Due to recent court decisions, relentless regulatory investigations and enforcement actions, and industry changes in response to the incentives and pressures of the Affordable Care Act (ACA), lawyers representing health care organizations should expect (or encourage) more questions from clients about the adequacy of their clients' directors and officers (D&O) insurance coverage.
To cite one well-publicized case that recently underscored concerns about coverage—among many other concerns— earlier this year, after a costly litigation battle, a federal court in Idaho ordered a regional hospital system to unwind its acquisition of a physician group due to antitrust law violations alleged by the Federal Trade Commission (FTC).1 The court ordered the divestiture despite the fact that the judge "applauded" the hospital's efforts to improve care coordination and develop an accountable care organization (ACO) through the acquisition, responding to requirements imposed by the ACA.
In light of the environment, health care executives and board members are more frequently looking to outside counsel to assess their organization's D&O insurance and seeking assurances that their coverage is as broad as possible with limits sufficient to protect the entity and all of its directors, officers, and other executives whose personal assets could be at risk. This article discusses counsel's role in reviewing D&O coverage and identifies some of the key policy terms to evaluate in connection with D&O policy negotiations.
D&O policies tailored to health care organizations are usually written to address (and, in some cases, specifically to exclude or limit coverage for) claims exposures unique to the industry. Although recent market studies show that health care organizations face higher rates and tightening terms—largely due the uncertainty of liability risks arising from changes in the industry following the enactment of the ACA—many D&O insurers are willing to negotiate policy terms depending on the specific nature of the client's business, the term at issue, and the client's premium tolerance or willingness to agree to co-insurance requirements or reduced sub-limits applicable to certain claims, among other factors.
Experienced and proactive brokers knowledgeable about health care-tailored insurance policies and risks facing health care organizations are vital in procuring the most advantageous terms possible. A good broker will have a bead on the range of terms potentially available in the market and the intent behind those terms. But counsel will typically have a better understanding of how the courts have, or likely will, apply those terms and where gaps exist between expectations regarding coverage, and how the policy terms will actually play out when coverage disputes arise. Additionally, D&O policies warrant review by counsel because they are, at bottom, complex and densely written contracts whose terms are (or should be) designed to interlock with the client's other policies and the organization's advancement of defense costs and indemnity obligations to its directors and officers.
For these and other reasons, review by counsel supplements the work of the broker in identifying and evaluating the policy terms that should be included in policy negotiations, and in advising clients about gaps in coverage. To do the job right, counsel should undertake a comprehensive review of the client's liability insurance program, including the following steps:
- Evaluate whether the D&O coverage extended to individual directors and officers fits with the mandatory and permissive rights of advancement of defense expenses and indemnification that the organization extends to its executives and board members through its charter and other governing documents or indemnity agreements, seeking to ensure that the D&O insurance will step in to provide first-dollar coverage to the individual executives and board members (without requiring individuals to pay large self-insured retentions that apply to coverage for the organization) if the organization does not indemnify them for a claim due to insolvency or for other reasons;
- Work with the client to identify the leading liability risks for the organization and its directors and officers who need D&O insurance, including risks that could arise from the client's business plans or other activities or challenges anticipated during the upcoming policy period (e.g., proposed mergers or acquisitions);
- Take into consideration the client's chief liability risks, regulatory claims exposure, and business plans, and work with the broker to identify the policy provisions that will enhance or jeopardize coverage, seeking to secure the most advantageous terms possible in both the primary and excess D&O policies;
- Work with the broker and client to identify an appropriate amount of D&O insurance, with the aim of obtaining sufficient limits to vigorously defend covered claims and to pay enough in settlements or judgments to dissuade plaintiffs' lawyers from pursuing the directors' and officers' personal assets;
- Assess whether the D&O coverage meshes with the client's other insurance policies, paying particular attention to any gaps in coverage between the D&O policy and the client's errors and omissions coverage (e.g., professional liability and/or health care management liability insurance), and evaluating whether the client has sufficient (or any) cyber liability coverage for Health Insurance Portability and Accountability Act (HIPAA) violations and other risks of liability for data security breaches and other potential cyber losses; and
- Review each of the excess liability policies in the client's D&O insurance tower to ensure that the terms in the primary and excess policies dovetail consistently and that there are no potential gaps in coverage between the primary and each of the excess policies based on the terms that determine when underlying policy limits are deemed exhausted and when each excess insurer's coverage obligation attaches.
Set forth below is a discussion of some of the key issues to consider and policy terms to review in assessing a health care organization's D&O insurance and in negotiating coverage enhancements in D&O policies.
Definition of "Claim"
The definition of "claim" is pivotal because it determines the events that trigger coverage under the policy, ranging from the commencement of a lawsuit or a criminal proceeding to a regulatory investigation. The definition of claim routinely includes (and should include): (1) written demands for monetary and non-monetary or injunctive relief; (2) civil, criminal, regulatory, or administrative proceedings commenced by service of a complaint, criminal indictment, or similar document; and (3) for policies insuring public companies, securities claims.
In recent years, insurers have been willing to expand the definition of claim. Counsel should thus review the meaning of claim to determine whether it includes the following events:
- A request to the insured to toll the statute of limitations period with respect to a potential claim;
- A shareholder derivative demand or claim for breach of fiduciary duties by an officer or director;
- The commencement of a government or regulatory investigation of the insured organization or its directors or officers;
- The issuance of subpoena to the insured company or to insured directors or officers by a governmental agency or regulatory body in connection with an investigation or inquiry targeting the organization or its directors or officers.
A key issue regarding the definition of claim is whether the policy will provide broad investigation coverage for both formal and informal investigations. Health care organizations are, of course, subject to a host of regulatory investigations and enforcement actions, such as federal enforcement of the False Claims Act (FCA), Stark Law, or Anti-Kickback Statute claims by the U.S. Department of Justice or Office of Inspector General, or FTC antitrust investigations following a merger.
Insures are typically willing to include governmental or regulatory proceedings and formal investigations within the meaning of a "claim," but policy terms differ substantially on what actions the authority must take before a "claim" commences. Some policies define a claim to include "civil, administrative, or regulatory investigations" against an insured so long as it is commenced by the filing of a notice of charges, investigative order, or similar document and/or so long as the investigation is maintained against an individual director or officer insured by the policy. Requiring a formal charge or order to be issued before a claim commences under the policy will leave some costly governmental investigations uncovered if no formal charge or order is obtained. Additionally, counsel should also consider removing from the definition of claim any requirement that an investigation must be maintained against an insured individual (not just the organization) before it qualifies as a "claim."
Finally, counsel should emphasize to the client that there are backhanded hazards to expanding the definition of claim. Most notice terms in D&O policies require the insured to report claims to the insurer as soon as practicable. If the insured fails to report a regulatory investigation or submit even a simple letter demanding damages, and related formal actions subsequently arise, the insurer may take the position that no coverage exists for such actions because the insured violated the notice requirements in the policy.
The Conduct Exclusions
D&O policies exclude coverage for certain misconduct by the insured, such as fraud, dishonesty, violations of law, and unlawful personal profit or remuneration. The wording of such exclusions must be examined with care because these exclusions are implicated by most serious claims. In almost every D&O policy, there must be some finding or ruling that the insured actually engaged in the prohibited conduct before the exclusion will apply; an allegation that the insured individual engaged in the misconduct listed in the policy is not enough for the exclusion to bar coverage.
Many policies provide that the exclusion applies only if a judgment or "final adjudication" establishes that the insured engaged in the bad acts referenced in the exclusion. However, counsel should seek to ensure that the policy provides that the exclusion applies only if a final, non-appealable adjudication in the underlying action establishes the referenced bad acts (e.g. fraud or illegal personal profit). By including this term, the exclusion cannot be triggered if the insurer files a coverage action in an effort to establish that the insured engaged in the excluded bad acts.
Instead of a final adjudication trigger in the conduct exclusion, some policies merely provide that the conduct exclusion applies if the referenced bad acts occurred "in fact." This "in fact" trigger is far less favorable for insureds because it is unclear who gets to determine whether the bad acts "in fact" occurred. Insurers may contend that they can make the determination and unilaterally deny coverage, or they can file a coverage action to have a court make the determination for purposes of denying coverage.
Also, counsel should work to make sure that the appropriate modifiers are used to describe the bad acts listed in the exclusion. For instance, the policy should refer to "deliberate fraud" and a "willful and knowing violation of law." Where policies exclude claims arising from illegal "profit or advantage," counsel should seek to change it to "profit or financial advantage," to limit the exclusion to illegal monetary benefits received by an insured person, rather than non-monetary advantages.
The policy should also include a term stating that for purposes of applying any exclusions, the facts pertaining to, and knowledge possessed by, one insured director or officer will not be imputed to, or attributable to, any other insured individual, such that the bad acts of one director or officer does not impair the coverage for any other director or officer insured under the policy. Although many D&O policies include such non-imputation clauses, the policies also will provide that the misconduct of certain executives may be imputed to the insured organization to determine whether the organization's coverage is barred based on the conduct exclusions. Counsel should seek to limit the executives whose knowledge can be imputed to the organization, and it should clarify that only the actual knowledge possessed by the identified directors and officers of the "named insured"— as distinguished from every affiliated company also insured under the policy—can be imputed to the insured organization for purposes of applying the exclusion.
Terms Related to Health Care-Specific Risks
D&O policies tailored to health care organizations typically contain terms that bar or limit coverage for certain health care-specific liability risks (such as certain types of regulatory actions or statutory based claims), or will include insuring agreements that specifically insure health care-specific claims, which are often subject to certain restrictions or reduced limits. Such terms warrant close attention and hard bargaining.
Many health care-specific D&O policies will affirmatively insure antitrust claims, providing full policy limits for such claims or providing coverage subject to a sub-limit and/ or subject to a co-insurance clause whereby the organization agrees to pay a fixed percentage of losses arising from antitrust claims.
As illustrated by the federal court's antitrust ruling referenced in the introduction, there are currently tensions (and unclear risks of liability) between antitrust law requirements and the requirements and incentives that the ACA imposes on providers to form accountable care organizations and take other steps to coordinate services and reduce costs. Counsel should thus pay particular attention to any antitrust- specific terms in the policy. Additionally, in the current environment, underwriters will likely seek a great deal more information from clients regarding their current or upcoming business plans and strategies, as part of the initial application or renewal process. Counsel can assist in responding to insurers' application inquiries to ensure that the information provided will not give the insurance companies grounds to challenge coverage for a claim based on a contention that the client did not provide accurate information in its policy application materials.
Some health care-specific D&O policies include exclusions or other terms barring or limiting coverage for certain regulatory actions, such as FCA or Anti-Kickback Statute claims. Some policies will provide defense costs coverage only for certain regulatory claims and enforcement actions (i.e., no indemnity coverage provided); and other policies will carve back coverage for certain types of claims such as HIPAA or Emergency Medical Treatment and Labor Act claims. Although most health care-specific policies limit regulatory action coverage to some extent, these are important terms to negotiate because of the range in the scope of coverage available in the market for various regulatory claims.
Insured Versus Insured Exclusion
All D&O policies contain an "insured versus insured" (I v. I) exclusion, which generally bars coverage for claims made by or on behalf of the company or made by any individual director or officer under the policy. The I v. I exclusion was designed to guard against collusive or friendly lawsuits brought by one insured against another for the purpose of tapping the company's D&O policy—e.g., the company sues an officer alleging mismanagement or waste solely to get at the D&O policy proceeds to recover business losses.
I v. I exclusions will include a list of carve-outs or exceptions, which provide that the exclusion does not apply to certain species of claim. Counsel should try to carve back coverage for the following claims—all exceptions to the I v. I exclusion currently available in the market and should thus be subject to negotiation:
- Shareholder derivative actions;
- Corporate whistleblower claims brought under state or federal whistleblower laws (although this may not be obtainable in health care-specific policies with express terms regarding certain statutory and regulatory claims);
- Claims brought by or on behalf of an organization in bankruptcy, including claims brought by trustees, liquidators, debtors-in-possession, and creditors' or bondholders' committees;
- Employment-practices claims against officers or directors;
- Claims brought by any insured directors of officers who have not served in that capacity for the last four years (or a shorter time period, if possible);
- Claims brought by any insured individual for contribution or indemnity for a claim, if such claim arises from another claim insured under the policy; and
- Claims against a provider brought by any former or current member of a health care staff for any sort of peer review, privileging, or credentialing activities.
Who Is an Insured?
To evaluate whether the coverage extends to all of the individuals that the client wishes to include within its D&O coverage, counsel should review how the policy defines an "insured individual" or "insured person," as it determines the individuals insured under the policy. Some health care-specific policies contain broad definitions of insured persons to include committee members, risk managers, staff physicians, faculty, in-house counsel, leased employees, independent contractors, and volunteers.
Advancement of Defense Costs
Counsel should ensure that the D&O policy contains provisions expressly requiring the insurer to advance defense costs as when incurred, rather than permitting the insurer to reimburse the insured for defense costs at the end of the case. A corporation is generally obligated to advance defense costs to officers and directors on a current basis as a matter of law, corporate bylaws, or contractual indemnification agreements. D&O policies should contain terms that likewise impose an obligation on the insurer to advance defense costs on a current basis.
Priority of Payments Clause
Counsel should ensure that the policy contains a "priority of payments" or "order of payments" clause, which specifies the priority order in which an insurer is required to make defense and indemnity payments if there are competing claims on the policy's proceeds, and the aggregate liability that may be covered by the policy exceeds the total limits under the policy. Such terms are critically important when the insured organization becomes insolvent. In a bankruptcy proceeding, the D&O policy is typically viewed as property of the debtor's estate and is thus subject to the automatic stay imposed by the U.S. Bankruptcy Code.
Tying up the D&O policy in a bankruptcy proceeding leaves individual directors and officers without access to policy proceeds needed to defend and settle claims against them. If a priority payment clause makes clear that the insured individuals are contractually entitled to first dibs on the D&O proceeds, bankruptcy courts will usually allow the D&O insurer to pay defense and indemnity payments for the benefit of insured directors and officers.
Application Severability Clauses
Currently, most D&O insurers will include an application severability term providing that the knowledge of one insured individual cannot be imputed to any other insured individual for purposes of denying or rescinding coverage based on misrepresentations in policy application materials.
Some insurers may seek to include a partial, rather than full, severability clause, which states that the policy can be rescinded and coverage voided as to all insureds if the individual officers who signed the application had knowledge of the misrepresentations. The insured should vigorously challenge such a term because in today's market, full severability clauses are widely available, making it clear that the insurer cannot rescind or deny coverage for any individuals who had no knowledge of the misrepresentations in the application materials.
Non-Rescindable Policy Terms
It is fairly common for D&O insurers to include (or they will agree to include if asked) terms providing that the directors' and officers' coverage is "non-rescindable"—meaning that even if certain officers made intentional misrepresentations in the policy application or falsified financial statements included within the meaning of application materials, coverage for individual insureds unaware of the misrepresentations cannot be rescinded. At the very least, the insured should insist on non-rescindable coverage for claims against directors and officers that the company is financially unable to indemnify or legally prohibited from indemnifying.
Definition of an Insured "Loss"
The definition of "loss" in a D&O policy should be examined to determine whether it includes, to the maximum extent permissible under law, coverage for punitive, exemplary, and multiplied damages, and to evaluate the types of things carved out of the meaning of a covered loss. Loss is typically broadly defined to include damages, settlements, judgments, awards, legal fees, and other defense costs, but the definition also includes an exception clause that carves out certain kinds of fines, penalties, and damages. Any exception to what constitutes a loss effectively acts as an exclusion under the policy and can have a significant impact on coverage. Counsel should thus seek to limit the list of exceptions in the definition.
Follow Form Excess Policies and Exhaustion
For many organizations, their primary D&O policy is the base of a tower of coverage made up of various excess policies that each provides an additional layer of D&O coverage. The terms of the primary policy are keenly important because in most cases the excess policies are "follow form" policies that generally provide coverage in accordance with the same terms and conditions as the primary policy. But so-called follow-form excess policies will usually provide that they follow the terms and conditions of the primary except as otherwise provided in the excess policy. And in many cases the excess policies will contain terms that differ substantially from the primary policy, such as choice of law provisions, mandatory arbitration clauses, different notice requirements, and other policy terms that stray substantially from the primary policy's terms.
One of the excess policy terms that should remain consistent from one excess layer to the next is the term that defines when the exhaustion of the underlying limits of insurance, often called the attachment point, triggers the excess coverage under the policy. Some policies provide that the excess insurer's liability attaches only after each of the underlying insurers beneath the excess policy exhausted their respective limits of liability by payment of losses under those policies. However, it is best to have attachment language providing that the excess insurer's liability attaches if any person or entity pays the underlying limits, or at the very least if the underlying insurer(s) or the insureds pay the amount of the underlying limits. This broader attachment language will ensure that excess coverage is not endangered if an underlying insurer becomes insolvent and unable to pay its limits; and it also permits an insured to settle coverage disputes with underlying insurers by accepting less than full limits payments from underlying insurers without jeopardizing coverage under upstream excess policies.
The Benefits of Side A Difference-in-Conditions (DIC) Excess Insurance
Many companies are purchasing Side A-only DIC excess insurance coverage in addition to the company's tower of traditional D&O coverage. Side A-only DIC excess policies insure directors and officers for non-indemnified loss; the policies do not provide any coverage to the organization, meaning that limits are not eroded by any coverage for the organization. These policies substantially enhance coverage for individuals insured under the policy by affording much broader excess insurance than standard D&O policies.
The terms of such excess policies in the market vary substantially. Counsel will need to consult with the broker to identify the most advantageous terms (and the insurers offering those terms). In evaluating the terms of Side A-only excess policies, consider the following (non-exclusive) list of coverage enhancements seen in many of the policies in the market today:
- The DIC part of the name (difference-in-conditions) indicates that the policy will drop down and fill in the gaps for non-indemnifiable claims not insured under the terms of the standard D&O coverage, or if one of the underlying insurers becomes insolvent. Thus, if one of the D&O insurers below the Side A-only excess policy denies coverage for a claim that would be covered under the broader terms of the Side A-only policy, the Side A-only policy with drop down terms should step in to provide coverage;
- No exclusion for pollution liability (pollution exclusions are standard in traditional D&O policies), and the policy does not exclude coverage for bodily injury or property damage claims that arise from pollution liability;
- No Employee Retirement Income Security Act exclusion (also standard in traditional D&O policies);
- The I v. I and conduct exclusions are much more favorable to the insureds. For example, the conduct exclusion does not apply to defense costs;
- No "presumptive indemnification" provision; thus the policy will provide coverage to directors and officers even if the company wrongfully refuses to indemnify them against a claim; and
- Fully non-rescindable policies.
Additionally, because the company is not an insured under the policy, Side A-only excess policies would not be considered an asset of the estate in bankruptcy or subject to the bankruptcy automatic stay in the event the insured company files bankruptcy.
Lawyers representing health care organizations should encourage their clients to have counsel evaluate their D&O insurance program and participate in policy negotiations. This article identifies only a handful of the issues that warrant attention in evaluating a client's D&O insurance coverage. To undertake the task properly, counsel will need to work with the broker and the client to review the language of each of the policies in the client's D&O program at every level to determine whether the client has the most advantageous terms possible.
Originally published in Hospitals & Health Systems Rx by the American Health Lawyers Association.
1 See St. Alphonsus Med. Ctr.-Nampa, Inc. v. St. Luke's Health Sys., Ltd., No. 1:12-CV-560 (D. Idaho Jan. 24, 2014).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.