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Allocation: Problems and Solutions
Allocation problems arise when part of a claim is covered under a policy and part is not. With directors and officers liability insurance, there are two situations under which allocation may be appropriate. The first are circumstances where there are covered and uncovered parties. The other is where there covered and uncovered claims or allegations.
The first circumstance is peculiar to directors and officers liability insurance. It arises due to the different insured interests of the directors and officers compared with the corporation in regard to the policy. The directors and officers are essentially insured for wrongful acts committed or alleged to have been committed in their capacity as directors and officers. The corporation's insured interest, on the other hand, is much more limited in that it is insured solely for its liabilities arising from its legally required or permissible indemnification of its directors and officers or having legally advanced defense expenses on their behalf. The corporation is not insured, however, for its own liability or the costs of its own defense.
The second aspect of allocation--covered versus uncovered claims and allegations--is not particular to directors and officers liability insurance. For example, if a claims-made policy contains a retroactive date limitation or prior acts exclusion, the insurer may be entitled to allocate a settlement or judgment amount if it can be proven that part of that amount is attributable to wrongdoing which took place prior to the retroactive date. Until recent years, most directors and officers liability policies were silent regarding allocation. Insurers are beginning to treat the allocation issue in various ways.
"Best Efforts" allocation
The first initiative to appear was a policy provision to the effect that both insureds and insurers would use their "best efforts" to reach an allocation as between covered and uncovered amounts under the policy. Some insurers believe that this language heightens the insureds' awareness of potential allocation issues and may even create a presumption that some allocation is appropriate in virtually every directors and officers liability claim.
Alternative dispute resolution allocation
Other directors and officers liability insurers began to introduce policy provisions providing for arbitration and other alternative dispute resolution (ADR) mechanisms to handle allocation disputes while the insurer "advanced" the allocable amount of defense expenses it deemed to be appropriate.
Predetermined allocation
Insurers then attempted to resolve the allocation issue with a formula approach. A predetermined allocation of defense provision was developed--and offered for an additional premium--that would apply to any claim under the directors and officers liability policy in which there was an allocation dispute. Typically, this predetermined defense cost allocation was 80/20. It applied to all claims, including securities fraud and employment disputes. Particularly in a dispute such as an employment matter wherein the corporate employer is generally the target and the more legally exposed defendant, the 80/20 allocation was quite generous.
"Entity Coverage" allocation
Shortly after the development of predetermined allocation, another allocation alternative was introduced in the marketplace. This was the so-called entity coverage alternative which, like predetermined allocation, was limited only to "securities claims."
"Concurrent Liability" allocation
A hybrid approach between entity coverage and predetermined allocation was recently introduced. In this approach, the insurer seeks to exclude from covered loss a certain percentage of any "concurrent liability," defined as "damages, settlements and legal defense expenses incurred jointly by both the corporation and its directors or officers."
Where then is the directors and officers liability policy heading?
Is it appropriate to use a directors and officers liability policy as a vehicle to insure both individual officers and the corporate employer in the context of a sexual harassment or employment claims under Title VII of the Civil Rights Act of 1964?
What will happen in the case of claims from the corporation's suppliers, customers, competitors, and others? The directors and officers liability policy could become a funding mechanism to satisfy a broad array of breach of contract claims, which would ultimately drive directors and officers liability premiums through the roof.
It is clear that the issue of insured party versus noninsured party in the context of a securities claim needs to be resolved. In light of the lack of a practical allocation mechanism arising from the courts, entity coverage makes considerable sense. Of course, this is an enhancement to coverage and should be priced accordingly.
Undoubtedly, we will see many variants of "entity coverage" and "predetermined allocation" in the near future. Other creative approaches are also likely to be tried. Nonetheless, the parties to the process--directors, officers, risk managers, lawyers, brokers and insurers--should all be mindful of the original intent and purpose of directors and officers liability insurance: to afford protection to the individual director and officer. Entity coverage may not the best means to serve that end.
(This article is adapted from a commentary by JOSEPH P. MONTELEONE, J.D. which appeared in the April 1996 issue of THE RISK REPORT. Mr. Monteleone is senior vice president and claims counsel in the New York office of Reliance National and a frequent speaker and author on insurance topics, particularly regarding directors and officers liability.)
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