◼ DIRECTORS AND OFFICERS LIABILITY

Excess Side A DIC Coverage: Considerations for Privately Held and Not-for-Profit Entities

By Tim Bennett, Senior Broker, U.S. Risk Brokers
March 1, 2022

In the last few decades, privately held and not-for-profit entities have come to recognize the wisdom of securing comprehensive Directors & Officers Liability (D&O) coverage. Like their publicly traded counterparts, these entities realize that D&O insurance is vital to their efforts to operate effectively, attract talent and protect their boards, management and the organization itself from a vast array of legal and regulatory actions. Particularly with current initiatives toward board and management diversity, climate change accountability and increased regulatory scrutiny, the necessity of strong risk management and finance in the areas of management liability exposures is growing in importance. But unlike publicly traded companies, the uptake of Excess Side A DIC (DIC) coverage by private and not-for profit entities remains relatively modest.

Arguably, the primary concern for publicly traded firms in purchasing this additional coverage is that corporations are generally not permitted to indemnify their management for judgments and settlements resulting from certain shareholder lawsuits. But even without this exposure, non-publicly traded organizations and their stakeholders should still consider including options for DIC coverage as a part of their management liability strategy. Below are some considerations these firms should make.

Excess Side A DIC coverage is broader than primary D&O policies

Anyone who has reviewed a D&O policy, even one that is market leading in terms of breadth, will certainly note the dozens of exclusions they contain. Should directors or management of an entity be personally brought into a lawsuit that alleges any of these excluded items, they will not have the protection of the policy for those actions. Actions relative to pollution, unfair trade practices, breach of contract, cyber liability, and professional liability are just a few that can result in actions naming individuals but be excluded under a D&O policy.

What’s more, depending on how these exclusions are worded, the stakeholders may even be without coverage for included allegations that would otherwise be covered by the policy. Most market leading DIC policies only contain exclusions for willful violation of law and obtaining any profit or advantage to which the insured was not entitled. If exclusions in the underlying D&O policies are triggered to negate coverage there, the DIC (Difference in Conditions) aspect the coverage will allow for coverage for the impacted parties. In addition, DIC policies can be crafted such that coverage is still provided for those individuals who did not know about or acquiesce to the actions that trigger the two exclusions that are common to these forms.

With an increased focus on attaching personal liability against management relative to hot button issues like climate change, pollution, discrimination and harassment, consumer protections and so forth, a DIC policy may be the only source of protection available to individual managers.

Excess Side A DIC limits are reserved for the protection of individuals

As the Excess Side A portion of the name of this coverage implies, DIC policy limits can only be used for the protection of the personal assets of the management and board. Quite purposefully, there is no coverage for the entity, or even for the entity’s indemnification obligations on behalf of management. Over the years, D&O policies have expanded to include coverage for the organization itself. Many of these policies now cover a broad array of exposures like employment practices, fiduciary, employed lawyers and even cyber liability. While this is positive on its face, adding additional insureds and exposures to the policy that was originally intended to protect the personal assets of management puts those individuals at risk of being without available limits should their D&O policy limits be exhausted.

Most notably, very often the personal protection limits afforded to management by the D&O policy are shared with the coverage for the entity. Even when separate limits are afforded by the primary D&O program, aggregate caps are also quite common. It is more than conceivable that a serious loss affecting the entity could impair or exhaust the limits available for the individuals. Since DIC limits can only be used by the individuals when there is no indemnification available from the company, those limits cannot be impacted by losses to the corporation.

Excess Side A DIC coverage is generally non-rescindable

In extreme situations such as allegations of application misrepresentations or even fraud, underlying carriers can pursue rescission of their policy. If this occurs, the DIC policy will still be available to the individuals as the policy is usually non-rescindable. Carriers rely on the application materials they are presented to issue D&O policies. Even unintentional but material misrepresentations within the information used for underwriting purposes can result in that carrier seeking to cancel the policy as though it was never issued. In those cases, the DIC policy will still be available for the protection of individual insureds.

Excess Side A DIC coverage can be accessed if the company refuses to indemnify management

DIC policies can be structured such that they will respond, even when the organization fails or refuses to defend or indemnify the individual insureds. Typically, this feature will be triggered if the entity fails for any reason to indemnify within thirty (30) days of receipt of a complaint or lawsuit. Particularly during periods of economic, social or industry disruption, it is not uncommon for management to be purged or boards to be reshuffled. Parties that have left the organization acrimoniously might feel that they cannot depend on their former organization to defend or indemnify them for their actions on behalf of the organization prior to their departure. In that case, that former executives can appeal directly with the DIC carrier to step in while those issues are resolved.

As a side note, this is also why it is recommended that directors and officers ask to be made aware of what their D&O coverages program looks like, and be provided with the details on how to file a claim directly to the carriers if the need arises.

Excess Side A DIC coverage provides protection in the event of corporate insolvency

The possibility of insolvency and the resultant inability of the corporation to provide indemnity to its management should also drive interest in DIC coverage. Even well run private and not-for-profit entities with consistent profitability and healthy balance sheets can run into financial trouble in the event of an economic downturn, a failed product offering, serious litigation, regulatory pressure and many other causes. Those companies that are already in financial straits, are very large, or are in certain industries may have very high retentions on the corporate indemnification coverage of their D&O program that they can’t afford to fund at the time of loss. If this were to occur and managers were to have to provide their own defense, a DIC policy may step in to provide that defense on a first dollar basis.

Summary

Excess Side A DIC policies have been ubiquitous within the publicly traded realm for some time. Given near record breaking periods of securities class action lawsuits and corporate scandals, DIC coverage for these firms has seen significant increases in premium in recent years. But for private and not-for-profit entities without the public securities exposure, DIC coverage can still be obtained at significant limits, for a reasonable cost. There are certainly those entities for which DIC coverage can represent a significant expense, such as for very large privately held companies, healthcare, colleges and universities, and so forth. But even in those cases, reviewing options for Excess Side A DIC is still a meaningful effort. When things go seriously awry at private or not-for-profit organizations, a DIC policy will be of paramount importance. When large losses are incurred, there are indications of fraud or serious mismanagement, D&O exclusions are triggered, or when solvency is an issue, Excess Side A DIC may be the last line of defense for managers and board members. ◼