is having difficulties,” Murphy said. “If there’s a 100% defense cost allocation, the directors and officers know that if the policy is responding, at least the defense costs are going to be covered.”
Another provision that’s rarely discussed is reporting. All D&O policies have some form of restrictions on how quickly the insurer needs to be notified of a claim. When companies are in financial distress, they are more likely to have staff coming and going. An employee could get notice of a lawsuit being filed that ends up lost in his or her desk because the employee leaves the company shortly thereafter, or a claim could be signed for by the mailroom and sit there for months because the recipient has shifted to remote work.
Whether the carrier needs to know in 30 or 60 days, or more broadly wants to be informed within 30 days of one of the top three executives knowing about it, notice requirements must be considered because “the company doesn’t want to miss the reporting window and have the carrier respond that you didn’t report in time,” warned Murphy.
In the uncertainty of the pandemic, she says it’s crucial for companies to examine these D&O policy provisions before confronting a significant threat.
“The more financially challenged a company is, the harder it’s going to be to negotiate better terms,” she noted. "If you wait until the worst happens to address the coverage, it’s too late.”