The ACE Report is a periodic publication distributed to policyholders and other interested parties as a service by ACE. Its purpose is to address insurance concerns worldwide, as well as present timely information on current developments in liability issues surrounding directors and officers. The Editor of The ACE Report is Dan A. Bailey, a lawyer at Arter & Hadden in Columbus, Ohio, USA and a respected voice in the complex area of directors and officers liability.

Although prepared by professionals, this publication should not be utilized as a substitute for legal counseling in specific situations. Readers should not act upon the information contained herein without professional guidance.

D&O MARKETPLACE OFFERS SMORGASBORD OF OPTIONS
As a result of the current competitive D&O insurance market, insureds now have an unprecedented number of coverage options available to them. Insureds who obtain competing proposals from numerous markets are being presented with as many as 150 different coverage alternatives.

To avoid utter chaos and confusion, insureds and their insurance professionals more than ever need to develop a target list of coverage options before entering the market. In preparing that list, an understanding of not only the available options but their true impact and worth is critical. The following summarizes many of the new options available from at least some insurers.

I. ALLOCATION
One or more of the following four alternative approaches to addressing allocation are now available.

A. Entity Coverage

Typically, this alternative grants coverage for Securities Claims against the company whether or not D&Os are co-defendants. The primary differences between the entity coverage offered by various insurers include the following:

• Some insurers define "Securities Claims" to include only violations of the federal or state securities laws. Other insurers use a broader definition, which includes any claim arising out of the purchase, sale or offer to purchase or sell securities of the company. A claim involving a change-in-control, for example, may not allege violations of the securities laws, but may arise out of the purchase or offer to purchase securities (e.g., a tender offering) and thus would be included within the broader but not the narrower definition. The broadest definition available includes any claim by any securities holder, thus applying to proxy claims, for example, where no purchase or sale of securities is involved.
• Non-officer employees are included as insured persons by some insurers with respect to Securities Claims. This extension of coverage further eliminates potential allocation issues since the insurer would not be able to argue that a portion of a Loss is attributable to the conduct of a non-defendant employee. Since the company is responsible for the wrongdoing of its employees, this extension of coverage arguably is a logical companion to entity coverage, although claims by non-officer employees should be excepted from the insured-versus-insured exclusion to avoid this coverage enhancement resulting in a coverage restriction.
• A co-insurance provision or higher retention amount may apply to Securities Claims. The co-insurance provision, when combined with entity coverage, effectively results in a predetermined allocation between covered and non-covered parties. The co-insurance or larger retention should not be applied only to the entity coverage, since that would require an allocation between company and D&O Loss in order to determine the applicability of the co-insurance or retention. Instead, those provisions should apply to all Loss under either the corporate reimbursement or entity coverage insuring clauses (but preferably not the direct D&O insuring clause in order to avoid D&Os personally paying the co-insurance or larger retention).

B. Predetermined Allocation

The primary differences between available predetermined allocation provisions include the following:

• Some provisions predetermine only the allocation between covered and non-covered parties, whereas other provisions also predetermine the allocation between covered and non-covered allegations or matters. The latter approach eliminates allocation disputes when a portion but not all of a claim is subject to a coverage defense. Insurers are still entitled under such a provision to deny a claim in full.
• Most predetermined provisions apply only with respect to Securities Claims since the range of potential allocation percentages in such claims is relatively small in most cases. A limited number of insurers offer the predetermined provision with respect to any type of claim (frequently called a "concurrent liability" provision which effectively predetermines the allocation at 100%) or define different allocation percentages for different types of claims. To avoid unintended allocation disputes, the latter approach should include a provision which states that if a single claim fits within two or more of the listed categories of claims (and thus triggers different allocation percentages), the highest triggered allocation percentage will apply.
• The predetermined percentage may apply only to defense costs, to both defense costs and indemnity, or may apply different percentages to defense costs and indemnity.
• Instead of predetermining the allocation, the policy could establish a minimum allocation percentage and allow the parties to negotiate a potentially higher allocation percentage. This approach appears to minimize the intended benefits from a predetermined provision since the parties will still be forced to negotiate and potentially disagree as to the appropriate allocation.

C. Clause A Coverage

The need to allocate between D&Os and the company rarely arises when the D&O Loss is non-indemnified and therefore a Clause A-only policy, such as the policies issued by CODA, effectively solve the allocation between covered and non-covered parties. D&Os typically incur non-indemnified loss either in derivative suits (i.e., claims on behalf of the company) or when the company is financially insolvent. In both instances, the company is rarely a co-defendant and rarely incurs Loss jointly with the defendant D&Os.

D. Methodology

Instead of eliminating the allocation problem, some policies simply define how the allocation will be determined in a particular case. The alternative methodologies typically included within a policy include the following:

• One defined methodology is to allocate based upon the relative legal and financial exposures of and relative benefits to the parties. This methodology is most favorable to the insurer typically and requires the parties to examine not only the factual and legal strengths and weaknesses of the case, but also the financial impact and collectability of the defendants and the benefits derived by each defendant from the settlement or defense.
• As somewhat of a compromise methodology between the pro-insured "larger settlement rule" and the pro-insurer relative benefits methodology, some insurers provide in the policy that the allocation will be based upon the "relative legal exposures" of the parties. This type of methodology excludes as irrelevant any consideration of the relative benefits and financial implications of the defense or settlement.
• Another approach is to simply provide that the parties will commit their best efforts to agree upon a fair and reasonable allocation under the circumstances of each claim. This approach leaves unresolved both what methodology should be used in determining the allocation as well as what the appropriate allocation is. In at least the Seventh and Ninth Circuits, this approach will likely result in the pro-insured "larger settlement rule" applying. However, this approach creates the greatest amount of uncertainty regarding allocation and thus will likely engender the most disputes between the insureds and the insurer.

II. ENTITY COVERAGE EXCLUSIONS
If entity coverage is afforded, the insurer will likely insist upon at least some of the following additional exclusions or exclusionary provisions:

1. In lieu of a warranty from the company regarding knowledge of facts which could give rise to a future covered claim, some insurers include a "listed events" exclusion which eliminates entity coverage for certain claims arising out of various defined events which occur within the first ninety days of the policy. The defined events which trigger the exclusion are intended to be significant adverse developments which because they occur so soon after inception of the entity coverage, senior management is presumed to have known of the potential for those events prior to inception of the entity coverage. These events may include a restatement of the company's financial statements, or a filing of an SEC Form 8K. This approach significantly limits the entity coverage since various events occurring within the first quarter of the policy period are excluded.
2. The dishonesty exclusion is frequently amended to clarify whose knowledge or intent is used to determine the applicability of the exclusion. For example, does the exclusion apply to the entity coverage if any employee behaves with the requisite fraudulent or willful intent, or only if directors and officers or perhaps only certain executive officers satisfy the exclusion.
3. The personal profit exclusion may be amended in two respects. First, the reference to "personal" could be deleted with respect to the entity coverage to confirm its applicability to the entity. Second, the reference to "advantage" or "benefit" may be deleted in order to avoid the exclusion's applicability where the company allegedly sells its stock at an artificially inflated price and thus realizes an illegal advantage or benefit therefrom.
4. An exclusion for claims alleging unfair or inadequate consideration in the purchase of securities is frequently included with respect to the entity coverage, although this exclusion does not apply with respect to defense costs in some provisions.
5. The definition of "claim" for purposes of the entity coverage may not include administrative or regulatory proceedings even if such proceedings are otherwise included within the definition for purposes of D&O claims.
6. The severability of exclusions and application warranties may be amended in order to explain how the severability applies to the company. For example, is the knowledge of any employee imputed to the company (in which case there effectively is no severability for the company) or is only the knowledge of directors and officers, certain executive officers or the signer of the application imputed to the company?

III. RETENTION
Several insurers now offer a creative provision relating to the retention in a Securities Claim. Under this provision, the retention applies only to defense costs, not to any settlement or judgment and does not apply even as to defense costs if all defendant insureds successfully defend the claim without the payment of any settlement or judgment. Some provisions waive the defense cost deductible only if the insured defendants are found not liable pursuant to a motion to dismiss, motion for summary judgment or at trial. Other provisions waive the defense costs deductible if the insured defendants are dismissed for any reason, including a voluntary dismissal by plaintiffs.

These provisions are intended to encourage the insureds to define an exit strategy early in the litigation. If the insureds believe they must ultimately settle the case, these provisions encourage an early settlement, thereby triggering coverage sooner, and thus avoiding needless defense costs. However, if the insureds believe they can successfully defend the case, these provisions reward such success by waiving the retention.

IV. POLLUTION
The primary methods by which the pollution exclusion is being narrowed include the following:

• Not applicable to direct D&O coverage;
• Not applicable to Securities Claims or derivative suits;
• Not applicable to defense costs; and
• Applicable only to claims "for" pollution, not "based upon or arising out of" pollution.

In addition, the recently amended CODA policy form not only continues to omit a pollution exclusion, but also provides that the bodily injury/property damage exclusion is not applicable with respect to pollution claims.

V. DISCOVERY PERIOD
The following enhancements to this provision are now available from certain insurers:

• The insureds are allowed to purchase discovery if either the insureds or the insurer cancels or non-renews;
• The insurer is obligated to quote an extended run-off coverage if the parent company is acquired;
• Notices of circumstances, and not just claims, can be reported during the discovery period.

VI. MISCELLANEOUS
The following miscellaneous coverage enhancements are frequently available:

A. Punitive and exemplary damages awarded against the company in a Securities Claim may be covered if otherwise insurable. This coverage is somewhat illusory since several courts have ruled that punitive damages may not be awarded for violation of Section 10(b) of the Securities Exchange Act of 1934. Alternatively, punitive damage coverage for any type of claim may be available subject to a relatively small sublimit. Many offshore insurers offer full punitive damage coverage without a sublimit.

B. Blanket non-profit outside position coverage for Section 501(c)(3) organizations is available on a double excess basis and blanket for-profit outside position coverage may be available on a triple excess basis.

C. The policy may be non-cancelable by the insurer (except for non-payment of premium) and non-cancelable by the insureds if the parent organization is acquired. This latter provision is intended to assure ongoing coverage for former D&Os in the event of a change in control.

D. The insured-versus-insured exclusion could contain an exception for any employment-related claim by an officer, not just a wrongful termination claim.

E. Multi-year policies with either a single aggregate limit of liability or separate per year limits are available. For single aggregate policies, various forms of reinstatement options are available, including a standard reinstatement provision and a provision placing the reinstated limit on top of a multi-layer D&O insurance program. The ability to elect the reinstatement may be at any time during the policy period or only within a defined time period following notice of any claim or certain types of claims.

CONCLUSIONS
A company's decision to select certain of these and other available options ultimately depends upon the company's perceived value of each option as compared with the price charged by the insurer for the option. Although companies should certainly take advantage of the current competitive market and obtain those coverage enhancements which it most desires, companies should resist the temptation to overly "shop" the market with respect to these options. As demonstrated over the last ten years, a long-term and mutual relationship between insureds and insurer remains the single most important factor in purchasing D&O insurance. Companies should not sacrifice this critical asset simply to maximize short-term coverage enhancements which may become unavailable in the not too distant future.