In the following guest post, John McCarrick and Paul Schiavone propose that as D&O insurers seek to return to profitability by raising prices, the insurers should also revisit many of the coverage extensions that have become standard in recent years. The authors present a “wish list” of specific items they suggest insurers might want to consider; the list itself is the result of the authors’ “anonymous survey” of insurer-side professionals. My commentary on the authors’ proposals follows below. John is a partner in the law firm White and Williams LLP and leads the Firm’s Financial Lines Practice Group. Paul is a Senior Vice President at Allianz, and is the Global Head of Alternative Risk Transfer and North American Head of Corporate Long Tail Lines. I would like to thank John and Paul for allowing me to publish their article on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is John and Paul’s article.
Capital providers supporting D&O underwriting facilities have been heartened to witness double-digit rate increases in D&O underwriting lines over the past several calendar quarters – marking a possible end to the decade-long soft market drought. D&O insurers reportedly are no longer reducing expiring premiums just to hold onto underwriting business, and appear to have already begun increasing premiums substantially on renewal or new accounts.
The profitability picture is less rosy for excess D&O insurers, where rates have been driven down as much as 80% in the past several years. Looking at the same data, industry experts estimate that it will take multiple years of substantial annual, rate increases to restore profitability to the excess segment of the D&O market.
How long or extensive the market turn will last is anyone’s guess. But we should all keep in mind that the long deterioration in D&O underwriting results was only partly a function of pricing. At the same time that pricing was depressed, D&O coverage expanded – and expanded dramatically.
So as we think about restoring profitability to the D&O segment of the underwriting business, perhaps we can consider peeling back some of the coverage enhancements that became standard features of competitive D&O underwriting in the past, and that now could be tradeoff compromises in negotiations over premium pricing.
Brokers and risk managers might have a viscerally-negative reaction to forfeiting the broadest possible wordings – particularly because brokers spent much of the past decade negotiating these coverage-broadening terms. But here’s another way to look at it: the steep pricing increases already in place, and likely continuing well into 2020, reflect the cost of level-setting premiums to match the expanded coverage risks inherent in broader policy wording. And so brokers and risk managers have two choices: either accept steeply-increasing premiums for the foreseeable future and light a candle — praying for the end of the hard market, or conform the D&O policy to a narrower scope of necessary coverage in exchange for more moderate price increases.
We took an anonymous survey of D&O underwriters and claims attorneys, and asked for their suggestions on soft market coverage enhancements that they’d like to see go the way of the dinosaur, and their collective suggestions are listed below. Think about this “wish list” as more like a menu of available options that can balance pricing and scope of coverage. Not every change below is appropriate for every account, and no one has suggested to us that these changes should be blindly implemented across the board on all accounts.
The following list is presented in no particular order of importance:
- Executives’ personal settlements of sexual harassment and similar disputes against them should be excluded from any proposed D&O coverage;
- The use of sublimits to reimburse amounts incurred in connection with derivative-type litigation, such as books and records demands, and internal and special litigation committee investigations, should be limited to small and middle-market companies that really need funded expertise, and are arguably superfluous and therefore unnecessary for the large and mega D&O accounts (e.g., SEC investigation of entity, disclosure event coverage, event study costs and tax liabilities);
- Coverage triggers for Side A and Side A-DIC policy should be narrowed, particularly with respect to presumptive indemnification, so that insureds don’t have broad latitude to simply tap this coverage at will;
- If the industry insists on waiving rescission as a remedy for misrepresentations in the application process, at the very least it should tighten up warranty language, and avoid granting severability in connection with warranty exclusions whenever possible;
- Avoid using the “that portion of Loss” language in the exclusions section of the policy, and limit its use elsewhere whenever possible;
- More rigorous use of “tie-in” limits endorsements on FI accounts, given the demonstrated propensity of related FI risks to run into claim trouble simultaneously;
- Revisit final adjudication and non-appealable requirements for conduct exclusions, where permissible by state law;
- Revisit severability for conduct exclusions;
- Consider broader Prior Wrongful Act exclusions, including wordings that do not require a showing of the insured’s actual knowledge of the prior act;
- Beef up insurers’ ability to control defense counsel rates in non-duty to defend policies, including reversing the historical watering-down of “reasonableness” wording;
- Delete the requirement that the insurer demonstrate prejudice in connection with late notice denials of coverage;
- Restrict the scope of the “Claim” definition, especially in connection with informal SEC investigations and Section 220 demands;
- Revisit the definition of “Loss:”
- exclude coverage for plaintiffs’ attorneys’ fees in certain instances (e.g., bump-ups, Section 11 claims, etc.);
- limit coverage for punitive, exemplary or multiple damages, where permissible;
- specifically identify the applicable state law governing insurability of Loss;
- Revisit prior notice exclusion language to conform to underwriting expectations;
- Return to broader “based upon, arising out of” exclusion preamble language in lieu of “for” language;
- Limit coverage in “bump-up” M&A cases to “Defense Costs” only;
- Specify a choice-of-law jurisdiction in policies if underwriters don’t want to be forced to litigate every D&O coverage dispute in Delaware;
- Revisit the scope of the contract exclusion and the professional services exclusion in D&O private company and private equity fund D&O/E&O forms;
- Revisit the language impacting underlying insurer limits depletion and potential gap-filling opportunities;Revisit the need for pre-suit mediation provisions; and
- Tighten up the relatedness language tying together related Wrongful Acts and/or related claims given some recent unfavorable law in Delaware, Florida and other pro-policyholder states.
One data point that’s difficult to quantify is the coverage exposure impact of any one or combination of these coverage-tightening changes. Will the suggested change impart frequency, severity or both? As to severity, will any suggested change impair settlements, defense costs, or both? Or until the change simply reduce the potential that an unfriendly court won’t enforce the policy terms as written?
And finally, what’s a reasonable premium tradeoff for a given set of coverage-tightening changes? Larger D&O policyholders might be prepared (i.e., have the financial resources) to absorb higher premiums instead of agreeing to shrink coverage, but smaller policyholders might reluctantly accept coverage changes to preserve access to D&O coverage limits, or to any D&O coverage at all.
[John F. McCarrick is a partner in the law firm White and Williams LLP and leads the Firm’s Financial Lines Practice Group. Paul Schiavone is a Senior Vice President at Allianz, and is the Global Head of Alternative Risk Transfer and North American Head of Corporate Long Tail Lines. The authors’ views are their own, and do not necessarily reflect the views of their respective firms.]
Let me say that I found it a struggle to find the right tone for my response to John and Paul’s article. To state it simply, on my first reading of the wish list, I had exactly the “viscerally-negative reaction” the authors anticipated policyholder-side representatives might have.
At the same time, I have known both John and Paul a very long time and I consider them both friends. I respect them both a great deal, both personally and professionally. I would not want my visceral reaction to their suggestions to translate into a response that sounded negative toward either of them.
In addition, I recognize that John and Paul have offered their observations to initiate a discussion of these topics. The very submission of their article for publication on my blog bespeaks their presumption that well-meaning insurance professionals can have a reasonable conversation about important topics, even about topics that may be controversial.
In that spirit of reasonable conversation among industry professionals, I offer a few observations here about John and Paul’s wish list. Please note that I have not attempted to respond to all of the items on the wish list. Instead, I have selected a few items on which to comment, as a way to convey my overall views about the list.
First of all, my visceral reaction notwithstanding, I don’t disagree with everything on their list. There are a few items that I think, subject to further consideration and elaboration, usefully might be adopted in D&O insurance policies.
For example, I do think there may be a role for the inclusion in D&O insurance policies of choice of law clauses. Uncertainty over the law to be applied to the interpretation of the policies can lead to disputes, and occasionally lead to the application of law having little or nothing to do with the parties or the policy. However, even if insurers may bridle at having the law of jurisdictions they view policyholder-friendly applied to policy interpretation, that does not make it right to have the law of insurer-friendly jurisdictions applied if the jurisdiction has nothing to do with the parties or the policy. I favor having the law of the jurisdiction of the insured entity’s U.S. corporate headquarters as the designated law; that is, the law of the place of contract delivery, the law that under standard choice-of-law principles actually should apply.
I also think there could be a useful dialog to consider whether the public company D&O insurance marketplace might usefully be stratified, so that some of the sub-limited coverage extensions that have become standard in recent years need not be offered to the very largest public companies. I agree that it is a reasonable question to ask whether these small, sub-limited coverage extensions make sense in the context of the very largest public companies’ D&O insurance programs, particularly if the removal of these terms actually would translate into meaningful cost savings for the insureds.
By the same token, there are other items on the wish list that that I think should not be on the table at all or by rights should quickly fall by the wayside.
For example, it took a long time to get it right with the after-adjudication trigger for the conduct exclusions. The current standard formulation means that mere allegations of misconduct are not sufficient to preclude coverage, and the final adjudication requirement ensures that insured persons do not lose their coverage when they arguably need it most (say, when appealing from an adverse trial outcome). The current formulation is also consistent with advancement and indemnification requirements in Delaware and other jurisdictions. In my view, the after-adjudication requirement is where it should be and it should not go back on the table. Period.
Similarly, no one who has ever represented policyholder-side interests could ever consider removing the now-standard provisions implementing severability of warranties and of the exclusions. From the perspective of individual directors and officers – the people the insurers have undertaken to protect – these provisions embody basic principles of fairness; that is, that no person should not lose their rights and interests because of the actions of others.
There are a number of “turn back the clock” items on the list that in my view are also better left out of the discussion.
For example, I do not believe that D&O insurers should be able to deny coverage based on late notice in the absence of prejudice; without a prejudice requirement, the notice provision becomes a meaningless “mother may I” provision, in which substantive rights are subordinated to mere ritual. The now-frequent addition of notice prejudice requirements within policies represents a long-overdue change, and trying to turn back the clock on this issue would represent a regression of the first order.
Similarly, I believe insurers have all too convincingly demonstrated in the past that policy exclusions with a “based upon, arising out of” preamble often are applied overbroadly, in ways that lead to preclusion of coverage for the very types of claims for which the insurer purchased coverage. As the Seventh Circuit recently said, exclusions with this preamble language can render coverage “illusory.” Trying to turn the clock back on this issue could seem like a good idea only to someone nostalgic for the “good old days” when insurers regularly applied exclusions overbroadly in order to be able to deny a wide swath of claim that in fact the policy was meant to cover.
Finally, there are items on the list that I think should be up for discussion, just not in the way expressed on the wish list.
For example, I agree we need to revisit the Contract Exclusions and the Professional Liability Exclusions found in most private and non-profit D&O insurance policies, but they should be revisited in order to narrow them so that they preclude coverage only for the claims that rightfully should be excluded, and are not applied to preclude coverage for the very kind of claims for which the policyholder purchased the coverage.
All of that said, I want to thank John and Paul for their effort to launch a dialog. As I suggested at the outset, there should always be room in our industry for reasonable conversation among thoughtful professionals, even with respect to ideas that may be controversial. Even though I believe a number of the items on their list belong in the dustbin, that is not a reason not to have a conversation.
In the end, conversation alone will not resolve the questions that John and Paul have posed. The items on the wish list ultimately can only be tested and addressed in the marketplace. One key consideration will be the relationship between any coverage changes and pricing. Ultimately, the refining fire of competition will determine whether any of the items on the wish list will go anywhere.