D&O Indemnity

Call to Duty

Should carriers defend a company in litigation or just indemnify it?
By: | October 15, 2013 • 8 min read

We are all familiar with “duty-to-defend” language commonly associated with general liability policies. There is “non-duty-to-defend” language in the marketplace as well. This language is often found in public, private and some nonprofit directors’ and officers’ (D&O) liability policies and employment practices liability (EPL) policies.

Confusion arises when risk managers, insureds and agents do not understand the differences and true context of these clauses.

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“Duty-to-defend” language is routinely found in most EPL (1,000 or less employees), private company D&O policies, and almost all nonprofit D&O policies. The term essentially means that, in the event a claim is made against a policyholder for an alleged wrongful act, the insurance carrier has the right and duty to defend the claim — even if it is groundless, false or fraudulent.

A “non-duty-to-defend” policy — also known as an “indemnity” — is used in all public D&O policies and some EPL and errors and omissions (E&O) policies. This type of policy states that it is the policyholder’s responsibility, not the insurance company’s, to defend a claim.

Then, there are some policies that state the carrier has the right, but not the duty, to defend a claim. In some unique circumstances, we have seen manuscript wording that allows an insured to choose the preferred option at the time of the claim. Such a choice needs to be part of the negotiation between the broker and carrier before the policy is issued.

R10-15-13p28-30_02D&O.inddIn one recent case, we had negotiated the right for the policyholder to choose between duty-to-defend and indemnity at the time of a claim. The insured, a manufacturer that had just suffered its first EPL claim, was able to select the option that best fit the company’s needs. It chose indemnity, because the policyholder felt the litigation would be settled quickly and at normal costs.

Choosing Self-Insured Retention or a Deductible

Self-insured retention (SIR) and deductibles are excellent tools for underwriters that want to avoid claims frequency and for insureds that want to manage their premium cost. As types of co-insurance, they hold the policyholder responsible for partial payment of a loss.

It is important to understand the difference between SIR and deductibles as well as the roles they play in the defense of a claim.

Most often, duty-to-defend policies use a deductible, which is always included as part of the defense costs and is not normally “first dollar” defense, as often perceived. When a deductible is used, that amount is subtracted from the amount of a claim as defense costs are incurred.

Because the carrier has a duty to defend the insured, the carrier can advance all defense costs on the policyholder’s behalf until a settlement is reached, then it will subtract the amount of the deductible. In situations where a claim was settled within the deductible amount, the carrier will require reimbursement from the insured for all of the defense costs it incurred.

The advantage is that the insured bears no out-of-pocket expense until settlement, helping their cash flow. Recently, a claim was reported that included covered and uncovered allegations filed against a security guard company in New Jersey. Because it was a duty-to-defend policy, the carrier defended all the allegations. This case was settled in August, and because of the global nature of the settlement, the insured avoided any allocation issues with the insurance company arising out of covered and uncovered allegations.

In contrast, a SIR is used almost exclusively in a non-duty-to-defend policy. In that situation, an insured must manage the litigation process from the time the claim is initially made until the amount of the SIR is satisfied. Then, the insurance company pays or advances funds.

Pros and Cons

When carriers have duty-to-defend clauses in their policies, they are obliged to manage the litigation process from the initiation of the claim.

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That means the policyholder’s defense strategy is predominantly in the control of the insurance company. Insurers have the right to select defense counsel, who are usually, but not always, on their counsel panel. When the insurance carrier’s counsel is used, the overall costs of the litigation are usually minimized.

The duty-to-defend policy form is customarily used with smaller, less sophisticated privately held companies and nonprofit organizations that benefit from the insurance company’s choice and relationship with qualified defense counsel.

On the other hand, policies with non-duty-to-defend clauses put the management of the litigation process squarely on the shoulders of the insured. That includes the selection of defense counsel and payment of defense costs as they are incurred, although arrangements are often made for the carrier to make quarterly payments.

R10-15-13p28-30_02D&O.inddThis approach is employed most often with either sophisticated large insureds and/or catastrophic potential exposures. Due to the nature of this type of D&O claim, it is in the insured’s best interest to control its own defense — particularly when allegations of fraud and misrepresentations are involved.

The reasons for this are fairly obvious. If a carrier providing the policy suspects the insureds have misrepresented themselves or committed dishonest, fraudulent or even criminal acts, the insurance company is less likely to view the policyholder in a favorable manner.

In some cases, the insurers may even try to rescind the policy because of such conduct. That has been the case for a number of notable, publicly held companies that have filed D&O claims during the past few years.

One drawback to the non-duty-to-defend option is the cost of defense, which may total hundreds of thousands of dollars. Such a protracted defense can become a financial burden. For this reason, the non-duty-to-defend form is frequently used by more sophisticated entities experienced in complex litigation matters.

The distinguishing difference between the non-duty-to-defend and the duty-to-defend policy is that the carrier does not step in to defend the claim until the SIR is satisfied. In practice, however, it remains the sole discretion of the carrier as to how they handle the SIR or deductible when a claim is made, because each policy contract varies, and each carrier handles claims differently.

Selecting Counsel

As mentioned before, when a duty-to-defend policy is used, the carrier generally retains the right to select legal counsel. In some instances, however, an insurance company may allow the insured to use its own defense counsel, if pre-approved in advance of a claim. This can be negotiated at the time coverage is placed. As an alternative, a number of insurance carriers now provide defense coverage via “panel counsel.”

Panel counsel consists of a group of pre-approved attorneys used by the carrier to handle claims on its behalf. They are experts in their fields, so the panel counsel acts as the insured’s claims counsel and manages the litigation process on the insured’s behalf, while working with the carrier to settle the claim.

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Because of this relationship, the cost of defense is usually less — mainly due to lower pre-agreed hourly rates and efficiency due to counsel’s legal expertise.

When panel counsel is used, the policyholder will select their representation from a list provided and developed by the insurance carrier. This is routinely done once the policy is issued. But in some instances, the insured may have the option to make that choice at the time of a claim.

A non-duty-to-defend policy stipulates that it is the “duty of the insured and not the insurer” to select his or her own defense counsel. Contractually, the carrier still retains the right to approve the selected defense counsel, but such consent cannot be unreasonably withheld. Most often, the carrier just wants to be comfortable that the insured’s choice is qualified for the particular area of law.

With the non-duty-to-defend clause, the cost of defense, as mentioned, is borne by the insured and is only reimbursed at designated periods throughout the claim process once the SIR is satisfied. To help with those costs, the insurance carrier often will “advance defense costs” to reimburse out-of-pocket expenses incurred by the insured, thus limiting the hardship on the policyholder’s working capital.

This type of arrangement is typically associated with D&O policies, and reimbursement is usually made quarterly or, in some cases, monthly. However, this is not without stipulations. The rule of thumb is, the more sophisticated the insured (i.e., public company, industry, size, etc.), the more likely they will be better served with an indemnity policy.

Under most policies, a carrier will require compliance with a number of conditions before the insured is reimbursed. As an example: The claim must be a covered claim; the SIR must be satisfied; and the insured and carrier must have agreed to the costs of defense. And lastly, if it is established that there is no liability under the policy, then the insured will reimburse the insurer for all costs of the defense.

Whether a deductible or SIR is used, the payment of defense costs will almost certainly reduce the limit of liability in most policies. Nevertheless, there are a few duty-to-defend carriers that will provide defense costs in addition to the limit of liability.

Also, as the market changes, D&O and EPL carriers may permit an endorsement that allows insureds to select either the duty-to-defend option or defend claims themselves. As a rule, that option must usually be exercised within 30 days of notice of a claim.

When selecting coverage, it is important to know what defense provision is the correct one for your organization. Risk managers should talk to their brokers about the differences in the policy forms and how that relates to the organization’s needs.

The ability to have a choice can be a big advantage for the insured and should always be considered when deciding which coverage proposal is the best option. With that said, there are tradeoffs that need to be evaluated when the defense is outside of the carrier’s or policyholder’s control.

Of course, there is no absolute answer when selecting the appropriate defense provision because each insured’s business and needs are different. For smaller entities, economics may play an important role, whereas a larger entity may feel more comfortable using its own defense counsel.

Peter R. Taffae, is managing director of ExecutivePerils, a national wholesale broker. He can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Insurtech

Kiss Your Annual Renewal Goodbye; On-Demand Insurance Challenges the Traditional Policy

Gig workers' unique insurance needs drive delivery of on-demand coverage.
By: | September 14, 2018 • 6 min read

The gig economy is growing. Nearly six million Americans, or 3.8 percent of the U.S. workforce, now have “contingent” work arrangements, with a further 10.6 million in categories such as independent contractors, on-call workers or temporary help agency staff and for-contract firms, often with well-known names such as Uber, Lyft and Airbnb.

Scott Walchek, founding chairman and CEO, Trōv

The number of Americans owning a drone is also increasing — one recent survey suggested as much as one in 12 of the population — sparking vigorous debate on how regulation should apply to where and when the devices operate.

Add to this other 21st century societal changes, such as consumers’ appetite for other electronic gadgets and the advent of autonomous vehicles. It’s clear that the cover offered by the annually renewable traditional insurance policy is often not fit for purpose. Helped by the sophistication of insurance technology, the response has been an expanding range of ‘on-demand’ covers.

The term ‘on-demand’ is open to various interpretations. For Scott Walchek, founding chairman and CEO of pioneering on-demand insurance platform Trōv, it’s about “giving people agency over the items they own and enabling them to turn on insurance cover whenever they want for whatever they want — often for just a single item.”

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“On-demand represents a whole new behavior and attitude towards insurance, which for years has very much been a case of ‘get it and forget it,’ ” said Walchek.

Trōv’s mobile app enables users to insure just a single item, such as a laptop, whenever they wish and to also select the period of cover required. When ready to buy insurance, they then snap a picture of the sales receipt or product code of the item they want covered.

Welcoming Trōv: A New On-Demand Arrival

While Walchek, who set up Trōv in 2012, stressed it’s a technology company and not an insurance company, it has attracted industry giants such as AXA and Munich Re as partners. Trōv began the U.S. roll-out of its on-demand personal property products this summer by launching in Arizona, having already established itself in Australia and the United Kingdom.

“Australia and the UK were great testing grounds, thanks to their single regulatory authorities,” said Walchek. “Trōv is already approved in 45 states, and we expect to complete the process in all by November.

“On-demand products have a particular appeal to millennials who love the idea of having control via their smart devices and have embraced the concept of an unbundling of experiences: 75 percent of our users are in the 18 to 35 age group.” – Scott Walchek, founding chairman and CEO, Trōv

“On-demand products have a particular appeal to millennials who love the idea of having control via their smart devices and have embraced the concept of an unbundling of experiences: 75 percent of our users are in the 18 to 35 age group,” he added.

“But a mass of tectonic societal shifts is also impacting older generations — on-demand cover fits the new ways in which they work, particularly the ‘untethered’ who aren’t always in the same workplace or using the same device. So we see on-demand going into societal lifestyle changes.”

Wooing Baby Boomers

In addition to its backing for Trōv, across the Atlantic, AXA has partnered with Insurtech start-up By Miles, launching a pay-as-you-go car insurance policy in the UK. The product is promoted as low-cost car insurance for drivers who travel no more than 140 miles per week, or 7,000 miles annually.

“Due to the growing need for these products, companies such as Marmalade — cover for learner drivers — and Cuvva — cover for part-time drivers — have also increased in popularity, and we expect to see more enter the market in the near future,” said AXA UK’s head of telematics, Katy Simpson.

Simpson confirmed that the new products’ initial appeal is to younger motorists, who are more regular users of new technology, while older drivers are warier about sharing too much personal information. However, she expects this to change as on-demand products become more prevalent.

“Looking at mileage-based insurance, such as By Miles specifically, it’s actually older generations who are most likely to save money, as the use of their vehicles tends to decline. Our job is therefore to not only create more customer-centric products but also highlight their benefits to everyone.”

Another Insurtech ready to partner with long-established names is New York-based Slice Labs, which in the UK is working with Legal & General to enter the homeshare insurance market, recently announcing that XL Catlin will use its insurance cloud services platform to create the world’s first on-demand cyber insurance solution.

“For our cyber product, we were looking for a partner on the fintech side, which dovetailed perfectly with what Slice was trying to do,” said John Coletti, head of XL Catlin’s cyber insurance team.

“The premise of selling cyber insurance to small businesses needs a platform such as that provided by Slice — we can get to customers in a discrete, seamless manner, and the partnership offers potential to open up other products.”

Slice Labs’ CEO Tim Attia added: “You can roll up on-demand cover in many different areas, ranging from contract workers to vacation rentals.

“The next leap forward will be provided by the new economy, which will create a range of new risks for on-demand insurance to respond to. McKinsey forecasts that by 2025, ecosystems will account for 30 percent of global premium revenue.

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“When you’re a start-up, you can innovate and question long-held assumptions, but you don’t have the scale that an insurer can provide,” said Attia. “Our platform works well in getting new products out to the market and is scalable.”

Slice Labs is now reviewing the emerging markets, which aren’t hampered by “old, outdated infrastructures,” and plans to test the water via a hackathon in southeast Asia.

Collaboration Vs Competition

Insurtech-insurer collaborations suggest that the industry noted the banking sector’s experience, which names the tech disruptors before deciding partnerships, made greater sense commercially.

“It’s an interesting correlation,” said Slice’s managing director for marketing, Emily Kosick.

“I believe the trend worth calling out is that the window for insurers to innovate is much shorter, thanks to the banking sector’s efforts to offer omni-channel banking, incorporating mobile devices and, more recently, intelligent assistants like Alexa for personal banking.

“Banks have bought into the value of these technology partnerships but had the benefit of consumer expectations changing slowly with them. This compares to insurers who are in an ever-increasing on-demand world where the risk is high for laggards to be left behind.”

As with fintechs in banking, Insurtechs initially focused on the retail segment, with 75 percent of business in personal lines and the remainder in the commercial segment.

“Banks have bought into the value of these technology partnerships but had the benefit of consumer expectations changing slowly with them. This compares to insurers who are in an ever-increasing on-demand world where the risk is high for laggards to be left behind.” — Emily Kosick, managing director, marketing, Slice

Those proportions may be set to change, with innovations such as digital commercial insurance brokerage Embroker’s recent launch of the first digital D&O liability insurance policy, designed for venture capital-backed tech start-ups and reinsured by Munich Re.

Embroker said coverage that formerly took weeks to obtain is now available instantly.

“We focus on three main issues in developing new digital business — what is the customer’s pain point, what is the expense ratio and does it lend itself to algorithmic underwriting?” said CEO Matt Miller. “Workers’ compensation is another obvious class of insurance that can benefit from this approach.”

Jason Griswold, co-founder and chief operating officer of Insurtech REIN, highlighted further opportunities: “I’d add a third category to personal and business lines and that’s business-to-business-to-consumer. It’s there we see the biggest opportunities for partnering with major ecosystems generating large numbers of insureds and also big volumes of data.”

For now, insurers are accommodating Insurtech disruption. Will that change?

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“Insurtechs have focused on products that regulators can understand easily and for which there is clear existing legislation, with consumer protection and insurer solvency the two issues of paramount importance,” noted Shawn Hanson, litigation partner at law firm Akin Gump.

“In time, we could see the disruptors partner with reinsurers rather than primary carriers. Another possibility is the likes of Amazon, Alphabet, Facebook and Apple, with their massive balance sheets, deciding to link up with a reinsurer,” he said.

“You can imagine one of them finding a good Insurtech and buying it, much as Amazon’s purchase of Whole Foods gave it entry into the retail sector.” &

Graham Buck is a UK-based writer and has contributed to Risk & Insurance® since 1998. He can be reached at riskletters.com.