Is it Time to Revisit the Scope of D&O Coverage?

The following article was co-written with John McCarrick. John is a partner in the law firm White and Williams LLP and leads the Firm’s Financial Lines Practice Group. Our article originally appeared as a guest post on the D&O Diary, a site published by Kevin M. LaCroix, attorney and Executive Vice President at RT ProExec, a division of R-T Specialty.

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Capital providers supporting D&O underwriting facilities have been heartened to witness double-digit rate increases in D&O underwriting lines over the past several calendar quarters – marking a possible end to the decade-long soft market drought. D&O insurers reportedly are no longer reducing expiring premiums just to hold onto underwriting business, and appear to have already begun increasing premiums substantially on renewal or new accounts.

The profitability picture is less rosy for excess D&O insurers, where rates have been driven down as much as 80% in the past several years. Looking at the same data, industry experts estimate that it will take multiple years of substantial annual, rate increases to restore profitability to the excess segment of the D&O market.

How long or extensive the market turn will last is anyone’s guess. But we should all keep in mind that the long deterioration in D&O underwriting results was only partly a function of pricing. At the same time that pricing was depressed, D&O coverage expanded – and expanded dramatically.

So as we think about restoring profitability to the D&O segment of the underwriting business, perhaps we can consider peeling back some of the coverage enhancements that became standard features of competitive D&O underwriting in the past, and that now could be tradeoff compromises in negotiations over premium pricing.

Brokers and risk managers might have a viscerally-negative reaction to forfeiting the broadest possible wordings – particularly because brokers spent much of the past decade negotiating these coverage-broadening terms. But here’s another way to look at it: the steep pricing increases already in place, and likely continuing well into 2020, reflect the cost of level-setting premiums to match the expanded coverage risks inherent in broader policy wording. And so brokers and risk managers have two choices: either accept steeply-increasing premiums for the foreseeable future and light a candle — praying for the end of the hard market, or conform the D&O policy to a narrower scope of necessary coverage in exchange for more moderate price increases.

We took an anonymous survey of D&O underwriters and claims attorneys, and asked for their suggestions on soft market coverage enhancements that they’d like to see go the way of the dinosaur, and their collective suggestions are listed below. Think about this “wish list” as more like a menu of available options that can balance pricing and scope of coverage. Not every change below is appropriate for every account, and no one has suggested to us that these changes should be blindly implemented across the board on all accounts.

The following list is presented in no particular order of importance:

• Executives’ personal settlements of sexual harassment and similar disputes against them should be excluded from any proposed D&O coverage;
• The use of sublimits to reimburse amounts incurred in connection with derivative-type litigation, such as books and records demands, and internal and special litigation committee investigations, should be limited to small and middle-market companies that really need funded expertise, and are arguably superfluous and therefore unnecessary for the large and mega D&O accounts (e.g., SEC investigation of entity, disclosure event coverage, event study costs and tax liabilities);
• Coverage triggers for Side A and Side A-DIC policy should be narrowed, particularly with respect to presumptive indemnification, so that insureds don’t have broad latitude to simply tap this coverage at will;
• If the industry insists on waiving rescission as a remedy for misrepresentations in the application process, at the very least it should tighten up warranty language, and avoid granting severability in connection with warranty exclusions whenever possible;
• Avoid using the “that portion of Loss” language in the exclusions section of the policy, and limit its use elsewhere whenever possible;
• More rigorous use of “tie-in” limits endorsements on FI accounts, given the demonstrated propensity of related FI risks to run into claim trouble simultaneously;
• Revisit final adjudication and non-appealable requirements for conduct exclusions, where permissible by state law;
• Revisit severability for conduct exclusions;
• Consider broader Prior Wrongful Act exclusions, including wordings that do not require a showing of the insured’s actual knowledge of the prior act;
• Beef up insurers’ ability to control defense counsel rates in non-duty to defend policies, including reversing the historical watering-down of “reasonableness” wording;
• Delete the requirement that the insurer demonstrate prejudice in connection with late notice denials of coverage;
• Restrict the scope of the “Claim” definition, especially in connection with informal SEC investigations and Section 220 demands;
• Revisit the definition of “Loss:” exclude coverage for plaintiffs’ attorneys’ fees in certain instances (e.g., bump-ups, Section 11 claims, etc.); limit coverage for punitive, exemplary or multiple damages, where permissible; specifically identify the applicable state law governing insurability of Loss;
• Revisit prior notice exclusion language to conform to underwriting expectations;
• Return to broader “based upon, arising out of” exclusion preamble language in lieu of “for” language;
• Limit coverage in “bump-up” M&A cases to “Defense Costs” only;
• Specify a choice-of-law jurisdiction in policies if underwriters don’t want to be forced to litigate every D&O coverage dispute in Delaware;
• Revisit the scope of the contract exclusion and the professional services exclusion in D&O private company and private equity fund D&O/E&O forms;
• Revisit the language impacting underlying insurer limits depletion and potential gap-filling opportunities; Revisit the need for pre-suit mediation provisions; and
• Tighten up the relatedness language tying together related Wrongful Acts and/or related claims given some recent unfavorable law in Delaware, Florida and other pro-policyholder states.

One data point that’s difficult to quantify is the coverage exposure impact of any one or combination of these coverage-tightening changes. Will the suggested change impart frequency, severity or both? As to severity, will any suggested change impair settlements, defense costs, or both? Or until the change simply reduce the potential that an unfriendly court won’t enforce the policy terms as written?

And finally, what’s a reasonable premium tradeoff for a given set of coverage-tightening changes? Larger D&O policyholders might be prepared (i.e., have the financial resources) to absorb higher premiums instead of agreeing to shrink coverage, but smaller policyholders might reluctantly accept coverage changes to preserve access to D&O coverage limits, or to any D&O coverage at all.