Understanding Side A, captive utilization, and how it compares to commercial insurance

What is directors and officers (D&O) liability insurance?

The directors and officers of a company lead and carry out an organization’s business. They have a responsibility, among other things, to avoid conflicts of interest and exercise care and diligence in managing the corporation’s affairs. Failure to fulfil their corporate obligations can expose them to liability. Claims against directors and officers can be expensive to defend, and they may be personally liable if they are found to have acted disloyally or failed to exercise care that causes a loss to the corporation, shareholders, or others.

If directors and officers are sued, the company will likely provide indemnification in the form of the advancement of defense costs and payment of settlements and judgments so they are not paying out-of-pocket. However, when the company is unable or refuses to indemnify its directors and officers, D&O insurance becomes critical.

The coverage will protect the company, reimburse it for its obligations to indemnify directors and officers, and protect the directors and officers if the company can’t, or won’t, indemnify, leaving them personally exposed. The coverage is generally made up of three main insuring clauses:

Side A: Insures wrongful acts of directors and officers when the company is not permitted to indemnify due to the broader of applicable laws or by-laws, bankruptcy, or otherwise refuses to indemnify.
Side B: Reimburses the company for the indemnification it provides to the directors and officers for claims against them alleging covered wrongful acts.
Side C: Insures the company itself for its own liability and, in the public company context, is usually limited to securities claims.

Captives are a natural option when companies face capacity and pricing challenges, especially when commercial pricing is viewed to be higher than the perceived risk. Traditionally, captives have been involved in Side B and Side C coverages, however, with the recent change in Delaware law, we’re seeing increased interest in using captive insurance to cover Side A, with inquiries coming from both clients with a captive and those without.

Side A D&O captive comparison

Since the law passed in February 2022, Delaware incorporated entities are now able to use captive insurance for Side A D&O. Based on client and market demand, Marsh Captive Solutions created a facility in Delaware for the express purpose of providing a captive insurance option that has a superior fact pattern over other captive options. The majority of D&O captive activity occurs in cell captives, not single owner captives.

The table below illustrates the major differences from the various options available to clients:


	Existing single parent captive	New single parent/cell	Third-party non-Delaware cell	Third-party Delaware cell
	Existing single parent captive	New single parent/cell	Third-party non-Delaware cell	Third-party Delaware cell
Funds segregation	No	Yes	Yes	Yes
Separate management	No	No	Yes	Yes
Conflict of law	Potential	Potential	Potential	No
Bankruptcy remote	No	Maybe	Yes	Yes

Definitions:

Funds segregation: Will the funds be segregated within the captive from other lines of business? Will the limits be fully funded and invested in short term, high quality investments? All options except one will segregate the funds if no other coverages are underwritten by the captive.
Separate management: Most captives do not have independent boards and most officers also serve as officers of the parent corporation. This could lead to conflicts in the determination of coverage or payment amounts. Delaware insurance regulators require an independent third-party administrator (TPA) and outside counsel to determine coverage and administer claims.
Conflict of law: This occurs when the corporate laws of the captive domicile or parent domicile do not permit indemnification for certain acts, such as derivative claims, yet the insurance regulator will permit it as part of a captive or cell business plan.
Bankruptcy remote: Captive or cell will only be bankruptcy remote if the captive is fully funded and the bankruptcy court does not prevail over the claims payment responsibilities of the captive.

Broad commercial Side A insurance

Conduct exclusions applicable to deliberately criminal or deliberately fraudulent acts and/or gaining personal profit or financial advantage to which such person was not legally entitled, subject to final non-appealable adjudication in underlying proceeding.

Exclusion does not apply to defense costs (defense is provided regardless of outcome)
Exclusion does not apply to independent directors
Exclusion does not apply to claims alleging violation(s) of sections 11, 12 or 15 of the Securities Act of 1933 (secondary debt offerings)

Cell captive Side A insurance in Delaware

Conduct exclusions applicable to deliberately criminal or deliberately fraudulent acts and/or gaining personal profit or financial advantage to which such person was not legally entitled, and/or a knowing violation of law by such person, subject to final non-appealable adjudication in underlying proceeding.

No exception for defense costs
No exception for independent directors
No exception for violations of sections 11, 12 or 15 of the Securities Act of 1933

Conclusion

The decision on how to manage your D&O coverages is an important part of your organization’s risk management program. When considering the overall risk appetite, along with the various options and scenarios for Side A coverage, it is important to have the right team in place to evaluate a decision.

Please contact your local Marsh representative to learn more.

Diverse group of professionals attenting business conference

Event

Understanding Side A, captive utilization, and how it compares to commercial insurance