Directors' & Officers' Liability Insurance: The Issue of "Non-Indemnifiable Loss"
By Donna Ferrara (2004)
For anyone who has been living on a desert island, there is a crisis in Directors' & Officers' Liability Insurance ("D&O")[i].' It was a long time coming. One carrier's website reports dismally that in 2001, rates had dropped to half of their level in 1996, while D&Oexposure had grown by one thousand percent[ii]. After ten years of increasing claims frequency and severity, resulting in dismal profitability, D&O insurers decided to raise prices and narrow coverage.
In an effort to return sagging lines of coverage to profitability, carriers have raised premium levels considerably, a fact that no insurance professional has missed. In addition, insurers arelimiting coverage. Certain policy amendments, such as the elimination of entity coverage and the imposition of co-insurance are obvious. Others, such as the use of "Non-Indemnifiable Loss" in conjunction with presumptive indemnification, are less so.
II. WHAT EXACTLY IS A "NON-INDEMNIFIABLE LOSS"?
A number of policy forms use the term non-indemnifiable loss, either to set a trigger of coverageor to define its scope. The term is most often defined as any loss that is not indemnifiable. "Indemnifiable" is defined as "[l]oss for which an Organization has indemnified or is permitted or required to indemnify an Insured Person pursuant to law or contract or the charter, bylaws, operating agreement or similar documents of an Organization."[iii]
To this point, the language is similar to thatfound in D&O policies for years. The section continues as follows:
For the purposes of determining whether Loss constitutes Indemnifiable Loss, the Organizations shall be conclusively deemed to have indemnified the Insured Persons to the to the maximum extent that an Organization is permitted or required to provide such indemnification pursuant to law, common or statutory, or contract or by thecharter, bylaws, operating agreement or similar documents of an Organization, which are hereby deemed to incorporate, for the purposes of this policy, the broadest provisions of the law which determines or defines such rights of indemnity.
The Organization hereby agrees to indemnify the Insured Persons to the fullest extent permitted by law, including the making in good faith of any requiredapplication for court approval[iv].
First, the term "non-indemnifiable" is not a statutory term. It has been used by some courts, though not in the same context as insurers have defined it. Whenever a term has a meaning in one arena that does not comport with its definition in another, there is potential for grave misunderstanding[v].
Second, while the concept of insuring loss thathas not been indemnified by the corporation is not new to D&O, the foregoing wording provides that regardless of whether a director[vi] actually has been indemnified, the insurer will presume that he or she has been[vii].
The third leg on the stool is the use of differential retentions: Claims that are "non-indemnifiable" - and therefore will be paid by individuals rather than corporations - willoften be subject to a lower retention than others, on the theory that an individual will be less able to absorb a larger share of the risk.
Over the past two or three years, retention levels of more than a million dollars have become common. For a director facing years of protracted litigation, this presents a grim picture.
In sum, to trigger coverage, the loss in question must fall under one ofthe following exceptions:
• It must not be indemnified already, so there is no chance of double payment; or,
• It must be something that the corporation cannot indemnify, even if the corporation has asked a court's permission to do so.
This returns us to the first question: What exactly is a loss that the corporation cannot indemnify?
If one asks a number of D&O underwriters to give...
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