Directors and officers (D&O) liability insurance is a policy that provides indemnification for the losses of third parties caused by gross negligence of a company’s directors, supervisors and senior managers in the course of performing their duties. This type of insurance is an important part of the governance of listed companies.
Q: What is the scope of D&O liability insurance?
A: As well as the company itself, it can provide coverage for individuals such as corporate top executives, employees with managerial responsibilities. While specific terms and provisions may vary between insurers, the coverage can basically be divided into three categories, as follows.
Side A coverage is for insured individuals, including corporate executives, to indemnify losses caused by their negligence, misconduct and/or liabilities borne by their spouses, agents and heirs. It is essential to note that this coverage is generally applicable when the insured company is unable or lacks the capacity to indemnify the directors and officers for their liabilities.
Side B coverage refers to company reimbursement coverage. When a company compensates its top executives for the liabilities they are obligated to bear in accordance with compensation agreements, articles of association or legal provisions, the insurer assumes the responsibility of reimbursing the company for such compensation.
Side A and side B coverage are the most commonly used provisions in the incipient stage of the D&O liability insurance market. With the development of the securities market and the consequent huge amounts of compensation for securities violations, side C coverage emerged. Side C mainly covers companies’ liability in relation to securities claims.
In addition, some D&O liability insurance policies also cover employment claims brought by employees against companies and their top executives, which also stems from increasing litigation related to employment liabilities.
Q: Who are the applicants and insureds under D&O insurance?
A: Applicants are usually a company, which is generally responsible for paying the premiums. Under Chinese law, article 39 of the Code of Corporate Governance of Listed Companies provides that listed companies can purchase liability insurance for their top executives with the approval of a general meeting of shareholders. In practice, purchasing D&O liability insurance is an effective way to improve corporate governance.
The insureds under D&O liability insurance typically include the company and insured individuals. Depending on specific provisions of the insurance policy, insured individuals usually encompass the past, present and future top executives, employees with managerial responsibilities, trustees, external company directors, shadow directors and their spouses, estate administrators, heirs, agents and will executors.
Q: What is a severability clause ?
A: A D&O liability insurance policy usually involves multiple insured parties. To avoid a situation where the acts of one insured individual nullifies the entire insurance coverage for all insured parties, policies generally include a severability clause. In this way, the policy separately covers the interests of each insured party. Whether one insured party is excluded from insurance coverage does not necessarily affect the available coverage for other insured parties.
However, some D&O policies may limit the scope of the severability clause. For example, the insurance clauses may further stipulate that the acts of insured individuals of the insured company should be considered as the acts of the insured company itself.
If certain acts made by these insured individuals result in the insurer having the right to void the policy or exclude the coverage, neither the individuals nor the insured company would be entitled to the coverage under the policy.
Q: What are the coverage limits?
A: Article 6 of the Regulatory Measures for Liability Insurance Business provides that liability insurance shall underwrite the insured’s legal liability for indemnification to a third party to whom the insured causes damage.
Insurance companies shall correctly grasp the definition of liability insurance, clarify relevant concepts and the relationship of rights and duties, strictly distinguish insurance liabilities, and shall not cover criminal fines or administrative penalties through liability insurance.
The principle of insurable interest is one of the fundamental principles of insurance law, which requires that the insured of property insurance have an insurable interest in the subject matter of insurance when the incident occurs.
From the legislative and regulatory intention of the regulatory measures, the primary purpose of criminal fines and administrative penalties is to punish the individuals and entities who intentionally commit criminal or fraudulent acts. Accordingly, even though criminal fines and administrative penalties may also cause losses to the individuals and entities, the individuals and entities have no insurable interest under the policy.
Thus, insurers should not assume such kind of losses; otherwise, the purpose of criminal fines and administrative penalties will be undermined. Therefore, if a D&O liability insurance policy is governed by Chinese law, insurers should pay special attention to avoid providing coverage for the risks and losses prohibited by the regulatory measures.
Q: What are the special provisions for the insurance period?
A: Beside the commonly used retroactive date provisions in liability insurance policies, a D&O liability insurance policy may also include a discovery period clause. This usually extends the insurance period for a certain period after the policy’s expiration.
The discovery period clause typically stipulates that, within a certain period immediately following the insurance policy’s expiration, the insurer will cover losses arising from the insured’s wrongful acts that first give rise to a claim for compensation during the insurance period or the discovery period.
The insured must report the claim or relevant information to the insurer during the insurance period, or before the end of the discovery period. Generally, D&O liability insurance policies have a free discovery period from 30 to 90 days. If the insured needs to extend the discovery period, an additional premium is usually required. In practice, the reporting obligation of the insured in liability insurance policies is often confused with the statute of limitations.
Wan Jia is a partner and Zhu Bingjing is an associate at AnJie Broad.
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