Most D&O insurance buyers understand the critical importance of limits selection – that is, deciding how much insurance to buy. But an equally important question involves the issue of program structure – that is, how the insurance program is put together. Many insurance buyers understand that, in order to be able to purchase an insurance program with the desired limits of liability, their D&O insurance will be structured with a layer of primary insurance and one or more layers of excess insurance. In addition, these days many D&O insurance buyers also purchase an additional layer – usually on the top of program – of Side A Difference in Condition (DIC) insurance. As noted in an interesting May 2, 2017 post on the Pillsbury Policyholder Pulse blog (here), “no coverage may be less understood” than the Side A DIC policy. But even if frequently misunderstood, the coverage provides corporate directors and officers an important safety net. Moreover, there are other important D&O insurance program structure issues, beyond just the need for Side A DIC insurance.
The starting place to talk about Side A DIC coverage is with the three-part structure of the underlying insurance. The traditional D&O insurance policies have three insuring agreements, denominated Side A, Side B, and Side C. The Side A coverage provides insurance when the insured organization is unable due to insolvency or legal prohibition to indemnify the company’s directors and officers (say, for example, in bankruptcy or in a shareholders’ derivative lawsuit judgment). The Side B coverage provides reimbursement to the corporation when it is indemnifying its directors and officers. The Side C coverage protects the insured organization itself (the “entity”) for its own separate legal liabilities. (In public company D&O insurance policies, the Side C entity coverage is limited to corporate liabilities under the securities laws.)
For purposes of our discussion of Side A DIC coverage, the important point here is that the Side A coverage under the traditional insurance policies provides protection for the individuals when protection from the company is unavailable.
The first and most basic feature of the Side A DIC policy is that it provides additional Side A protection for the individual directors and officers when the limits of liability of the underlying traditional policies has been exhausted by payment of loss under their Side A coverage provisions. In this respect, the Side A policy provides excess Side A insurance protection when the underlying insurance has been exhausted by payment of Side A loss.
This excess coverage protection is of course important, but what makes the Side A DIC policy such a valuable part of a company’s D&O insurance program structure are the two other features of the Side A DIC policy’s insurance protection — the Side A DIC policy’s “drop down” insurance protection and the Side A policy’s “broad form” scope of coverage.
The Side A DIC policy’s “drop down” protection comes into play to fill gaps that can arise in the operation of the underlying insurance. The Side A DIC policy drops down to provide first dollar protection when, as the Pillsbury law firm’s blog post puts it, “any underlying insurer fails or refuses to pay, attempts to rescind coverage, or becomes insolvent.” In other words, the Side A DIC policy can provide protection at what would otherwise be some critical moments.
The Side A DIC policy’s so-called “broad form” protection arises from the fact that the Side A DIC policy does not have some of the exclusions typically found in most traditional D&O insurance policies, including, for example, the Insured vs. Insured exclusion and the Pollution exclusion.
As the Pillsbury law firm’s blog post puts it, what the Side A DIC policy’s drop down protection and broad form coverage mean in practice is that “a company can usually trigger its Side A DIC policy by showing that any underlying insurer in the tower has failed to indemnify a Side A claim.” The Side A DIC policy in effect “backstops” the company’s traditional D&O insurance. If any insurer in the tower refuses to indemnify a Side A claim (for example, if one insurer in the tower refuses to participate in a claim settlement because it believes there is no coverage under its policy for the claim), the Side A DIC policy will drop down to fill the coverage gap, and then pursue a subrogation claim against the insurer that refused to participate.
These features of the Side A DIC coverage, as well as its excess Side A insurance protection, are the features of the policy that make it an “important safety net” that can “help attract and retain qualified board members who desire broader protection that their personal assets will not be put at risk if and when claims are brought against them.” The Side A DIC policy’s features make it “a very useful, multi-faceted form of coverage” that “fills in the gaps, saving the directors and officers from falling without a net.”
The protection afforded by the Side A DIC policy is indeed critically important, but there is one aspect of its protection that the Boards of Directors will want to carefully consider.
That is, the protection afforded by the Side A DIC policy is shared among all of the company’s officers and directors. This could be a particular concern in a serious claims situation in which each of the various individuals has retained their own lawyers. The rapidly accumulating claims expenses in this scenario could exhaust all of the available insurance. This possibility of course has important implications in the context of limits selection; the best protection against the possibility of running out of insurance is to buy more insurance.
This concern about what might happen in the event of catastrophic claim also has implications for the D&O insurance program structure, particularly from the perspective of the non-officer directors. These outside directors will want to be sure that no matter what there is a pool of funds with their names on it available to protect them.
In my experience, non-officer directors want to know about the ways the insurance program can be structured so that there is dedicated insurance set aside that cannot be eroded or exhausted by the defense expenses and indemnity obligations of the company or the company’s officers. They want as much reassurance as they can get that no matter what happens, they will not have to go out of pocket in any way. The way to address this issue is with an additional layer of excess Side A DIC insurance, with the policy’s definition of named insureds modified so that the only individuals that may avail themselves of this protection are the company’s non-officer directors.
Corporate officers, even those who recognize the theoretical value of these products, often are most concerned with considerations pertaining to cost. Even officials persuaded of the need for the company to acquire excess Side A insurance to protect the individual directors and officers may not be susceptible to persuasion of the need for separate limits set aside just for the outside board members, and frequently the stumbling block to further consideration of these issues is an unwillingness to incur additional D&O insurance expense.
These issues recur with sufficient frequency that it is my universal recommendation to non-officer board members that they request a separate presentation directly to the board about the company’s D&O insurance, to afford all of the board members a separate opportunity to inquire about their interest and the level of insurance protection available to them.
There is considerable value in having the D&O insurance program separately and independently reviewed. D&O insurance is of course only one part of the company’s overall insurance program, but from the outside board members’ perspective, the D&O insurance is the only insurance the company has that insures them directly, so they are highly motivated that the insurance program is the best available.
Though both the company’s officers and its board members are equally interested in ensuring the adequacy of the D&O insurance program, my own experience is that a separate insurance audit on behalf of the non-officer board members frequently discloses a variety of ways the overall D&O insurance program might be improved, sometimes materially.
The interests of a wide variety of insureds are yoked together in a single D&O insurance program. But that does not mean that the various constituencies’ interests cannot be considered separately. A separate consideration of competing and sometimes conflicting interests can sometimes result in the selection of different insurance structures. An independent insurance audit can provide an opportunity for the separate review of the adequacy and appropriateness of the terms and conditions in the applicable policies.