By Carrie C. Cope, David Curkovic and Virginia Morris-Ardin
This commentary examines allocation issues across the nation in the context of "management liability policies." Such policies are often sold in "packages" combining multiple coverage parts, each of which address a specific risk (e.g., employment liability, fiduciary liability, directors and officers liability). Allocation in this context involves apportioning loss between covered and uncovered parties and covered and uncovered matters.
"Allocation" is a complex subject that means different things to different people. If you raise the issue with an economist, the conversation will likely involve an energetic discussion of resource distribution and methods of maximizing efficiency in distributing those resources. In the world of computer programming, data allocation is a complicated topic that, despite being "tech savvy" coverage attorneys, we cannot even begin to correctly explain. Even in the insurance industry, although allocation invariably involves determining who pays for what portion of a risk, the term has a very different meaning depending on the type of insurance being discussed. In other words, the context matters.
For example, allocation in the context of occurrence-based commercial general liability policies (when applied to long-tail environmental, asbestos or similar claims) means engaging in the legally and factually complex process of apportioning damages either "pro rata" across multiple triggered policies or instead to a "tower" of policies in a single year. While this article doesn't address the allocation of loss among insurance policies issued by different insurers, it discusses another equally challenging multifaceted concept: the allocation of loss within insurance policies covering management liability risks. Allocation in this context involves apportioning loss between covered and uncovered parties and covered and uncovered matters.
So why is understanding allocation in the management liability insurance context important? Allocation allows an insurer to pay a portion, as opposed to the entirety, of an insured's defense costs, as well as the costs of a settlement or judgment, on the basis that the claim triggering coverage involves some uncovered matters or multiple defendants, some of whom are not insured under the applicable insurance policy, but who are being represented by the same defense counsel. Allocation becomes a pivotal issue when insureds first realize, often after a claim has been made against them and then to their dismay, that the management liability policy they purchased to cover their management liability claims, doesn't provide full coverage for defense costs or other types of loss.
For the insurer, the purpose of allocation would seem to be apparent — an insurer does not wish to afford coverage for a risk that was not contemplated in the underwriting process and for which the insured did not pay premium. Courts have recognized this rationale as supporting an insurer's right to allocate loss. Insurers also have good reason to avoid agreeing to pay uncovered loss at the outset of a claim, because an incautious insurer may find that it has made a "voluntary" payment, and has lost any right to seek recoupment or reimbursement of amounts that it has paid.
Although insureds may be displeased upon discovering that they must pay a portion of their defense costs or settlement, especially if the cost does not quite fit their budget, allocating loss can prove to be beneficial for insureds. Liability insurance policies typically have a maximum or "aggregate" limit of liability for a designated policy period that is eroded by the payment of defense costs. As a result, if the policy's limit of liability has been reduced by an insurer's payment of defense costs for the uncovered portion of a claim, or payments made on behalf of an individual who is not insured or who committed acts in an uninsured capacity (such as an insured director while sitting on the board of an unaffiliated entity), in the event of a catastrophic claim, there may be no limits available to cover a settlement or judgment or to cover a subsequent claim made against the insureds during the same policy period. Even if an insured purchases coverage for defense costs in addition to the policy's limit of liability, an insurer's obligation to defend or pay defense costs ceases once the limit has been exhausted by the payment of a settlement or judgment. Consequently, understanding how allocation works, and the law that governs it, is crucial to the successful management of liability risks.
One of the preliminary, and critical, questions in any analysis of a liability policy's allocation clause (or an insurer's right to allocate in the absence of one), involves determining the scope of the insurer's defense obligation under the policy and applicable law given that an insurer's ability to allocate defense costs is commonly predicated on the extent of that obligation. A liability insurer's defense obligation typically falls into one of three main categories: (1) the insurer has the duty to defend a covered claim; (2) the insurer has the duty to advance defense fees and expenses for a covered claim; or (3) the insurer has the duty to reimburse the insured for fee and expenses incurred in the defense of a covered claim. An insurer's right to allocate may also be impacted by whether the applicable policy contains an express provision specifying when the right to allocate is triggered and how allocation of loss will be accomplished.
What can make the analysis so challenging is that contemporary management liability insurance policies are anything but uniform and contain much broader coverage than was afforded in the first policies of their kind. Directors and officers ("D&O") liability insurance policies are a form of management liability insurance. Early D&O policies covered risks faced directly by directors and officers and contained two distinct insuring agreements. One insuring agreement affords coverage for losses for which the directors and officers are not indemnified by their corporation. The second insuring agreement, identified as the corporate reimbursement coverage, reimburses the corporation for amounts which it is lawfully permitted or required to expend in indemnifying its officers and directors. Both coverage parts apply only to loss incurred by an organization's directors and officers for claims made against them and not for loss incurred by the corporation for claims made against it.
Since those early days, the scope of what constitutes a "management liability risk" has morphed from exposures faced directly by directors and officers to encompass other types of risks such as those engendering corporate liability, employment liability, fiduciary liability and, in light of rapidly advancing technology, internet-related liability risks. Not surprisingly, coverage under management liability insurance policies has evolved as well, and continues to do so as insurers respond to market demands and attempt to differentiate themselves from their competitors. In fact, such policies are often sold in "packages" combining multiple coverage parts, each of which address a specific risk (i.e. employment liability, fiduciary liability, directors and officers liability) that falls under the broader purview of "management liability." In order to properly address allocation for management liability insurance policies; however, it is necessary to return briefly to the origin of the issue in the first D&O policies.
Carrie E. Cope is a shareholder of Schuyler Roche & Crisham, PC. She specializes in insurance coverage, claims and regulatory law. She and her team provide claim monitoring, litigation, regulatory and coverage consulting services to the insurance industry with an emphasis in addressing management liability insurance issues (including directors' and officers' liability, employment practices liability, professional liability and fiduciary liability) and cyber liability.
David Curkovic is an associate at Schuyler, Roche & Crisham, P.C. in Chicago, Illinois. Mr. Curkovic practices in the area of insurance coverage litigation and specializes in management liability insurance. He has litigated coverage issues for insurers in state and federal courts nationwide.
Ginny Morris-Ardin is a Senior Claims Professional Liability Specialist for the Indemnity Insurance Company. She has worked for commercial carriers on intellectual property, coverage, and complex litigation issues. She is a graduate of the New England School of Law.
The views expressed in this article are those of the authors only, are intended to be general in nature, and are not attributable to Schuyler, Roche & Crisham, P.C. or Philadelphia Indemnity Insurance Company. The information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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