In a recent post, I expressed a variety of opinions about claims notice issues arising in connection with D&O insurance renewals. Apparently, my commentary and proposals triggered enough of a reaction from my good friend John McCarrick that he felt compelled to write a response. John is a partner at the White & Williams law firm and chair of the firm’s Financial Lines Group. John is also one of the most widely respected professionals in the D&O insurance industry, and so I am pleased he took the time to write a response to my article and pleased to publish his response here. Here is John’s response.
I was very interested to read Kevin LaCroix’s recent post on ways to better address and resolve issues of late notice that arise during renewal policy periods. To be sure, this is a difficult issue for all involved – especially given both the mutual investment of a multi-year relationship between the policyholder and its insurers, and the binary consequences (i.e., coverage or no coverage) of a coverage position based on late notice in these circumstances. And Kevin has done his usual excellent job of laying out a logical discussion of the issue grounded in both his decades of experience and the applicable law and policy language.
But I can’t help thinking: does the discussion go far enough?
Here are some reactions I had while reading Kevin’s post, in no particular order, followed by my own suggestions to add onto Kevin’s thoughts on a better way forward.
First, clear and precise policy language – much like aesthetically-pleasing fences between neighbors – likely leads to better relationship outcomes because the parties have shared expectations about what comes next. That said, the D&O policy, by design, provides much room for negotiation in the context of a noticed claim. I’ve always thought that a D&O policy operates, as a practical matter, on a 20-20-60 rule: 20% of matters definitely are covered, 20% definitely aren’t covered, and the remaining 60% may or may not be covered based on the unique circumstances of a claim scenario, and are therefore most often negotiated aspects of the policy.
In exchange for that relatively high level of uncertainty, D&O insurers can charge a reasonably-low level of premium. This distinguishes D&O coverage from financial guarantee instruments, where policyholders can purchase additional contract certainty at astronomically-higher cost because financial guarantee instruments are designed to leave no room for negotiation; either the guarantee pays out or it doesn’t. And so the fact of some contract uncertainty should not be considered an insurance product defect. It’s actually the feature that permits such insurance to be sold and purchased at relatively affordable amounts.
Second, given my working assumption of some necessary contract uncertainty, I would then consider whether a given coverage issue – here, the coverage consequences of late notice under a renewal policy – is an issue that is better addressed to a level of contract certainty or left open, and therefore potentially subject to negotiation in the context of an actual claim.
Kevin’s post helpfully identified several ways in which the late notice problem disadvantages policyholders, and he is, of course, correct about those assessments. But let’s look at the other side of the coin:
- Large, sophisticated policyholders and small and middle-market entities have very different kinds of internal D&O insurance claim-reporting mechanisms, and generally vastly-different levels of internal resources to undertake the claim-reporting function. While one can see the appeal of shielding a small, unsophisticated policyholder from the draconian consequences of failing to timely report a D&O claim, should the same consideration be given to a larger or more sophisticated policyholder with substantially more in-house experience in identifying and reporting D&O claims and notices of circumstances? If not, then a solution designed for smaller, unsophisticated policyholders that also benefits large, sophisticated policyholders seems like an overly-expansive fix for a more limited problem.
- The historical reasons for introducing claims-made policies as a replacement for occurrence-trigger policies included the recognized desirability of tying the claim event closer to the policy pricing process so that the subsequent policy period premium would reflect the recent loss experience. Late notice between successive policy periods undermines the D&O insurer’s ability to reasonably price the year 2 policy (during which late notice was provided) to reflect the loss experience in year 1 (when the claim was actually made). In this scenario, if the insurer agrees to waive its late notice defense, then the insured will get both the benefit of coverage under the prior policy and going-forward protection under a current policy already priced as if the policyholder had no such loss history under the prior policy.
- Another consequence of late notice into a renewal policy period — in addition to the loss of a possible premium adjustment — is the insurer’s loss of an opportunity to add coverage limitations to the renewal policy designed to lock down exposure for the noticed matter into the policy period in which the claim was made. Tailored exclusions, such as so-called “specific event” exclusions are favored in situations where the insurer is concerned that additional actions may be commenced in the future relating to the facts or circumstances that gave rise to the previously-noticed claim. So this rational underwriting response is also undermined by late notice into the renewal policy period.
- Finally, we know that outside agents of the policyholder, such as outside counsel or brokers, are already charged with claim reporting responsibilities on behalf of the policyholder. Wouldn’t a proposal to ease notice requirements, if implemented, effectively shift potential E&O liability from the agent to the D&O insurers? That outcome might be favored by policyholders and their notice agents, but it’s difficult to imagine that D&O insurers would embrace that additional exposure, especially in the absence of additional premium to reflect that additional assumed risk.
Turning now to Kevin’s proposals, including more widespread adoption of a notice-prejudice standard expressly into D&O policy language, here are some additional elements of an acceptable solution to this thorny problem that I suggest be on the table too:
- The industry might consider, as part of any adoption of a contractual notice-prejudice exception to this condition precedent is a requirement that the policyholder provide some rational explanation for its failure to provide timely notice, which I think of as the mirror-image of a notice-prejudice rule: shouldn’t both parties be expected to explain the case-specific reasons why the parties should or shouldn’t depart from the normal requirement?
- The notice-prejudice rule approach treats the outcome as necessarily binary: coverage or no coverage. But are there alternatives to this binary approach that could provide the parties a more approximate benefit-of-the-bargain? Of course, it’s probably impractical to allow the D&O insurer to impose a surcharge premium to the renewal policy. The policyholder might conclude that any additional premium charged is arbitrary and excessive, and the insurer might conclude that any additional premium amount is insufficient. Instead, would the prospect of a higher retention or a sublimit of liability applicable to late-noticed claims be a more predictable compromise for the parties? There is some penalty imposed on the policyholder for a late-noticed claim in a successive policy period, but the prospect of no coverage at all is taken off the table. For the insurer obligated to now provide coverage under an expired policy, the prospect of paying only above a higher retention, or facing potential exposure for an amount less than the stated limit of liability, might be a palatable compromise.
I completely agree with Kevin that this difficult issue warrants further discussion and perhaps some contractual response. And, like Kevin, I look forward to others’ insights and suggestions on a better way forward.