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Article | FINEX Observer

COVID-19 and executive risk: how can D&O coverage help in this pandemic?

Risk & Analytics|Financial, Executive and Professional Risks (FINEX)
COVID 19 Coronavirus

By John M. Orr , Rob Yellen and Angus Duncan | May 5, 2020

In the context of the COVID-19 pandemic, we discuss D&O insurance topics including claims, policy language considerations and emerging changes in D&O underwriting behavior.

Organizations around the world have been dealing with a myriad of COVID-19-related issues and resulting financial and operational hardships. Risks associated with directors and officers (D&O) liability are among the many risks that are top of mind. In the context of this pandemic, the risks may include:

  • The adequacy and accuracy of disclosures in a financial/business environment with so much in flux, including many businesses trying to cope with shutdowns and other unprecedented pressures.
  • Fiduciary and other duties owed. Changes are occurring quickly and there is no real precedent for many of today’s tough decisions.
  • Complications and challenges in balancing the needs and priorities of today’s diverse and complex interests among key stakeholders.
  • Regulatory and compliance uncertainty in facing unparalleled events and responses by authorities.
  • Workforce and operational adjustments bring new, potentially unanticipated risks.
  • Legal, financial and other external advisors may be overtaxed or unavailable as many others are wrestling with COVID-19 related issues.
  • Reputation risk arising from perceptions, well-founded or not, of how management has responded to the pandemic.

Below, we address D&O insurance coverage issues and questions, including how we would anticipate a foreseeable D&O claim to be addressed, coverage and policy language considerations, and emerging changes in D&O underwriting behaviour.

Do COVID-19 D&O claims fall within policy insuring agreements?

Insuring clauses in both public company and private company D&O policies typically have broad triggers. The coverages are segregated into three distinct insuring clauses: coverage for non-indemnified D&O loss (Side A), indemnified D&O loss (Side B), and entity coverage in respect of securities claims (Side C). All three clauses customarily cover “loss” in respect of “claims” against an “insured” in connection with a “wrongful act.”

Applying the traditional definitions of these terms, there are foreseeable COVID-19 D&O claims which would fall within the insuring agreements, thus being potentially covered and subject to the policy’s remaining terms and limitations. Importantly, entity coverage would not be available to a public company for negligence-based claims that are unrelated to the purchase or sale of company securities, as public company entity coverage is almost always exclusive to “securities claims.” As an example, a COVID-19-related securities claim may involve a shareholder class action alleging violations of securities laws relating to the adequacy of COVID-19 risk disclosures. As of this writing, two such actions have been filed.

The policy may also extend to cover costs associated with certain regulatory, judicial or government investigations and inquiries. Wording varies from company to company and product to product.

To be clear, D&O wording is not likely to speak to specific risks associated with COVID-19. Nevertheless, most policies will respond well to traditional D&O perils, even those triggered by COVID-19 events. This “silent COVID-19” coverage is “silent” because it does not expressly address pandemic perils, but it may nevertheless respond to them.

Beware of coverage limitations potentially being applied in unexpected ways

  • Bodily injury exclusion: Generally, there are two types of bodily injury exclusions. The first excludes losses “for” bodily injury, sickness, disease, etc. – i.e., direct losses, such as medical expenses. To the extent a COVID-19 claim seeks damages for indirect financial losses, we do not anticipate the bodily injury exclusion to be a coverage impediment. A second, broader variation of the exclusion, often found in the policies of healthcare and life sciences companies, and companies engaged in more hazardous operations, precludes coverage for claims “based upon, arising out of” a bodily injury. Exceptions to the exclusion for Side A losses and securities claims may be available.
  • Pollution exclusion: Pollution exclusions preclude coverage for claims “for” or, alternatively, “based upon, arising out of,” the release or dispersal of pollutants, including specified contaminants, some of which may have a bearing on COVID-19 claims. Examples may include “germs,” “viruses,” and “biological irritants.” Exceptions to the exclusion may be available for Side A losses and securities claims.
  • Conduct exclusion: The exclusion for fraudulent or dishonest acts may trigger upon a final, non-appealable adjudication of such conduct. In light of the high hurdles of intentionality and adjudication, we would not envision the exclusion to apply in most COVID-19 cases.
  • Professional services (E&O) exclusion: Similar to a bodily injury exclusion, should an E&O exclusion appear in a policy, it is likely to exclude loss “for” or “based upon, arising out of” acts or omissions in the rendering or failure to render professional services. The “based upon” wording may have more impact in COVID-19 cases for companies in affected industries, such as healthcare and life sciences. Exceptions for Side A losses and securities claims may be available.
  • Other insurance: Should claims trigger coverage under the D&O policy, they may also implicate additional coverage lines, such as general liability or environmental. How each policy responds, whether as primary, excess, or via a shared arrangement, will depend on the specifics of the claim and the additional policies’ respective other insurance wordings.

Coverage considerations for private companies

Although public and private companies’ policies have similar structures and share common terms, there are differences that may be material in a COVID-19 claim. For example, private company D&O insurance often forms part of a sectional product which may also include broader entity coverage (corporate legal liability). Thus, claims against a private company relating to COVID-19 risk mitigation, preparedness, response measures, among others, may be covered (subject to other policy terms and conditions). In contrast, the public company’s entity coverage is implicated only in securities claims.

In addition, with broader entity protection, private company policies will customarily have more exclusions unique to the company’s Side C coverage. Examples include: contractual liability exclusions, which in the context of COVID-19, may be relevant to alleged failures to fulfil contractual obligations due to disruptions in travel, product or services sourcing, and logistics; and employment practices exclusions, which may apply to claims relating to layoffs or other corporate actions impacting employees.

Insolvency considerations and D&O coverage

With a potential global recession on the horizon, cascading bankruptcies could well disrupt whole industries or economies. Previously well-performing businesses may find themselves confronted with mandated closures, seemingly insurmountable workforce challenges, and cash management concerns. This brings with it, amongst many other potential issues for directors and officers, the potential spectre of personal liability for trading whilst insolvent (“wrongful trading”). Several governments around the world have recognised this challenge and have brought in measures to temporarily relieve or are planning to relieve directors of personal liability for wrongful trading. These include the UK, Australia, Germany and Singapore. Nonetheless, these measures, while welcome, do not relieve directors and officers of the many other pressures which potential insolvency can raise. Not least, the advancement and indemnification protections executives typically rely on to protect themselves may not be available when they need them most. D&O coverage may be the only protection they can count on. As expense pressures grow, D&O coverage is not a place to look to cut costs. It has never been more important.

With this in mind, companies should turn their attention to policy provisions that have the potential to come into play in these situations.

  • Side A: Coverage for non-indemnifiable D&O losses could be impacted to the extent insolvency law restrictions may curtail the company’s ability to advance or indemnify losses. Side A is a critical, last-line-of-defense coverage that should be a part of every enterprise’s D&O risk management plan. It should be considered a D&O coverage tool that can yield dramatically different results depending on strategic choices relative to breadth and levels of coverage, form choices, coverage enhancements, and program structure.
  • Order of payments: An order of payments provision provides that the insurer will prioritise claim payments under Side A before paying losses under Side B or C. In some cases, the clause may authorise the organisation to advise the insurer to delay payments under Sides B and C in favour of future Side A payments.
  • Insolvency exclusion: In the current market, one reaction we have seen from some insurers is to seek to add an insolvency exclusion. This should be avoided where possible and, if it is excluded, efforts should be made to try to limit the application of the exclusion to Sides B and C.
  • Entity v. Insured/Insured vs. Insured exclusion: In the context of insolvency, claims may be asserted against directors and officers by trustees, receivers, and other bankruptcy constituencies. To mitigate against application of the exclusion, companies should seek to exempt such claims from the exclusion.

Potential opportunities from often overlooked first-party coverages

  • Crisis management: First party coverage may be available in some instances for crisis management expenses to the extent a company has experienced a “crisis” due to COVID-19 factors. Events that may trigger coverage include negative earnings announcements, key executive resignations, employee layoffs, product recalls, elimination or suspension of dividends, among others. The coverage is customarily subject to a sublimit of liability.
  • Reputational risk: Similar to crisis management coverage, some policies may include first party coverage for a director’s or officer’s “reputation crisis.” Also traditionally sublimited, the coverage may be applicable to individuals to the extent their reputations are adversely impacted by certain developments arising from a COVID-19 crisis. The triggers may be narrow and could require the act of an enforcement authority.
  • Business interruption: D&O policies do not cover first party business interruption exposures. Should a company experience losses due to a permanent or temporary shutdown of operations, neither public nor private company D&O policies would afford coverage; however, third party liability claims, such as lawsuits arising out of a business shutdown or other interruption, may be covered.

Get ready early for a challenging renewal

The London D&O insurance market was already experiencing considerable upheaval and the COVID-19 pandemic has made the market even more challenging. A long period of suppressed premiums combined with increasing losses had already led to London D&O insurers reducing capacity, increasing premiums and imposing stricter terms. The shock to share values and depression of many companies’ anticipated revenues have only made the situation worse.

Insurers are reacting to this in a number of ways, which varies from insurer to insurer. At the least, in advance of renewal, especially those in the nearer term, insureds should expect heightened underwriter focus on COVID-19 impact, plans and disclosures.

So far, top D&O underwriting areas of focus are liquidity and industry. Inquiries may be tailored to company-specific concerns or they be limited to a consistent COVID-19 questionnaire that asks the same questions of all insureds. Inquiries may also drill down on COVID-19-related risk disclosures, the impact on financial results, operations, product/services shortages, industry-wide concerns, liquidity/solvency, and cyber security. For some companies, insurers may attempt to modify terms that were, several weeks back, formally or informally quoted or conveyed.

Conclusion

We are in fluid and changing times. Companies should engage their brokers on COVID-19 D&O risk more deeply and scrutinize coverage terms going forward. We encourage companies to begin renewal protocols early, and to advise their brokers of anticipated changes in exposures, such as M&A transactions and bankruptcy filings. Previously challenging market conditions are likely to become more challenging very quickly. Although coverage may also be more expensive, with the heightened risk this environment presents, it may be far more valuable today than it ever was.

Disclaimer

Each applicable policy of insurance must be reviewed to determine the extent, if any, of coverage for COVID-19. Coverage may vary depending on the jurisdiction and circumstances. For global client programs it is critical to consider all local operations and how policies may or may not include COVID-19 coverage.

The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal and/or other professional advisors. Some of the information in this publication may be compiled by third party sources we consider to be reliable, however we do not guarantee and are not responsible for the accuracy of such information. We assume no duty in contract, tort, or otherwise in connection with this publication and expressly disclaim, to the fullest extent permitted by law, any liability in connection with this publication.

Willis Towers Watson offers insurance-related services through its appropriately licensed entities in each jurisdiction in which it operates.

Authors

Executive Director
Coverage Specialist, FINEX


Executive Vice President, D&O and Fiduciary Liability Product Leader, FINEX

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