Typical D&O Liability Exclusions and Why They Matter
What do brokers mean when they talk about policy exclusions? An exclusion is essentially something that is not covered by your insurance provider (carrier). 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.
When it comes to Director & Officer policies, coverage varies from policy to policy and carrier to carrier, which is why it’s important to get familiar with the most common types of D&O insurance exclusions and how they can affect the coverage you are providing for your leadership team.
Other Insurance Exclusions
The intent of D&O policies is to cover only the risks involving executives in their capacity as a director or officer. Because of this, carriers exclude other areas that should be insured 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 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. This is because professional liability insurance and/or cyber insurance will not respond to a stockholder lawsuit.
Insured vs. Insured Exclusions
Carriers 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 is in your best interest these modifications are listed on the policy.
Derivative Shareholder Action Carve-Back
A board member has an obligation to act in the best interest of the company and its stockholders. 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,” which happens to be the most common D&O claim 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 the investigative and other appropriate expenses to evaluate the merits of the allegation.
Private companies are facing increasingly complex antitrust exposures from federal and state regulators in addition to private plaintiffs. Antitrust laws are put in place by federal and state governments to regulate the conduct of business corporations in order to promote fair competition.
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 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 exclusions or completely remove them from your policy.
Prior Knowledge Claims Exclusions
These exclusions allow carriers 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 those “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 as well as from an individual insured receiving illegal profits or remuneration to which they were not legally entitled. However, defense is normally 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 this exclusion contains 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. Therefore, all costs will be insured under the policy.
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 exclusion terms can vary greatly even within a single provider. When shopping for D&O policies, make sure you stack your exclusions side-by-side and work with your broker to define key exclusions in a narrow way.
Knowing your 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 Ultimate Guide to D&O Insurance.
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