Broadly speaking, a D&O insurance policy offers liability cover to companies' directors and officers for claims made by others resulting from decisions and actions made while undertaking their normal duties under the employment contract. The policy includes different types of exclusions; one of them is insolvency and bankruptcy exclusion.
The insolvency and bankruptcy exclusion is a provision under a D&O policy that excludes coverage directly or indirectly from the insolvency or bankruptcy of the company.
Purpose of the Insolvency and Bankruptcy Exclusion
1. Risk Management: The increased risk associated with a situation involving insolvency or bankruptcy is a consideration noticed by insurers while bringing forth this exclusion. In particular, claims tend to increase at times when a company is undergoing financial trouble and stakeholders are trying to recover their losses.
2. Moral Hazard: The exclusion helps cap moral hazard, whereby directors and officers may take more risks, knowing the insurance will respond to their decisions even if the company becomes insolvent.
3. Claims Volume: When the company goes bankrupt, the flow and levels of claims increase, adding to large claims payouts. Insurers reject a big liability to such circumstances that reduce profits as well as increase risk bearers.
Implications to Directors and Officers
1. Personal Liability: In the absence of protection against claims arising from insolvency, these decisions can render the directors and officers personally liable since the decisions are said to contribute to or aggravate the company's solvency.
2. Legal Defense Costs: Directors and officers may need to incur legal defense costs personally if claims are brought during or after insolvency proceedings.
3. Due Diligence: The exclusion puts an added impetus on the requirement for directors and officers to exercise due diligence, and to seek expert advice, more so when the company is in a distressed financial condition.
Mitigating the Risks
Side A Coverage: Some D&O policies provide for Side A coverage, which covers directors and officers directly when the company is unable to indemnify them, for example, in cases of insolvency.
Run-Off Coverage: This is the coverage most people refer to when they say "tail coverage." A person or organization can be protected by a D&O policy for claims brought beyond the end of the policy term, and even after the subject company has gone into insolvency.
Insurance Policy Terms Negotiation: An organization can discuss with insurers the extent or terms of the insolvency exclusion to be revised or reduced in either case, although this may be at a cost of greater or other premium or terms.
The company's directors and officers have to understand the insolvency and bankruptcy exclusion under the D&O policies. Upon realization, thus, of the limitations of coverage and the taking of proactive risk-mitigation steps, the directors and officers could better find ways to free themselves from the possible serious negative fallout with insolvency or bankruptcy.
If in doubt, it would be prudent to consult an insurance broker to more clearly understand the meaning of the insolvency and bankruptcy exclusion in the D&O insurance policy.
We at Zen Insurance Brokers assist in choosing an insurance policy with clauses suited to your requirements. Choose your insurance policy wisely. Get in touch with us for any assistance.
Disclaimer:
Zen Insurance Brokers is an IRDA registered broker which facilitates quick and adequate insurance broking services. We deal with only regulator approved products of insurers. We do not underwrite the products.
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