Legal departments serve important roles managing the risks that their organization faces. Insurance is an important risk transference mechanism whereby a financial institution can assume all or part of the risk.
Insurance policies are first and foremost legal contracts but with certain special features and pitfalls. As such, the legal department’s involvement in the risk transference process is important. The legal department’s role should include the following:
- coordinating with the risk management department/personnel to identify the risks that are proposed to be transferred via insurance;
- ensuring that the terms of the policy in fact achieve the risk transfer - while insurance intermediaries are specialists in insurance coverages, most are not legally trained;
- ensuring the integrity of the application process - misrepresentations in the application can undermine the whole policy;
- presenting the insurance application facts in a way that will enhance the underwriting and maximize the coverage while minimizing the premiums;
- presenting the coverages to management and especially the board of directors; and
- acting as a resource to ensure that insured claims are properly handled.
Each of these topics is discussed below.
Coordinating with risk management
Risk identification and management is being recognized more and more as an important area requiring discipline, resources and expertise. Operational, reputational, liquidity, technology, regulatory, and reputation risks can damage, cripple and even kill an organization. Identifying the risks and managing them on an enterprise wide basis have become important disciplines with some organizations having separate departments and even Chief Risk Officers. The risks are ever evolving as are the publics’ and the regulators’ expectations of how companies must address them. For example, cyber-risk is a new and rapidly developing risk and in the United States the authorities from the SEC to the President have issued directives to address it. Boards of directors are focusing more and more on risk as an integral element of their governance oversight.
Since time immemorial, commercial enterprises have been developing mechanisms to share and/or transfer all or some of the risks that they face. For hundreds of years, insurance has been an important risk transfer mechanism and in the western world all enterprises obtain insurance. In common law jurisdictions both statutes and judicial decisions over the centuries have developed special rules for insurance contracts and their interpretation. These provide opportunities and pitfalls for organizations that legally trained knowledgeable professionals are well suited to deal with.
Identifying the risks that the organization faces, determining which can be insured, to what extent it can and should be insured (policy limits) and at what cost is a multidisciplinary task. The risk department/officer; the insurance intermediary; and the market all have a role to play.
The policies to transfer these risks are important legal documents that, like other important legal agreements, should involve the legal department.
Most insurance contracts are structured in a similar manner: the coverage clause(s) that specify the risk being assumed by the insurer; exclusions that cut back the risks assumed; definitions; conditions to coverage and reporting claims including the issue of defence of claims; and general terms. Depending on the origin of the policy and the breadth of coverage, a number of these elements can get intermeshed. Definitions may contain exclusions. Exclusions may have carve-backs whereby certain matters are excluded from exclusions. It is usual for general policy terms to be supplemented (amended) by endorsements, sometimes many endorsements.
Underlying all of this is important policy structures and interpretation approaches that the courts have developed over the years, including the following:1
Policies can be either occurrence or claims based contracts.
- Pure occurrence-based policies respond to a claim arising from an event that occurred during the policy period regardless of when the claim is made. Property policies are usually occurrence based and some old liability policies are as well. It is important to archive these policies as otherwise the opportunity to make a claim may be compromised.
- Pure claims-based policies respond to claims made during the policy period regardless of when the event giving rise to the claim occurred. Most liability policies including Directors & Officers and Errors & Omissions Policies are of this kind.
Courts have held that the general rules of contract interpretation apply to insurance policies. However, courts recognize that for the most part insurance contracts are not negotiated and are drafted by the insurers and thus, courts have developed some special rules:
- The onus is on the insured to prove that the coverage clause applies to the claim. However, coverage clauses are to be interpreted widely in favour of the insured.
- Once the insured has shown that the insurance clause applies, the onus shifts to the insurer to show that an exclusion applies. Exclusions are to be interpreted narrowly, again in favour of the insured.
- In the case of an ambiguity, it is to be resolved in favour of the insured.
- Where a policy is unclear, the reasonable expectation of the insured can be used in interpreting the policy.
- Just because insurers have maintained a position over the years does not mean that the courts will approve it. “Accident” which is a lynchpin of a number of insurance policy coverages has been undefined for years and was only recently defined by the Supreme Court of Canada.2 The Supreme Court of Canada recently interpreted a Comprehensive General Liability policy in favour of an insured and contrary to the way the insurers have been interpreting it for decades.3
- Insurance coverages are not written in stone. If a particular definition or term is inappropriate to your organization, raise it and get the policy endorsed to deal with it. Examples include unanimous shareholder agreements and income trusts in the context of Directors & Officers policies.
- The insurance industry is notorious for providing a certificate of coverage but not providing the policy contract terms until later. As the claims arising from the events of 911 involving billions of dollars, which were analyzed based on whether the policy counted it as one occurrence or two, having the policy contract terms nailed down can be important. Legal departments can impose some discipline in this regard.
- As you would expect, insurers modify their policies to address court decisions. However, older forms or older occurrence policies may have different wording and, hence, apply differently. This is particularly true for old liability policies in the area of pollution claims.
The Application Process
Accuracy in the insurance application is crucial to ensure coverage. The courts have held that misrepresentation (including non-disclosure) of a material fact that is objectively reasonable for an underwriter to determine whether or not to accept the risk or to set the premium enables the insurer to void the policy whether or not the application expressly addresses the fact.
Since the application is the lynchpin of the coverage, the legal department should understand what the policy provides, who needs to be part of the disclosure and that mechanisms are in place for such full disclosure to be made.
Lawyers are also trained to make disclosure in a way that is most favourable to the company, and in particularly complicated areas of the application form, it may be especially important to involve persons with a legal training.4
The disclosure may involve proprietary, sensitive or privileged information. As in other cases of disclosure, the legal department should ensure that the appropriate legal safeguards are put in place to protect the company or the privilege.
If it is subsequently determined that a material misrepresentation may have been made, the legal department may be able to remedy the matter before a claim arises after which remedies will be difficult if not impossible to effect.
Understanding and Explaining the Coverages
The various components of the organization may not all have the same interests in particular circumstances. Boards of directors are a good example. Not unreasonably, directors may assume that they are covered by the organization’s D&O policy. However, most directors would not have much knowledge about what the policy covers, who the policy covers and the implications.
When the insurance market is soft, as the D&O market is now, insurers add coverage to justify maintaining the premium level. This is how the Side B coverage reimbursing the company for its director indemnification obligations arose. However, as these coverages are added, they all share the same policy limit. Directors might be surprised to learn that events partly related or unrelated to their activities might cannibalize the policy limits.
They might also be interested in understanding what is excluded and how that risk is addressed, if need be by an additional policy. An example is pension plan liabilities where the company is the plan sponsor.
The legal department may be the appropriate place to have such policies reviewed periodically and presented to the board in a format that assists the directors in understanding and addressing the risks that they face.
Policies cover risks in two very important ways:
- they provide for how the claim is to be defended. Litigation is expensive and a vigorous defence may be your organization’s most important protection. Who has the duty to defend - the company or the insurer? What conditions must be met before defence counsel is engaged? Who is the defence counsel? Is there a need for more than one? How is/are defence counsel paid? The law department is equipped to deal with litigation matters including those covered by insurance policies; and
- they provide indemnification if the claim proves to be successful. Insurers sometimes deny claims, sometimes provide a defence with reservation of rights, sometimes resist or try and control counsel and minimize their costs. Legal departments can be very helpful in understanding and resolving these types of issues and should be involved.
Policies contain claim reporting procedures, conditions and requirements that need to be adhered to, like contract provisions in general, failing which, rights might be lost or compromised.
1 The leading case is the Supreme Court of Canada’s decision in Reid Crowther & Partners Ltd. v Simcoe & Erie General Insurance Co.,  1 S.C.R. 252, 99 DLR (4th) 741.
2 Co‑operators Life Insurance Co. v Gibbens, 2009 SCC 59,  3 SCR 605.
3 Progressive Homes Ltd. v Lombard General Insurance Co. of Canada, 2010 SCC 33,  2 SCR 245.
4 See Lloyds Syndicate 1221 (Millennium Syndicate) v Coventree Inc., 2012 ONCA 341, 291 OAC 178 (leave to appeal refused) and Frank Palmay, “Coventree D & O coverage – important lessons to be learned” (2012), online: http://www.mcmillan.ca/Coventree-D--O-coverage-important-lessons-to-be-learned.