New D&O Offerings Provide Better Protection

There’s a change taking place in the market for Directors and Officers (D&O) liability insurance. Since the demise of Enron and WorldCom, there has been increasing interest in the purchase of D&O insurance for the sole benefit of a company’s directors and officers. These mammoth bankruptcies highlighted the danger that a bankruptcy court might refuse to allow directors and officers to access D&O policies that also provide coverage to the company. It was argued that the only sure solution was to limit the beneficiaries of the policies to the directors and officers.

The Bermuda insurance market initially set the pricing curve for these new policies, creating a product known by the cumbersome name, Excess Side-A Difference-in-Conditions (Side-A DIC) policy.

These Side-A DIC policies not only protect directors and officers from bankruptcy courts, they are also designed to fill insurance coverage gaps created when an underlying insurer becomes insolvent, rescinds its policy, or refuses to cover a director or officer. The Bermuda Side-A DIC policies also tend to apply when a director’s or officer’s company wrongfully refused to indemnify the director or officer.

Until recently, Bermuda insurers have maintained a large share of the Side-A DIC D&O market. Initial forays by domestic insurers into this business could well be described as half-hearted. They have offered Side-A DIC policies, but often on terms much less favorable than their Bermuda counterparts.

However, some new products from U.S.-based insurers not only rival the Bermuda competition, they surpass them in many ways. A product from AIG called “Executive Shield” provides coverage for buyers looking for a U.S.-based product.

As a policy holder-side insurance coverage lawyer, I am keenly aware that not all insurance policies pay when they should pay. From a director’s or officer’s standpoint, what is important is having the best coverage terms available. The director or officer then deals from a position of strength in claims negotiations with its insurer. If litigation becomes necessary, the odds of winning are increased. The benefits of AIG’s new policy over its Bermuda rivals are apparent in this regard.

First and foremost, unlike Bermuda competitors, AIG’s Executive Shield does not require directors and officers to arbitrate their insurance coverage dispute in a less than hospitable forum, under less than favorable law, and without the normal advantage of ambiguities being construed in their favor. Bermuda policies have arbitration provisions requiring arbitration outside the United States. Those same arbitration provisions often require less-than-favorable English or New York insurance coverage law to be applied to the dispute. Importantly, in Bermuda arbitrations, the loser is often required to pay the winner’s attorney’s fees–-a daunting drawback for an individual deciding whether to sue an insurance company. AIG’s new Executive Shield allows directors and officers to sue under normal rules of play in United States courts.

Second, Bermuda D&O policies typically can be read to allow the insurer to re-litigate whether a director or officer committed fraud. AIG’s product follows the more traditional approach. If the director or officer settles the underlying securities fraud or derivative claim, the insurer cannot raise the fraud and illegal benefit exclusions as a defense to coverage.

Finally, AIG’s Executive Shield contains no insured vs. insured exclusion–-a dangerous exclusion contained in most other D&O insurance policies, including Bermuda Side-A DIC policies. The insured vs. insured exclusion has been argued to bar coverage when new management has the company sue its former management or board or when a member of management assists securities fraud or derivative plaintiffs’ by giving testimony or serving as a confidential informant.

Timothy W. Burns is an attorney in the insurance Recovery Practice Group at Heller Ehrman in Madison, Wisc.