Am I Covered? What to Look for in your D&O Insurance Policy.
WHO SHOULD READ THIS
- Company directors and executive officers, in-house counsel.
THINGS YOU NEED TO KNOW
- In some market segments, particularly for listed companies, significant premium and retention increases can be expected.
WHAT YOU NEED TO DO
- Review your D&O insurance policy annually prior to renewal; and
- Check the key aspects of the policy including limits of liability, retention levels and the scope of definitions dealing with insured parties, claims and losses covered.
Company directors and officers have a wide range of statutory and common law duties and responsibilities. Failing to discharge those duties may expose a director or officer to legal action and personal liability from a number of sources. In our first article in this series, we look at who is covered under a Directors and Officers (D&O) Liability Policy and how it operates.
Why have cover?
When making decisions on behalf of a company, even those taken with the utmost care, circumstances can arise which may lead to claims against company directors and officers.
These claims can come from a variety of sources including the company itself, other directors, shareholders, creditors, customers, employees, liquidators and administrators and regulators such as the Australian Securities and Investments Commission (ASIC) (who have the main responsibility for enforcing the Corporations Act) and Workplace Health and Safety authorities.
Most commonly, claims will arise from alleged breaches of the Corporations Act 2001, under which directors and officers can be prosecuted. For public companies, disclosure requirements under ASX listing rules is a very common class of claim from both ASIC and/or shareholders.
These claims may lead to a liability to pay compensation, a fine or a penalty. In addition, directors and officers will face exposure to the cost of defending these claims that can be significant.
Directors may be indemnified for claims against them by the company, either by a formal deed of indemnity, the company constitution, or both. However, often companies cannot or may not be willing to indemnify directors for all costs and liabilities and large claims may be beyond the financial capacity of the company to pay from available resources.
It is therefore critical that companies and their directors and officers have insurance cover that provides financial protection for such liabilities.
Who is covered?
D&O insurance is usually obtained and paid for by the company itself that is referred to as the Policyholder. The parties who are covered can vary from policy to policy, however the primary purpose of the policy is to cover an ‘insured person’.
‘Insured person’ usually includes any past, present or future director or officer of the company and can should also extend to employees while acting in the course of their employment.
What does the policy cover?
A traditional D&O insurance policy generally contains three types of cover for directors and officers and, in some instances the company itself.
- The first provides cover to directors and officers for liability for wrongful acts committed in their capacity as directors and officers where the company is unable to indemnify them. This is known as Side A cover.
- The second reimburses the company for claims made against the directors and officers by third parties for wrongful acts committed by them in their capacity as directors or officers for which it is legally permitted to indemnify them. This is known as Side B cover.
- The third provides cover for the company itself, as distinct from its directors and officers, in relation to claims arising from wrongful acts associated with the offer, sale or purchase or trading of of its shares or securities. This is known as Side C cover.
Side C cover is intended to protect publicly listed companies from claims against the entity itself which often include shareholder class actions involving the trading of the company’s securities.
An entitlement to cover will be triggered by a ‘Claim’. This is usually defined to mean a written demand for damages or some other legal remedy or a civil, criminal, administrative or regulatory proceeding by a third party against an insured person in their insured capacity or the company.
The financial loss covered by a D&O policy will usually include liability to pay damages and defence costs. It can also include cover for civil pecuniary penalties and fines payable by the director or officer.
The definitions of what amounts to a ‘Claim’ and a ‘Loss’ under a policy will be critical to determining the scope of cover that is available and should be checked carefully to ensure that they are sufficiently broad for the activities of the company.
D&O insurance policies operate on a ‘claims made’ basis. This means that all ‘claims’ made against the company or directors during the policy period (which is typically 12 months) must be notified to the insurer, also during the policy period or any applicable extended reporting period.
In Part 2 of this focus series, we look at when claims and circumstances which may lead to a claim should be notified to the insurer.
What is excluded from cover?
A D&O policy will exclude cover for risks that either cannot be insured or which are covered by some other class of insurance.
In those categories, it is usual for a D&O policy to exclude cover for claims for fraudulent or dishonest acts by the insured person or company and wilful violation or breach of any law. However, such exclusions will usually not operate until the conduct in question is finally adjudicated by a court. This allows the advancement of defence costs by the insurer to the insured person so that they can defend themselves against the allegations.
Claims for bodily injury or property damage and claims arising from the rendering or failure to render professional services by the company or an insured person to a third party will also be excluded as these may be covered by other policies (general liability and professional indemnity respectively).
Prior known claims or circumstances relating to an act or omission which took place before the commencement of the policy and which could have been notified to an insurer under a previous policy will also be excluded.
A major shareholder exclusion excludes cover for claims brought by a party holding a specified level of controlling interest in the company (usually between 10% and 20%) or a board position with the company.
Limit of liability and retention
Coverage limits are specified in the policy schedule. The limit of liability is the maximum amount that the insurer will be liable for in the event of a claim, over and above any applicable retention. The limit of liability is often inclusive of defence costs and investigation costs.
There will also be an annual aggregate limit of liability set out in the policy. This means that the overall amount of cover available during the policy period is limited to the specified amount, regardless of how many individual claims arise during that policy period. There may also be sub-limits, which are limits within the overall limit of liability, that apply to certain classes of claim such as Workplace Health and Safety claims.
It is common for D&O policies to require that the company pay a ‘retention’ or deductible amount first, before the insurer is required to pay under the policy. Usually, these retentions only apply to side B and C covers, but can sometimes apply to side A direct cover.
If there is not a sufficient limit of liability available under the D&O policy situations may arise where the limit is eroded by one type of claim, with no further cover available for the balance of the policy period.
For example, if a D&O policy covers a company for a class action by shareholders under side C cover, the legal costs alone in defending such an action may erode the limit leaving no cover for any actual liability of the directors.
Care must be taken to ensure that the policy provides an adequate limit of liability, having regard to the nature and extent of the company operations and its perceived risks. Additional cover may be available under the policy or on a ‘top up’ basis.
State of the market
The market for D&O insurance has historically been cyclical with periods where broad cover is readily available at reasonable rates (soft market) and at other times, the cost is high with a narrower scope of cover available (hard market). The state of the market is influenced by a range of factors such as the number of insurers and reinsurers willing and able to provide capacity as well as by the prevailing claims environment.
The GFC and its aftermath saw significant inflows of capital into the insurance market seeking returns. This generated heated competition for market share, expansion of the scope of cover and reduction in premiums and retentions. At around the same time this was occurring, there was also a progressive deterioration of the claims environment. Inevitably, this has created significant pressure on insurer loss ratios.
The market conditions for D&O insurance for publicly listed companies is particularly challenging. An increase in class action proceedings as well as the availability of litigation funding means that Australia is one of the most litigious jurisdictions outside the United States. The Hayne Royal Commission into the Banking, Superannuation and Financial Services Industry has also contributed substantially to rate increases of anywhere between 70 and 400 percent on both renewals and new business.
In order to address the deteriorating claim performance for companies in the financial services sector, insurers are looking to confine their Royal Commission liabilities to a single policy year by imposing an absolute exclusion on any future claims arising out of or connected with any matters within the terms of reference of the Inquiry. Insurers are also seeking to impose increases in retentions and are generally taking a tougher stance on underwriting.
The market for D&O insurance for private companies is less volatile with a stronger insurer appetite for these risks, however insurers are seeking to impose premium increases to make up for losses incurred in other parts of their portfolios.
Overall, cover restrictions, premium and retention increases are occurring and longer lead times for marketing or re-marketing of cover are required to ensure optimal outcomes for all companies, public and private alike.
How we can support you
McCullough Robertson and our insurance advisory service, Allegiant IRS, can assist you with the drafting and interpretation of indemnity and insurance clauses in your contracts. We can also guide you through the process of placement and renewal of insurance cover that operates consistently with your contract provisions.
For further information on this alert, please contact the below team.
This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.