What to Ask About Your D&O Policy

The board must determine whether the company’s D&O policy was negotiated to provide the broadest coverage at the best price, since the policy is subject to negotiation. More specifically, the board should at least ask the following:

1. Does it protect board members from having to pay the policy’s retention if the company fails to do so?
2. Does it have broad definitions of key terms such as “claim,” “loss,” and “wrongful act?”
3. Does it minimize the effect of exclusions such as “bad conduct,” “prior notice,” and “insured v. insured” exclusions, which reduce or eliminate coverage?
4. Does it maximize coverage for board members even if the company goes bankrupt?
5. Does it have unfavorable alternative dispute resolution clauses?

In a nutshell, ask if the policy limits match both your risks and your peers’ insurance coverage. Has a D&O insurance broker experienced with banks reviewed the policy and advised on the important limitations and exclusions in the policy and has experienced counsel done the same with both the broker and the board? Is the policy a duty to defend policy? (i.e. Who gets to select counsel to defend the directors and officers?) Because D&O insurance is a backstop for your corporate indemnification, is the company’s indemnification provision as broad as possible? Of particular note for any bank in dire capital position and, thus, a candidate for failure, does the policy contain a “regulatory exclusion” andor an “insured versus insured” exclusion that might exclude coverage for claims brought by the Federal Deposit Insurance Corp. (FDIC), as receiver of the bank?

Boards should be particularly focused on the coverage exclusions. For example, D&O policies have traditionally excluded coverage for securities fraud judgments, and ordinarily those exclusions will also provide for recoupment of the carrier’s prior payments of defense costs if there’s ultimately a finding that the carrier is not liable. More recently, we have seen policies that exclude securities claims altogether (as distinguished from final judgments), which may permit the carrier to avoid paying defense costs prior to a final judgment. Because of the extraordinarily high defense costs often associated with securities claims, the resulting burden can impose serious hardship on individual directors and executive officers, and even on the company (which usually will be required to indemnify the directors and officers until the entry of an adverse judgment). Regulatory actions are also increasingly excluded from policies, although in addition to policy limitations, directors and executives should be aware of laws that impose strict substantive and procedural requirements for indemnity and advancement of expenses for enforcement actions and resulting liabilities. Lastly, many of the more reputable insurance carriers—but not necessarily all of the best-known ones—will advance defense costs subject to what’s known as a “reservation of rights,” which allows the carrier to recoup prior advances if, ultimately, there’s a determination that the liability was not covered.

The key questions for the board to ask are:

1. What acts are excluded from coverage?
2. Does coverage terminate on a change of control?
3. What are limits for “tail” coverage or can you even buy it in the event of policy change or change in control?
4. Do we have side A and B coverage?
5. When and for what reasons can the insurer terminate coverage?

Directors should have the answers to the following questions about the company’s D&O policy:

1. What are the current limits of liability, and are they sufficient to cover legal fees, judgments and settlements, given current standards for each?
2. Are regulatory enforcement actions, civil money penalty assessments and securities litigation covered, or are there exclusions that impact these kinds of claims?
3. How long has the policy been in place and what is the experience with the company on claims that have been made?
4. What are the claims notification requirements of the policy?
5. How does the policy dovetail with indemnification to directors and officers provided by the company in its bylaws so that there will not be gaps?
6. How do the D&O policies work with regard to service on the board of the parent, one or more subsidiaries, or both?

The D&O insurance world has changed since the financial crisis. Among many questions, directors should ask:

1. What “wrongful acts” does the policy cover? Some carriers contend if there’s an adverse judgment for anything other than negligence, there’s no coverage.
2. Are policy limits sufficient? Defense costs can consume limits.
3. Is there a regulatory exclusion? Avoid this if possible.
4. Is there protection for securities claims and cyber liability?
5. Should our bank buy the extended reporting period under an expiring policy? Probably so, if you are changing carriers or the current carrier is issuing a narrower policy.