Allocation Clauses in D & O Policies: One Reason that you Might Need a Insurance Attorney When your Company and or Board of Directors Have Been Sued.

Watch Out for The Allocation Clause in Your D & O Policy

Insurer Tactic for Reducing D & O Policy Payouts

Directors and Officers (D & O) liability insurance forms an important part of a company’s insurance portfolio, providing coverage for directors or officers, reimbursement for the company for indemnification payments made to directors and officers and sometimes direct protection for the corporate entity itself. It also helps attract and retain top talent by attempting to protect high ranking executives and directors from liability associated with high-stakes decisions.

Insurance companies issuing directors and officers liability policies often use a paragraph buried in the policy to attempt to cut their liability for defense costs and settlement or verdicts. Here is an example of how this might happen:  your company and members of your board of directors have been sued for a business deal gone wrong or for some other alleged corporate malfeasance. You file the claim with your insurance broker who forwards it on to your directors and officers liability carrier who picks up the defense. Things seem to be well in hand until you get a letter from the directors and officers liability adjuster saying that under the policy you will be responsible for over half of the defense cost and any settlement. How could this happen and what can you do about it? It may be time to hire an insurance attorney.

The Allocation Clause

Directors and Officers policies often contain allocation clauses. Allocation clauses allow the insurance company to pay only for settlement amounts or defense costs for covered claims or individuals and not pay for defense costs or settlement amounts for uncovered claims or individuals. These clauses can differ and some of them allow for full payment of defense costs but allocation of settlement costs. Here is an example of an allocation clause:

If, in any Claim under a liability Coverage Part, the Insureds who are afforded coverage for such Claim incur an amount consisting of both Loss that is covered by this Policy and also loss that is not covered by this Policy because such Claim includes both covered and uncovered matters or covered and uncovered parties, then coverage shall apply as follows:

1. Defense Costs: one hundred percent (100%) of reasonable and necessary Defense Costs incurred by such Insured from such Claim will be considered covered Loss; and

2. loss other than Defense Costs: all remaining loss incurred by such Insured from such Claim will be allocated between covered Loss and uncovered loss based upon the relative legal exposures of the parties to such matters.

Note that the wording of this clause does not allow allocation of defense costs, but does allow allocation of indemnification costs (settlement or verdict amounts).

Why Do Allocation Disputes Arise?

Allocation issues frequently arise in D & O policies because suits often allege both covered claims and uncovered claims and because many D & O policies do not contain coverage for the business entity, but the lawsuit will name both the company and directors. When this happens, the insurance company often will argue for an allocation that seeks to contribute as little as possible. As a result, when you do have an insurance claim implicates your D & O policy, it can be important to get an insurance lawyer involved as soon as possible. An insurance attorney can maximize the amount of insurance dollars that go toward defending your company and settling the case and minimize the money taken away from your business operations.

How Will A Court Decide?

When these allocation debates make it into court, courts may apply a couple of different concepts, the relative exposure rule or the larger settlement rule. These are not opposites and do not necessarily conflict. Under the relative exposure rule, the court allocates percentages of fault or liability to the various claims or parties and then divides costs among them. The court then subtracts the appropriate non-covered percentage from the amount owed by the insurer. This approach creates problems when liability is difficult to apportion between different claims.

However, under the larger settlement rule, when a settlement or verdict results from claims against covered and uncovered parties (for instance claims against officers, directors and the company), courts will allocate monies to non-covered defendants only if the acts of the non-covered defendant increased the size of the settlement or award. The reason for this rule is that often in the  D & O context, the company is being based on the actions of the individual defendants and would only be liable if they were liable.  The rule would apply whenever the non-covered defendant’s liability was based on the actions of the covered defendants. As a result, when this is the case, there should be no reduction of the amount paid by the insurance company. However, if the non-covered defendant did have liability independent of the covered defendants and this liability increased the size of the settlement or verdict, then the court would not require the insurer to pay this additional amount.

If you are a defendant in a suit involving D & O insurance and want to make sure that you maximize the policy benefits available to you, Contact Us now.