Negotiating Tips For Getting Comprehensive D&O Coverage

The legal, regulatory and political fallout from the recent plague of corporate scandals, financial restatements, bankruptcies, and mega shareholder claims means directors and officers face an unprecedented level of risk. Yet, most directors and officers would be surprised by just how inadequate typical D&O liability insurance policies are in the face of these threats.

The only way to buy a D&O Liability insurance policy that works well is to know what to ask for. The best and most reputable insurers sell D&O policies that benchmark poorly against the quality of coverage they’re capable of providing, if asked.

This isn’t about paying more for better coverage. Insurers usually come to know better the risks presented by a particular company as a consequence of underwriting the requests for enhanced coverage. More often than not, this results in the insurer attributing less rather than more risk to the company.

Good insurers appreciate thoughtful, well-supported coverage requests, understanding that a tailored policy often leads to a long-term relationship with their policyholder.

The following are examples of key issues to consider when negotiating the purchase of D&O liability insurance.

Know What’s Important

Be clear on why you’re buying this insurance. For example, the interests of the corporation, management and independent directors are not always complimentary when it comes to insurance.

Why do directors and officers want to share their policy with the corporation? For that matter, do outside directors want to share their policy with the CEO or CFO? Ask the directors of WorldCom how they feel about having shared an insurance policy with Bernard Ebbers.

And, at what point does expending corporate assets to buy insurance for the exclusive benefit of directors or officers present its own corporate governance issues? The particular balance you want to achieve between these competing interests necessarily will influence the type of insurance program you negotiate.

Understand The Implications Of Shared Insurance Limits

The idea of competing interests in a traditional corporate D&O insurance policy is based largely on the fact that the policy, which pays the cost of defense and settlements or judgments, has an annual aggregate limit. All the parties to this policy share this same limit.

Traditional D&O policies provide some element of coverage for the corporation itself (i.e., “entity coverage”). Limits available to individuals can be wiped out by the defense and settlement of a claim against the entity (e.g., a securities claim, an employment claim, etc.)

Consider negotiating separate aggregate limits for those parts of the policy covering the entity. Likewise, ask for an option of a higher limit for the part of the policy (section A) that covers individual officers and directors.

Alternatively, seek an option for an entirely separate “A-Side” policy that protects individual directors and officers against loss that is not indemnified by the corporation. The fact that the company is not a beneficiary of the policy also means the proceeds are less likely to be considered part of the company’s estate in a bankruptcy, another advantage an A-Side policy has over a traditional corporate D&O policy.

Plan For The Worst

Consider those issues that would be most relevant in a worst-case scenario, such as bankruptcy or an accusation of fraud against the company’s CEO or CFO. For example, policies for private companies often exclude claims by a bankruptcy trustee. This exclusion can usually be removed by providing the insurer financial detail that supports the company’s solvency.

Likewise, any company needs to pay attention to the specific language of the fraud exclusion. Don’t buy a policy that allows the insurer to apply the exclusion before the fraud has been established in final adjudication.

Given the increase in corporate financial restatements, request the policy be amended to state that it can’t be rescinded on the basis of a misrepresentation in the application for individuals who didn’t have knowledge of the misrepresentation.

Without such a statement, an insurer may be permitted to rescind the policy regardless of whether the insured directors or officers either knew the information included in the application was in error or intended to mislead the insurer.

Look For The Obvious

Next, consider the most likely sources of claims and look carefully at the terms of the policy in the context of these claims. For example, some policies exclude claims by major shareholders or creditors.

With some discussion regarding the company’s relationship with its shareholders and creditors exclusions of this type can often be negotiated off the policy. Likewise, the standard policy offered by some insurers excludes employment claims by an officer of the company who is also a director, thereby eliminating coverage for wrongful termination claims by a CEO and chairman forced out by the board.

Other policies don’t cover breach of employment contract claims. Others exclude claims related to stock options. Some policies don’t cover claims arising out of wrongful acts committed prior to the inception of the policy.

There are even policies that exclude any claim related, directly or indirectly, to the company’s products, services or intellectual property. These and other coverage problems can usually be mitigated or eliminated entirely through negotiation.

TAnticipate Claims Handling Problems

If you and your company’s insurer fundamentally disagree with what a “reasonable and necessary” defense should cost, you will almost certainly get drawn into a dispute over the payment of defense expenses. As part of the policy negotiations, consider seeking the pre-approval of your choice of legal counsel, including an agreement on the rate schedule at which the insurer will pay selected counsel.