Using Your Captive In Your
D&O Insurance Program
IBC’s 9th Annual Executive Forum On Captives
Boston
October 22-24, 2003
By
Michael A. Rossi
Insurance Law Group
Main Office (Los Angeles)
655 North Central Avenue
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Glendale, California 91203
Ph: +1-818-649-7654
Representative Office
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Ph: +44-(0)20-7877-0078
www.inslawgroup.com
Goals For Today’s Presentation
• To give a policyholder-oriented coverage lawyer’s
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
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)
Why Are Some Companies Exploring
The Use Of Their Captive? (cont’d)
“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,
you’re fighting with one hand tied behind
your back.”
Risk Manager
Fortune 500 Company
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 corporation’s indemnity obligations to its
directors and officers for claims made against them
• Side C Cover (aka Entity Coverage)
– Insures a corporation’s liability for “securities
claims” made against the corporation (the
definition of “securities claims” varies from one
insurer’s form to the next)
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
Captive “Plays” In D&O (cont’d)
• 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
Captive “Plays” In D&O (cont’d)
• 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
Captive “Plays” In D&O (cont’d)
• 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
Legality/Enforceability Issues
• There are certain prohibitions against a
corporation’s 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
Legality/Enforceability Issues (cont’d)
• If the corporation enters into bankruptcy,
and the captive’s 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?
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 indemnification of claims otherwise permitted by a state’s
corporations code
Corporate Indemnification (cont’d)
• 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 person’s 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
corporation’s captive insurer
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)
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 captive’s policy if captive is
unable to perform
• Other Hedges?
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
Questions?