August 20, 2020

Key D&O Terms You Should Know

Entity Coverage/Allocation Provisions

Claims can get complicated when the corporate entity is named as a defendant along with directors and officers. If the D&O policy does not include entity coverage, the insurer must allocate defense and settlement costs among the (covered) directors and officers and the (uncovered) entity to determine how much of these costs the policy will pay.

Allocation provisions determine how the claims payments will be allocated. Some assign specific percentages — such as 70 percent and 30 percent — which means the insurer would pay 70 percent of costs and the corporation 30 percent. Other allocation provisions leave the allocation up to negotiation between the insurer and corporation.

Severability Provisions

The person who signs the application for D&O coverage must warrant that the information included is true to the best of his/her knowledge. If the application contains a “material misrepresentation,” traditional insurance law voids coverage. A severability provision provides that material misrepresentation by one person will not void coverage for others. Most policies today only provide partial severability, which generally means that the CEO and CFO, who must sign off on the financial statements many insurers require, would not be covered in the event of a material misrepresentation.

Insured vs. Insured Exclusions

The insured versus insured exclusion prohibits coverage for claims filed by a corporation against its directors and/or officers. Originally intended to eliminate coverage for ordinary business losses due to bad judgment, the traditional insured versus insured exclusion could also eliminate coverage in a bankruptcy situation. You can ask your insurer to modify the exclusion, so it does not apply to claims or suits brought by a bankruptcy trustee or similar party.

“Hammer” Provisions

Insurers want to resolve a claim as quickly and inexpensively as possible. This can sometimes mean settling a claim that could have been won in litigation, to avoid high defense costs and potential costs of a loss in court. Some policies include a provision, nicknamed the “hammer provision,” that encourages insureds to accept “reasonable” pretrial settlement offers by limiting the insurer’s liability for the claim to the amount of the proposed settlement. Policyholders should negotiate to have these provisions removed.

Alternative Dispute Resolution (ADR) Provisions

ADR provisions require the insured to consent to participate in ADR at the insurer’s request. ADR can cut defense and litigation costs, but it can also limit your options in a claim situation. When possible, you should negotiate to remove these provisions.

D&O insurance is a complex, nonstandard product, with many possible provisions and exclusions. For more information on structuring D&O coverage for your organization’s specific needs, please call us.

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