Coverage traps: will your D & O insurer pay when you have a claim?

• Author: Weiss, Stephen J.
• Position: Directors' and officers' liability insurance

THE ACID TEST of a D & O insurance policy is whether it actually pays when you have a claim. Unfortunately, even if you have a policy with broad coverage terms, there is no guarantee that your insurer will actually pay losses, since even broad policies have coverage traps. We identify some of the most common traps below.

Trap One: Notice

D & O policies are typically written on a "claims-made" basis. This means you must give notice of a claim as soon as is practicable. Failure to comply with this requirement may allow your insurer to deny coverage for an otherwise covered claim owing to late notice. Late notice is one of the most common reasons insurers deny coverage.

Insureds who report claims late tend to do so for one of two reasons: They fail to recognize that certain events constitute a claim; or, they decide not to report a claim because they assume (incorrectly) that the claim can be resolved for less than the applicable retention.

* Recognizing Claims: It is important to remember that a claim is not limited to a lawsuit. It can include a written demand for monetary or non-monetary damages; a civil, criminal or administrative proceeding; or even a governmental investigation. Under this definition, an angry letter from a shareholder demanding governance changes would be a claim. Failure to report it could result in a loss of coverage for that claim and any related claim as well.

* Deciding Not to Report a Claim: Another common mistake is failing to report a claim because you assume it will never exceed the retention of the policy. Sooner or later, a claim that everyone expected would be disposed of for a nominal amount will blow up into a more serious situation or, worse yet, spawn a significant, related lawsuit. If you don't give notice promptly, you could lose coverage for the original suit and the related suit.

Given the obvious need to report a claim promptly, it is important for your company to have a well-defined system in place for identifying a claim and forwarding notice of the claim to the company's risk manager and, ultimately, its insurers.

Trap Two: Selecting Defense Counsel

Most D & O policies place limits on your selection of defense counsel. For example, some policies require insureds to choose from a pre-approved list of law firms ("panel counsel"). Failure to use panel counsel could be construed as a breach of the insurance contract, which would entitle the insurer to refuse to cover any defense costs.

Avoiding this...