8 September 2021ArticleAnalysis

D&O Side A liability in captives

Directors’ & officers’ (D&O) Side A coverage has been an outlier in the captive world and is challenging relative to feasible solutions. The cover protects directors & officers for claims brought where the corporation is either unwilling or unable to indemnify them.But while it remains challenging, there has been an evolution in the thinking around the subject leading to some opportunities for captive programmes in Bermuda. This, however, is not the first time that Bermuda has been at the forefront in such innovation.The 1980s—group captives
What many people don’t remember is that Bermuda was the selected domicile for a number of group captives that were formed in the mid-1980s. In October 1986, 53 US corporations came together to form the most consequential of these, Corporate Officers & Directors Assurance (CODA).Unlike most group captives of the time, this was a heterogenous group of corporations, bound together only by the impact of a D&O market that had virtually disappeared. As might be expected, non-executive directors of these large ‘Fortune 500’ entities were reluctant to serve without insurance to protect them, hence this was a critical problem.CODA was extremely successful in its early years, not paying any claims for the first three years of its existence. In 1993, ACE Bermuda acquired CODA and, today, subsequent to Chubb’s acquisition of ACE, CODA remains as the primary platform for Side A D&O within the Chubb group. This business is still written in Bermuda and CODA is still a market leader albeit no longer a captive.Today—innovative funding structures
Although the group captive approach was successful, there has never been a significant move towards having wholly-owned captives participate on Side A D&O policies.The challenges for a wholly-owned captive solution have included:Local prohibitions on the indemnification of D&Os—the captive may be considered an extension of the parent, and therefore claims payments might still be corporate reimbursement and hence prohibited;
Consolidation in bankruptcy—in the event of parent bankruptcy, there is a likelihood of captive assets being consolidated into the bankruptcy estate and consequently being unavailable to pay claims to D&Os, most likely when they are in the greatest need;
Independence of claims handling—it is quite possible in a claim situation that the interests of the director or officer will no longer be aligned with those of the parent.
In recent years we have seen harder markets again with some corporations unable to procure Side A D&O coverage at a realistic price. Capacity, although it has not vanished as it did in 1985, has also tightened.So far, there doesn’t appear to have been sufficient market pressure to generate demand for a major new group policyholder-owned vehicle such as CODA. But in numerous cases an alternative is needed, and interest has grown substantially in finding alternative risk financing options.Once again, Bermuda is the domicile where these alternative solutions are being developed and implemented.Accepting that a wholly-owned captive is unlikely to be a workable solution in most instances, attention has turned to the use of Segregated Accounts Companies (SACs) which may provide a ‘cell’ approach. In the event a corporation wishes to self-fund for D&O risk and has sufficient confidence in its risk being superior to the insurance market’s perception, an SAC may be able to offer a solution that addresses the three main challenges that a captive would have.

“It is important to have the policy written on a claims-made basis and to limit any extended reporting period.”

Paul Bailie, WTW

A number of D&O Side A cells have been established and these share the following features:

  • Fully pre-funded—by a combination of premium and other funding or collateral, the entire policy limit is funded in advance with the SAC and maintained in a dedicated separate account that is not accessible by the policyholder;
  • Independent claims handling—a TPA or law firm is engaged by the SAC to handle claims on behalf of the SAC. Any such claims management is fully independent of the policyholder;
  • Use of SAC structure—Bermuda’s Segregated Account structure allows for accounts that are segregated from the core of the SAC, any other Segregated Accounts within the SAC, and any other entities. This structure provides a high level of comfort in ensuring remoteness in bankruptcy;
  • Ultimate profits returned to the policyholder—once a policy has expired and all liabilities have been extinguished, the SAC will return the profits and funding of the cell to the policyholder, including the investment income earned on those funds.

A cell programme is not for everyone, largely because it is cash-intensive at inception with a likely long-term commitment of funding to the SAC before liabilities have been fully extinguished. To mitigate this, it is important to have the policy written on a claims-made basis and to limit any extended reporting period.Additionally, education of the directors & officers will be required in order that they can understand the strength of the protection they have from an otherwise unrated carrier as well as the independence of the SAC in claims handling.It is a testament to Bermuda’s innovative captive marketplace that new solutions to old problems are being developed and put into action. This is the product of the quality of our captive management and consulting resources, coupled with a highly evolved regulatory environment.This is, of course, a complex subject which requires detailed consideration and most likely specific legal advice regarding both bankruptcy remoteness and the general efficacy of such an approach. It is important to consult with captive experts in this field. However, there are now alternatives to commercial insurance available, and it may be worth investigating these as part of a comprehensive risk financing strategy.Finally, Sides B/C do not face the same challenges as Side A coverage, and these can readily be written in wholly owned captives. As part of a larger strategic approach to risk financing there may be instances where such a captive solution is also worthy of consideration and captive owners may want to consult their captive managers or advisors accordingly.