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

Learn more about Side A D&O liability insurance, including how utilizing Marsh’s Delaware cell captive facility compares to commercial insurance.

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08/16/2023 · 6 minute read

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 fulfill 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.

Differences between commercial Side A insurance and cell captives domiciled in Delaware

Claims against directors and officers when the company cannot indemnify (including shareholder derivative claims/federal law violations/bankruptcy)

Broad commercial Side A insurance

1. 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)

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2. Third-party commercial Side A insurance can respond in the event of bankruptcy.


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3. It has been suggested that commercial insurance would respond to losses arising under federal securities laws, where there is a finding; however, it is rare to see securities violations reach a determination, so this theory is largely untested.
 

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4. Carrier(s) make coverage determination and payment with respect to claims(s) based upon policy terms and conditions applied to facts and allegations of the claim.

Notice is furnished to stockholders as part of the claims settlement process, without the separate requirements that stockholders be noticed of the insurance payment.

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5. Commercial Side A D&O insurance has a proven track record; covered claims are paid if directors and officers are not indemnified by the company.

Cell captive Side A insurance in Delaware

1. 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

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2. One issue is whether the captive will be able to pay legal and administrative costs, post-bankruptcy, that would otherwise have been paid by the company (the parent organization that owns the captive).

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3. Commentators have suggested that since violations (findings or judgments) of federal securities laws are not indemnifiable as a matter of public policy, a captive policy may be prohibited from providing coverage for such losses.

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4. Requires that any coverage determination and claim payment be made by a TPA or by disinterested directors, an independent committee of the board, independent counsel, or stockholders. Policy will include claims procedures.

Prior to any derivative settlement, notice is required to be given to stockholders about such proposed payment under a captive policy.

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5. Execution risk exists as utilization of cell captive method of Side A D&O insurance (in accordance with the recent Delaware law change) is not yet tested. It is yet to be proven that captives are not simply serving as a subterfuge mechanism for corporations to indemnify directors and officers.

Differences between commercial Side A insurance and cell captives domiciled in Delaware

Claims against directors and officers when the company cannot indemnify (including shareholder derivative claims/federal law violations/bankruptcy).
slected option

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

Broad commercial Side A insurance

Third-party commercial Side A insurance can respond in the event of bankruptcy.

Cell captive Side A insurance in Delaware

One issue is whether the captive will be able to pay legal and administrative costs, post-bankruptcy, that would otherwise have been paid by the company (the parent organization that owns the captive).

Broad commercial Side A insurance

It has been suggested that commercial insurance would respond to losses arising under federal securities laws, where there is a finding; however, it is rare to see securities violations reach a determination, so this theory is largely untested.

Cell captive Side A insurance in Delaware

Commentators have suggested that since violations (findings or judgments) of federal securities laws are not indemnifiable as a matter of public policy, a captive policy may be prohibited from providing coverage for such losses.

Broad commercial Side A insurance

Carrier(s) make coverage determination and payment with respect to claims(s) based upon policy terms and conditions applied to facts and allegations of the claim.

Notice is furnished to stockholders as part of the claims settlement process, without the separate requirements that stockholders be noticed of the insurance payment.

Cell captive Side A insurance in Delaware

Requires that any coverage determination and claim payment be made by a TPA or by disinterested directors, an independent committee of the board, independent counsel, or stockholders. Policy will include claims procedures.

Prior to any derivative settlement, notice is required to be given to stockholders about such proposed payment under a captive policy.

Broad commercial Side A insurance

Commercial Side A D&O insurance has a proven track record; covered claims are paid if directors and officers are not indemnified by the company.

Cell captive Side A insurance in Delaware

Execution risk exists as utilization of cell captive method of Side A D&O insurance (in accordance with the recent Delaware law change) is not yet tested. It is yet to be proven that captives are not simply serving as a subterfuge mechanism for corporations to indemnify directors and officers.

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.  

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