Coverage confusion can mean disas – Liability
Steven J. Gladstone
A common perception among insureds and attorneys is that insurance companies often try to find ways to deny claims. Here’s a look at why claims may be denied–and what can be done to prevent claims from being denied in the first place.
Not too long ago a senior partner of a law firm called to discuss a claim made against his client, an officer of a company. After chatting about the underlying facts, the merits of the claim and his defense strategy, the conversation turned to the coverage under his client’s directors’ and officers’ insurance policy. Offhandedly, the attorney remarked “I assume like all insurers you will find a way to deny coverage for this one.” By way of his comment, he let it be known he either had not bothered to read the policy, he had read the policy but did not understand it or in the past he had some very bad experiences with insurance carriers. Probably the most surprising or, depending on how you look at it, disappointing aspect of his comment is the frequency insurers have heard the same or a similar lament.
Further complicating matters is the fact that in the last few months we seem to be learning on almost a weekly basis of some new corporate calamity. Sometimes it is a whole industry segment seemingly imploding overnight, or the latest corporate celebrity caught in the middle of some kind of corporate misconduct, or just another company accused of misstating its earnings. With today’s fickle financial markets, heightened governmental scrutiny and D&O claims becoming more serious and costly, it is increasingly important to have a clear understanding of the operation of the directors’ and officers’ insurance policy. Moreover, as the D&O product has become more costly and valuable, it is exceedingly important for insureds to maximize the coverage they purchased.
This article will briefly examine some of the most commonly made errors, misunderstandings, or mishaps that may lead to the limiting or precluding of coverage under the policy.
Nature of the Coverage
With few exceptions directors’ and officers’ insurance policies are underwritten on a “claims made” policy form providing coverage for claims made during the policy period. While in a broad sense, all D&O policies operate pretty much the same way, upon closer examination there are some substantive distinctions among the numerous policies available in the marketplace.
The definition of “claim” in a D&O policy in a number of instances materially varies from policy to policy. There are some D&O policies that limit the definition of a claim to a civil proceeding brought in a court of law, Other D&O policies take a more expansive approach and include written demands within the definition of claim. Still other policies include criminal proceedings within the definition of claim. There have also been policies that didn’t bother to define a claim. A court may not look too kindly on an insurer who attempts to use the lack of a definition of claim as a defense to coverage under the policy.
An insured who doesn’t have a clear understanding of the definition of claim in the policy may be walking a potentially dangerous path. For example, an employee of a company is terminated from his job one year prior to the inception of the D&O policy. Subsequently, during the policy period, the former employee files suit against the officer who terminated him. Would that claim be covered under the D&O policy? That will depend on a number of factors including the policy language and what if anything occurred prior to the inception of the policy. If, for instance, the definition of claim within the policy includes a written demand and the terminated employee prior to the inception of the policy wrote a letter to the company threatening suit, it is possible the written demand would constitute a claim under the policy. The D&O insurer might justifiably contend a claim was made prior to the inception of the current policy and the D&O policy preceding the existing policy is the rightful owner of the claim.
Noticing the Claim
Furnishing timely, complete, and comprehensive notice to the insurer at the time a claim is made and then regularly communicating with the insurer thereafter serves more than a few purposes. First, it will help fulfill the policy notice obligations. Second, once the insurer is on notice of a claim, the insurer will begin its investigation so that it will be in a position to carry out its responsibilities under the policy. Third, notice to the insurer is the first and almost certainly one of the most important steps in opening up a line of communication between the insurer and the insured. This is especially important when a claim reaches a critical stage and the insured is looking to the insurer to respond promptly to the needs of the insured.
Just as with the definition of claim, the language in D&O policies concerning notice is not always the same. Some D&O policies call for the claim to be reported “as soon as practicable” after it is made. Other policies state the claim must be reported as soon as practicable but no later than a set number of days after the claim is made. Still other policies require the claim to be reported during the policy period. The last iteration may be burdensome if a claim is made on the second to last day of the policy period and it is served on someone who has no idea that it must be reported to the D&O insurer before the policy expiration date.
Language in the policy calling for the claim to be reported as soon as practical can turn out to be problematic as well. A claim, for example, is made on a Monday against an insured. On the following Wednesday, the company decides the best way to resolve the claim is to immediately enter into settlement discussions with the claimant. On Thursday, the parties agree to a settlement. On Friday, the claim and news of the settlement is reported to the insurer. Although the claim has ostensibly been reported to the insurer within a very short period of time, under the circumstances the insurer may think differently.
Even after the claim is timely reported, it is important to keep the insurer up to speed on the status. Insurers and insureds for the most part do not appreciate being surprised. An ongoing and open line of communication will minimize the chance of either party being caught off guard. A few years ago, a small bank reported a claim concerning a bank teller who had filed a gender discrimination suit against the bank and a bank officer alleging she had been wrongfully passed over for a promotion. After reporting the claim to the D&O insurer and retaining counsel to defend the claim, the insurer and the insured agreed that as the policy did not provide coverage for the entity, they would split defense costs 50/50. Defense counsel was of the opinion that after a minimal amount of time was spent “softening up” the plaintiff, the case would easily go away for $25,000 or less. Though the insurer had asked and defense counsel agreed to keep the insurer apprised of the progress of the suit, defense counsel never bother ed to follow up with the insurer. Two years later on the eve of trial, counsel for the insured called the insurer suggesting this might be the right time to settle the litigation. Shortly thereafter the litigation was settled for $75,000. Unbeknownst to the insurer or the insured, defense counsel had decided early on this would be an excellent case to train one of the firms’ young attorneys. The firm proceeded to rack up $275,000 in defense costs. While reviewing the bills, it became apparent that although the young attorney was extremely hardworking, he was inexperienced and not very efficient. After much discussion between the law firm, the insurer and the insured, the law firm agreed to absorb more than $80,000 of unrelated and unsubstantiated costs and expenses.
Nearly all D&O policies treat defense costs as a part of loss that will erode the policy’s limit of liability. Defense counsel who does more work than is reasonably necessary may potentially put his or her client in peril if the policy proceeds that should have been available for a settlement or judgment were spent elsewhere. The insurer and the insured have a mutuality of interest due to the eroding nature of the insurance coverage to ensure the money is spent in an efficient and cost-effective manner.
Defending the Claim
D&O policies sold to large or publicly held companies typically allow for the insured to select their own counsel subject to the consent of the insurer. If the insurer does not consent to the insureds’ selection of defense counsel, it is usually as a result of defense counsel who lacks the requisite experience or expertise, or there is a conflict or potential conflict of interest that may compel counsel to withdraw from the defense of the case at some point in the future.
In one case where a company and its directors and officers were alleged to have committed securities fraud, one of the officers chose an attorney who admitted he had never defended a securities case and had limited his practice for the last 20 years to the field of personal injury law. The attorney went onto request the insurer advance him $100,000 so he could purchase office equipment and hire an associate who could teach him the intricacies of securities law. In addition to boosting his chances of being found to have violated the securities laws, the officer also heightened the possibility that a finding of securities fraud might negate coverage under the policy. After further discussion, the insured elected to retain counsel experienced in securities litigation.
Allocation of Loss
As those who have participated in a dialogue regarding allocating loss between covered and uncovered matters can attest, determining the appropriate portion of loss is not always trouble-free and can easily turn into a contentious issue. Allocation-of-loss issues arise when a claim involves covered and uncovered parties or covered and uncovered claims. It is understandable the insured and the insurer may have different views of what is a reasonable allocation of loss. What is not covered by the D&O policy must be absorbed by some other source, most likely the insured.
In the past, allocation disputes arose because there was a belief the policy did not always provide specific enough guidance as to how to allocate loss for a particular claim situation. In an effort to remedy this dilemma, D&O insurers included specific allocation language in the policy.
While the addition of this language goes a long way toward solving the uncertainty associated with reaching an appropriate and fair allocation of loss, there is always the chance there will be circumstances, facts or events that are not easily resolved.
Too many times the allocation dispute between the insurer and the insured appears to take precedence over the underlying claim and as a consequence both parties waste valuable time and resources. The best advice when negotiating an apportionment of loss is each party needs to bring a reasonable and realistic expectation to the bargaining table.
In one memorable case, an officer of a company thought he had found a foolproof method around the company having to pay its agreed upon share of the loss. The officer instructed the law firm retained to defend the directors and officers to do all of the defense work on behalf of the directors and officers and the company but delete any mention of representing the company on the defense bills sent to the insurer. The only hitch with this strategy was the firm representing the company had been sending its bills to the insurer. It soon became apparent one firm was doing a lot more work than the other firm. After being presented with the evidence, the insured agreed to move forward with a more reasonable and fairer approach to allocating loss.
History tells us much of the litigation involving directors and officers of corporations has settled prior to trial. Knowing when it is the right time to settle a case depends on a number of factors. After counsel for the insured has finished their investigation of the underlying facts and started to prepare a defense, it is sensible for the insured to sit down with the insurer to discuss the insured’s strategy for defending the litigation. It is important to bear in mind most if not all D&O policies require the consent of the insurer prior to the actual settlement of the claim.
The rationale is straightforward. If the settlement of the claim is going to implicate the insurance policy proceeds it is only fair for the insurer to be kept fully informed of all material goings-on in the claim. As the potential for settlement increases the insured should make extra effort to keep the insurer completely up to speed on the status and their analysis of the case. By being proactive in this way it should help decrease the potential for the insurer to have reason to question or object to the insureds’ decisions with respect to how the claim is managed.
While there may be common threads running through just about every claim situation, first impressions can be deceiving. What may appear to be typical and similar from one claim to another may not be the case. D&O policies can be vastly different from insurer to insurer and even if it is the same insurer, coverage enhancements can dramatically affect how the claim will be dealt with. It is critical for the insured to work with a broker or agent knowledgeable about the D&O policy and the marketplace in order to ensure they purchase a comprehensive insurance product tailored to their particular needs. This is of vital importance now that we are experiencing an increase in severity of D&O claims and the D&O policy is fast becoming more expensive and restrictive in nature.
Secondly, the best insurance product won’t be of great value if there is not a clear understanding of what the product can and cannot do. Third, each party must approach the claim with a realistic and pragmatic mindset. In most instances unrealistic expectations will not be fulfilled and at least one party to the contract will leave disappointed.
As a final point, maintaining an open line of communication will reduce the possibility of misunderstandings leading to coverage disputes.
Steven J. Gladstone is the senior vice president of claims for Executive Liability Underwriters (ELU), based in Hartford, Conn. ELU is a U.S. -based division of XL Capital Ltd., the Bermuda-based financial services firm. He can reached via e-mail at SGladstone@XLELU.com. The views expressed in this article are those of the author only and do not necessarily reflect the views of Executive Liability Underwriters or the XL Capital Group of Companies.
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