02/10/2022 · 8 min read
On February 7, 2022, Delaware Governor John Carney signed into law a groundbreaking bill that opens up new directors and officers (D&O) liability insurance options for companies. Senate Bill 203, which passed the legislature unanimously on January 27, 2022, clarifies how companies can use captives for Side A D&O coverage.
When exploring the impact of this law on their D&O insurance programs, companies should consider the following:
Background detail about captives and D&O insurance, an overview of the new Delaware law, and the law’s implications can be found below.
A captive can be used as an alternative to purchasing a commercial insurance product for any particular peril. There are different ways to structure a captive. Most commonly, a company may create a wholly owned subsidiary entity that acts as a captive. That subsidiary is capitalized to protect against potential claims. Another mechanism to accomplish the same goal is to utilize a “cell” within a pre-existing captive owned by an unaffiliated third party.
Captives can be used to insure a wide range of risks that would otherwise be covered by commercial insurance. Coverages like workers’ compensation, which is characterized by a high degree of claims frequency, are often a practical choice for captive use due to the extensive claims history and loss predictability. This claims history allows for robust and accurate actuarial modeling when determining how much capital to include in the captive to fund potential claims. Through proper planning, a captive may provide a more efficient use of capital to cover a particular risk area.
While the perils insured by D&O insurance — such as securities class action litigation — do not typically happen very frequently, companies can face sizeable defense cost and settlements when they do. This is often a reason why D&O insurance has not been included in a captive structure as frequently as other coverages.
Another significant reason revolved around uncertainty as to whether or not a captive could protect the directors and officers against a non-indemnifiable claim when the company is prohibited or financially unable to indemnify them.
A frequent example is a settlement payment in a shareholder derivative action. To date, Delaware law has permitted companies to indemnify defense expenses on behalf of an individual director facing a derivative claim, but not any resulting settlement. The public policy rationale is that the damages represent harm to the company itself and by indemnifying the individual for that amount, the company ultimately is not recovering any compensation. This raised the question: Is a company’s wholly owned captive allowed to include coverage for what would be non-indemnifiable, Side A loss?
The recently approved amendment to Section 145(g) of Delaware’s general corporation law specifies that companies can provide D&O coverage to their board members and executives through a captive. Notably, it expressly indicates that companies can include Side A coverage in captives where a loss may otherwise be non-indemnifiable by the company.
The amendment synopsis stipulates that D&O exposures can be included in a captive insurance company controlled by a corporation and can provide coverage “like third party insurance” for liabilities “whether or not the corporation would have the power to indemnify them under Section 145.” And, the amendment allows captives to cover amounts to satisfy judgments and settlements of claims brought by or in the right of the corporation, even though the corporation would not have the power to indemnify the covered persons against such amounts.
Beyond this clarification, the amendment synopsis notes that non-exculpated liability stemming from duty of oversight or “Caremark” claims can also be covered by a captive insurance policy.
The amendment also clarifies that the captive insurance company can be licensed in Delaware or another jurisdiction. The captive can be procured pursuant to a “fronting” arrangement with a third-party commercial insurer or another reinsurance arrangement.
The amendment further identifies some coverage restrictions when using a captive for D&O exposures, including one that mirrors the fraud or conduct exclusion commonly found in D&O insurance policies. This exclusion would apply to “deliberate criminal or deliberate fraudulent acts or any knowing violations of law.” Importantly, the exclusion is subject to a final non-appealable adjudication in the underlying proceeding. The amendment also has non-imputation language, making clear that the text was calibrated to conform with favorable insurance language available in the commercial market. The amendment, however, leaves open the possibility that companies could include exclusionary provisions beyond those identified in the text.
The amendment also addresses claims administration, allowing for the use of a third-party or a pre-established procedure to ensure that any persons claiming entitlement to the proceeds of a captive are not the same persons making the decision about whether to pay claims. This requirement would be of particular importance to commercial insurance carriers writing layers excess of the captive limit.
Companies considering a captive for their D&O exposures in light of the recently signed Delaware law should be mindful of a number of open questions and issues.
The approved Delaware law is a significant step forward as it allows more companies to consider a wholly owned captive or a “cell” as a partial or complete solution for covering Side A D&O claims. Companies with very high insurance premiums or that are struggling to obtain sufficient capacity in the commercial market may be particularly interested.
The process of setting up a captive for D&O exposures is no small undertaking and involves a number of considerations. Setting up a “cell” is much simpler and faster and provides a more arms-length approach to fund non-indemnified loss compared to a wholly owned captive. The fact that a “cell” is part of a standalone entity whose ownership, management, and control are largely independent of the company seeking to insure its directors and officers could reduce potential concerns about influence by company management and about disgruntled shareholders.
A company’s determination as to how best to manage its D&O exposures also will be impacted by the heightened competition and sharp deceleration of insurance premium increases in the commercial D&O insurance market.
A qualified insurance professional and captive consultant can help guide you through a D&O risk transfer assessment process and help you ascertain whether a D&O captive solution might be a good fit for your organization.
President, Marsh Captive Solutions
D&O Product Leader