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Using Your Captive In Your D&O Insurance Program IBCs 9 th Annual Executive Forum On Captives Boston October 22-24, 2003 By Michael A. Rossi Insurance.

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Presentation on theme: "Using Your Captive In Your D&O Insurance Program IBCs 9 th Annual Executive Forum On Captives Boston October 22-24, 2003 By Michael A. Rossi Insurance."— Presentation transcript:

1 Using Your Captive In Your D&O Insurance Program IBCs 9 th Annual Executive Forum On Captives Boston October 22-24, 2003 By Michael A. Rossi Insurance Law Group Main Office (Los Angeles) Representative Office 655 North Central Avenue Tower 42, Level 6 17 th Floor 25 Old Broad Street Glendale, California London EC2N 1HN Ph: Ph: +44-(0)

2 Goals For Todays Presentation To give a policyholder-oriented coverage lawyers view of current thinking on using a captive in a D&O insurance program Probable Uses –For the Primary Layer –For an Excess Layer –As a Direct Insurer or as a Reinsurer Issues to Consider –Legality/Enforceability Issues –Hedging Legality/Unenforceability Risk

3 Why Are Some Companies Exploring The Use Of Their Captive For D&O Insurance? Might view D&O insurance as too costly –In bad renewals, rates on line are coming in at 30% and more (one insurer confirmed charging $45 million for a primary layer in recent months) Might view D&O insurance as too illusory –Might not have severability as to exclusions or the application for insurance (very bad if application is deemed to include all documents filed with the SEC, etc.) –Might have one or more problematic exclusions Might not be able to get D&O insurance at all! –There is at least one reported case of this happening (occurred in Germany); publicly traded company could not get renewal quotes (as a result, all directors resigned and company closed its doors)

4 Why Are Some Companies Exploring The Use Of Their Captive? (contd) When the market hardens, your captive becomes another competitor in your insurance renewal process. It gives you direct access to reinsurers and puts pressure on your traditional insurers. Without it, youre fighting with one hand tied behind your back. Risk Manager Fortune 500 Company

5 D&O Insurance Terminology Side A Cover (aka D&O Liability Coverage) –Insures claims made against directors and officers that are not indemnified by the corporation Side B Cover (aka Corporate Indemnification Coverage) –Insures a corporations indemnity obligations to its directors and officers for claims made against them Side C Cover (aka Entity Coverage) –Insures a corporations liability for securities claims made against the corporation (the definition of securities claims varies from one insurers form to the next)

6 Captive Plays In A D&O Program Providing a Primary Layer –As direct insurer (retain all the risk, or reinsure out the Side A risk) –As reinsurer (assume all the risk or just Side B/C risk) –First excess layer is true risk transfer layer, but follows form to the coverage wordings dictated by the primary layer

7 Captive Plays In D&O (contd) Filling Gap in Excess Layers –As direct insurer (potentially can reinsure out the risk) –As reinsurer (likely have to assume assume all of the risk) –Allows you to tap into higher-layer excess carriers that will write the program only at certain attachment points

8 Captive Plays In D&O (contd) Providing All or Part of a Side-A Only D&O Insurance Program –Some companies are buying only Side-A D&O insurance (they have stopped buying Side B/C) –The captive can play a role in such a program by insuring all or part of the program –Why use the captive for only part of the program? Some companies want to build their captive participation up over time Excess policies provided by third-party insurers can drop-down if a legality/unenforceability issue arises

9 Captive Plays In D&O (contd) Providing All or Part of an Excess/DIC Side A Layer –Same play as for Side-A only program, but this is for an Excess/DIC Side A layer –Excess/DIC Side A insurance sits on top of a layer of D&O insurance that provides Side A and B/C coverage –It provides excess Side A insurance if underlying limits are exhausted –It also can drop down over underlying insurance that does not pay out for any number of reasons, and provide first-dollar Side A cover

10 Legality/Enforceability Issues There are certain prohibitions against a corporations ability to indemnify its directors and officers for claims made against them If coverage provided by a captive insurance arrangement (whether as direct insurer or reinsurer of a front) is deemed, as a matter of law, to be an act of corporate indemnification, the ability of the captive insurance arrangement to pay out could be subject to the same prohibitions

11 Legality/Enforceability Issues (contd) If the corporation enters into bankruptcy, and the captives assets are rolled up into the bankruptcy, or the bankruptcy trustee otherwise takes action against the captive, the captive might not be able to pay out on claims Other legality/enforceability issues?

12 Corporate Indemnification Issues For some states, indemnification of a settlement payment or award/judgment in a derivative action is not allowed Excerpt of Delaware Corporations Code § 145(b) –(b) A corporation shall have power to indemnify any person who was or is a party... [to] any action or suit by or in the right of the corporation... against expenses (including attorneys fees) actually and reasonably incurred by the person in connection with the defense or settlement of such action... Some states permit indemnification of settlement payments and/or judgments in derivative actions Federal securities laws might prohibit indemnifi- cation of claims otherwise permitted by a states corporations code

13 Corporate Indemnification (contd) A corporation can buy insurance that covers claims against directors and officers that the corporation cannot itself indemnify Excerpt of Delaware Corporations Code § 145(g) –(g) A corporation shall have power to purchase and maintain insurance on behalf of [directors and officers]... against any liability asserted against such person and incurred by such person in any such capacity, or arising out of such persons status as such, whether or not the corporation would have the power to indemnify such person against such liability under this section. Some states corporations codes expressly provide that this insurance can be purchased from the corporations captive insurer

14 Some Corporations Codes Expressly Discuss Use Of A Captive For D&O Insurance With respect to the use of a captive insurer, the statutes appear to fall into one of the following categories: –No restrictions on % ownership, and no requirements of % of 3rd-party risk insured, and can cover claims/liabilities the corporation cannot itself indemnify (Arizona, Colorado, Louisiana, Nevada, New Jersey, Ohio) –No restrictions on % ownership, and no requirements of % of 3rd-party risk insured, but can cover claims the corporation cannot itself indemnify only if the corporation gets shareholder approval (Texas) –Restrictions on % ownership or how used, so that not really helpful (California, Maryland)

15 Hedging Legality/Enforceability Risk Use Only a Captive that Has Sufficient Third-Party Risk so That it Constitutes Insurance –If the captive has sufficient third-party risk so that you can deduct the premiums, it arguably qualifies as insurance as used in Delaware Corporations Code §145(g) and similar codes from other states that do not expressly discuss buying D&O insurance from a captive D&O Insurance Wrap –Concept is the same as punitive damages wrap –Policy sits behind captive insurance policy and provides coverage on same basis as captives policy if captive is unable to perform Other Hedges?

16 Concluding Thoughts To do proper due diligence on the use of your captive in your D&O insurance program, a multidisciplinary team should be assembled Consider making a presentation to the Board of Directors after doing a brief feasibility study – they might shoot down any alternative that has questions and save you a lot of time Share information with your colleagues to understand who is doing what, why they are doing it, and how they are doing it

17 Questions?


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