In a development that has set the D&O insurance industry commentariat abuzz, on January 27, 2022, the Delaware General Assembly passed Senate Bill No. 203, which amends the Delaware General Corporation Law (DGCL) to permit Delaware corporations to put captive insurance in place as an alternative to traditional D&O insurance. The legislation awaits the signature of Delaware Governor John Carney, who reportedly has already said he will sign it. As discussed below, the legislation has several interesting features, but the more interesting question is what the practical impact of the legislation will be.
Section 145(g) of the DGCL has long permitted Delaware corporations to purchase D&O insurance protecting directors, officers, and other indemnified persons “against any liability asserted against such person … whether or not the corporation would have the power to indemnify such person against such liability.” These provisions have been understood to permit companies to buy traditional D&O insurance including Side A protection for non-indemnifiable loss.
As readers of this blog well know, in recent months, the D&O Insurance industry has been in a so-called “hard market,” characterized by rising prices, increased self-insured retentions, and reduced capacity. In light of the increased costs, many buyers have elected to purchase less insurance than they have in the past. As companies and their advisors considered alternatives, questions have arisen whether companies may use of alternative risk transfer mechanisms such as captives. One specific question with respect to these alternatives is whether a captive insurer could, as is the case with respect to traditional D&O insurance, provide insurance protection for liabilities that cannot be indemnified by the corporation itself.
Senate Bill No. 203
The Senate Bill passed by the General Assembly amends the DGCL’s provisions relating to indemnification and insurance to provide clarification with respect to Delaware corporation’s use of captives to provide insurance for D&O liability. The Bill, which was proposed by the Delaware Bar Association’s Corporate Law Council, received expedited consideration.
The main purpose of the Bill is to authorize Delaware corporations to use captive insurance, which is described in the synopsis accompanying the Bill as insurance provided by or through a wholly-owned subsidiary funded by the corporation, to protect their directors and officers and other indemnifiable persons from liability. The Bill also clarifies that a Delaware corporation’s establishment or maintenance of a captive insurance company does not subject the corporation to the provisions of the Delaware Insurance Code.
Notably, the Bill specifies that the captive insurer need not be organized under the laws of Delaware; the Bill states that the captive insurance company will be “organized and licensed in compliance with the laws of any jurisdiction.”
The synopsis to the Bill also clarifies that, like third-party insurance, the captive insurer may indemnify indemnifiable persons “whether or not the corporation would have the power to indemnify them under Section 145.”
The synopsis to the Bill also states that, notwithstanding the required exclusions (described below), the Bill’s amendments provide that “directors may be covered under a captive insurance policy for certain liabilities that are not exculpable under Section 102(b)(7), including non-exculpated liability stemming from so-called Caremark or oversight claims where this is not otherwise a finding that the directors knowingly caused the corporation to violate the law.”
However, the Bill also includes several limitations on the use of captive insurance. Section 145(g)(1) specifies that the captive insurance must contain several exclusions mirroring equivalent provisions in third-party D&O insurance policies.
Thus, the policies must provide that the insurer may not make any payment in respect of loss arising out of, based upon or attributable: (1) any personal profit to which the covered person was not legally entitled; (2) any deliberate criminal or deliberate fraudulent act; and (3) any knowing violation of law.
These exclusions are subject to a requirement that the preclusions would apply only if it is established after a final adjudication in a separate proceeding that the prescribed conduct has occurred. The amendments further specify that, for purposes of determining the application of these exclusions, the conduct of an insured person shall not be imputed to any other insured person. The statutorily required exclusions seem to represent minimum provisions; the corporation apparently has discretion to include additional limitations or exclusions.
In addition to the required exclusionary provisions, the Bill also specifies certain procedural requirements. Section 145(g)(2) provides that any determination to make payment under a captive insurance policy must be made either by an independent claims administrator or in accordance with Section 145(d) (that is, by a majority of directors not party to the proceeding; a committee of directors of the independent directors direct; independent counsel; or the stockholders).
Finally, while a corporation may implement a captive insurance policy without notice to the shareholders, before any payment under the captive policy may be made in connection with the dismissal or compromise of a suit brought by or in the right of the corporation as to which shareholder notice is required, the corporation must include in the notice that a payment is proposed to be made under the captive policy.
Shortly after the Bill’s passage, my email mailbox was filled with notes asking me what I thought of the Bill and what I thought the impact would be. I am frankly hamstrung in my ability to respond to these messages by the limitations of my knowledge about captive insurance generally. I have set out some comments below, but the limitations of my knowledge about captive insurance must be kept in mind; others know more about captives than I do, and so my comments below should be considered for whatever they may be worth (which may be very little).
The fact that this Bill was prepared and considered at the initiative of the Delaware Bar Association’s Corporate Law Council suggests that there was a perception that the Association’s clients need or were perhaps even clamoring for this type of legislative relief. However, I am skeptical that captive insurance will be an attractive alternative for may insurance buyers. Time will of course tell, but my perception that past efforts to organize a captive solution for D&O insurance have not really gotten anywhere (to be sure, the prior efforts may have faltered for the very concern about using captives to insure non-indemnifiable loss that this bill addresses). I also have a perception that single-company captives have not always proven cost-effective for liability coverages, although this perception admittedly is based on limited experience.
I also have more practical questions about how any given company might implement captive insurance. It is easier for me to envision a company structuring all of its D&O insurance through a captive, since trying to fund only one layer within a program of otherwise conventional third-party insurance could create all sorts of complications. By the same token, however, it is hard for me to envision many public companies being willing to grapple with the funding complications that would go with trying to ensure their entire D&O insurance program through a captive (although, again, this concern could be a reflection of my limited experience).
One industry observer dropped me a message noting the challenges that can arise ensuring that the insurance captive is protected in the context of the bankruptcy of the corporate parent (that is, the very context when the insurance may be needed most). The bankruptcy context could also create challenges for claims funding decisions for captives that are not fully funded. There concerns may be the kinds of things that persons more knowledgeable about captives may be well-positioned to address, but I note these questions simply to underscore that there may be a lot of complexity involved, and for good reason.
The big question here is whether we are about to see a stampede of buyers seeking to put captive solutions in place for their D&O insurance program. The only honest answer I can give is, I don’t know. I will say that if the big deal here is the clarification that Delaware corporations can institute captives to insure against non-indemnifiable loss, the possibility of putting captive insurance in place to insure non-indemnifiable loss will have to be compared to the alternatives available in the traditional marketplace to insure non-indemnifiable loss. The Side A policies currently commercially available are quite broad, potentially in some circumstances broader than the coverage available with the minimum required exclusions under the Delaware provisions. But to the extent I can see insurance buyers seeking a captive solution, it is easiest for me to envision with respect to Excess Side A insurance, especially given the specifics of the amendments to the Delaware insurance and indemnification provisions.
Again, this may simply be a reflection of my relative lack of experience with captives, but I am skeptical that captive insurance is going to be a good D&O insurance solution for may insurance buyers. It will work best, I think for very large companies with ample supplies of cash. It may or may not be an attractive solution for other buyers.
I encourage readers to please let me know using this site’s comment feature what they think, in particular if they think I am wrong about the feasibility of captive insurance as a D&O solution for most buyers.
For a good summary of the Delaware legislation, please refer to the January 28, 2022 memo from the Richards, Layton & Finger law firm, here. UCLA Law Professor Stephen Bainbridge has an interesting take on the legislation on his ProfessorBainbridge.com blog, here.
Special thanks to the several readers who send me notes about the Delaware legislation.