Typical D&O Liability Exclusions and Why They MatterInsurance Explained
Few things are worse than purchasing an insurance policy, thinking you’re protected, and later realizing that your particular situation is not covered.
If this happens to you, your insurance provider will probably cite exclusions written into your policy.
But what do brokers mean when they talk about policy exclusions?
An exclusion is essentially something that is not covered by your insurance provider. Most importantly, you should always know what is excluded from your insurance policy and make a conscious decision that the restriction is acceptable for your business.
This holds especially true for complex coverages such as directors and officers insurance. D&O policies provide liability coverage for company leadership and executives, protecting them and their personal assets from claims that could arise from the decisions and actions they take during the course of performing their typical duties as company representatives and leaders.
D&O exclusions can be particularly important because they are numerous and can exclude a wide array of risks and often limit how much of your defense costs will be covered if your company leadership is sued.
Additionally, when it comes to directors & officers policies, coverage varies widely from policy to policy and insurer to insurer, which is why it’s important to get familiar with the most common types of D&O exclusions and understand how they can affect the coverage provided for your leadership team.
Let’s break down the most common and potentially dangerous D&O exclusions:
Insured vs. Insured D&O Exclusions
Insurers will exclude lawsuits between directors and officers at the same company to avoid collusion and fallout from corporate infighting. This exclusion translates to your directors and officers paying their legal fees out-of-pocket in the event that they sue one another. While the exclusion broadly prohibits coverage for an entire category of claims, it often also has exceptions that preserve coverage for certain situations.
The most common exceptions apply to actions brought by bankruptcy trustees, whistleblower suits under the False Claims Act, and claims brought by former D&Os that haven’t participated on the board for a certain period of time. It’s important to talk to your broker, and make sure that these modifications are listed on the policy.
Derivative Shareholder Action Carve-Back
Board members have an obligation to act in the best interest of the company and its shareholders. Consequently, if an individual breaches this fiduciary responsibility and no action is taken by corporate management, a shareholder can bring a suit against the director or officer on behalf of the company. This is known as a “shareholder derivative action,” and it has been one of the most common D&O claim types seen over the past few years.
Consequently, since one insured is suing another, the policy will typically exclude this action. However, an exception to the exclusion, or carve-back, should be obtained to reimburse you for investigative and other expenses needed to evaluate the merits of the allegation.
Antitrust laws are put in place by federal and state governments to regulate the conduct of corporations in order to promote fair competition. Private companies are currently facing increasingly complex antitrust exposures from federal and state regulators in addition to private plaintiffs.
Most D&O policies will have exclusions prohibiting coverage for any loss (including defense costs) arising from activities that impede competition. This is especially important since these D&O exclusions can often have a broader impact by eliminating coverage for unfair and deceptive trade practice claims as well as general competition law violations. However, it’s possible to negotiate a limited coverage amount for certain aspects of these D&O exclusions or completely remove them from your policy.
Prior Knowledge Claims D&O Exclusions
These exclusions allow insurers to restrict or eliminate coverage for claims or activities known prior to purchasing the policy. Insurers will routinely ask in the insurance application whether you are aware of any circumstances that might lead to a future claim under the policy. If the answer is “yes,” you will be required to provide more details regarding the circumstances of the potential future claim. This allows the underwriter to determine whether this is a risk that the insurer will accept.
If this information is intentionally omitted during the application process, the potential claim may lead to a rescission of the policy. Rescission is a practice in which the insurer moves to retroactively cancel the coverage by citing misrepresentation in the initial application. However, this rescission clause can be eliminated.
To assure coverage will apply for all current and previous business activities, you should always endeavor to secure “full prior acts,” which will address all management decisions since the company was formed. Any restrictions for prior actions should be limited to a reported claim only.
In addition, you can limit the effect of prior knowledge of events to only those individuals who were aware of the circumstances so that “innocent” individuals who had no knowledge of the events remain protected under the policy.
D&O policies include an exclusion for losses related to criminal or deliberately fraudulent activities. Additionally, if an individual insured receives illegal profits or remuneration to which they were not legally entitled, they will not be covered if a lawsuit is brought forward due to this. However, defense will normally be provided until final adjudication, or a formal court judgment exists, that attests to the action being criminal or fraudulent.
What this means is that allegations alone are insufficient to trigger the exclusion. The best-negotiated policies contain “final non-appealable adjudication” wording on this exclusion that triggers coverage for the defense costs of D&O misconduct claims. In addition, it is important for this exclusion to contain a provision that allows coverage for those “innocent” D&Os who were not a party to the alleged criminal or fraudulent action.
Defense Cost Exclusions
A D&O suit will commonly include extensive allegations. Therefore, you cannot be certain all aspects of the claim will be insured by the policy. The insurance company technically is only responsible to defend your interest based on the actual coverage the policy affords.
While there are no specific exclusions, incorporated into many D&O policies are limitations that can restrict the defense provisions to only the covered portion of a claim. Some simply exclude any defense costs reimbursement for the uncovered portion of the claim, while others may proportionately determine an amount between the covered and uncovered parts.
To avoid any confusion or conflicts, it is important to obtain a “100% Defense Cost Allocation Clause,” which outlines that defense coverage applies as long as a portion of the claim is covered. With this stipulation, all costs will be insured under the policy.
Other Insurance D&O Exclusions
One of the most common D&O exclusions pertains to the coverage that other polices offer. The intent of D&O insurance is to cover only the risks involving executives in their capacities as a director or officer. Because of this, insurers exclude other areas that should be covered by different policies, such as cyber risk, professional risk, and so forth. Therefore, the purpose of these exclusions is to clarify the scope of the D&O policy as it relates to actions by corporate management. For instance, bodily injury/property damage exclusions exist to assure that the D&O policy isn’t called upon to cover those claims, as they should be addressed by your commercial general liability policy.
However, these D&O exclusions can have an unintended effect and leave you, the policyholder, with gaps in coverage. One common example is claims arising from the performance of professional services, such as software development provided by a technology firm, being excluded from the D&O policy. Consequently, a shareholder suit that arises from professional activities that caused a drop in the company’s stock price would not be covered unless the professional services exclusion is modified. Since professional liability insurance and/or cyber insurance will not respond to a stockholder lawsuit, you may be left completely unprotected.
The Bottom Line on D&O Exclusions
Working with a knowledgeable insurance broker is the best way to reduce the risk of having a gap in your coverage, as they will have an easier time ensuring that your policies fit together seamlessly.
D&O exclusions can vary greatly even within a single provider, and simply paying more for D&O insurance will not guarantee full protection. When shopping for D&O policies, make sure you stack your exclusions side-by-side and work with your broker to better understand what these exclusions could mean for your company.
Understanding D&O exclusions gives you an opportunity to negotiate better policy terms so if, and when, a claim happens, you’ll get the largest payout possible from the insurance company.
Want a complete walkthrough of D&O insurance, including claims examples? Check out our extensive guide to D&O Insurance.
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Having quality D&O coverage and a broker who can help you navigate the terms and conditions and the claims process can save you money and, more importantly, time. If you need more help or information, don’t hesitate to reach out to our team of expert brokers.
Even on the advice of a broker, how do you actually know you’re paying a fair price for your Directors and Officers (D&O) coverage? The answer lies in due diligence plus asking your insurance broker the right questions. Here’s the key advice to consider: Know your average costs of D&O …