This article was originally written by our North American colleagues for a U.S. audience. We have shared this article for information purposes only as it may be of interest to our global clients. Please speak to your local office contact to further discuss any of the points raised in this article.
Challenges associated with placing D&O insurance in a captive may soon be eased, leading many organizations to re-evaluate their captive strategies. Modifications to the Delaware General Corporations Law (“DGCL”), passed by the state’s House and Senate on January 13 and 27, 2022, respectively, are a governor’s signature away from becoming fully effective. The amendments would authorize, with conditions, the use of a captive insurer to cover director and officer (“D&O”) liabilities whether or not the corporation would have the power to indemnify them under the law.
The change is welcome news to, among others, organizations that have refrained from including D&O insurance in their captives due to concerns about whether such insurance could legally cover “non-indemnifiable” exposures – coverage that is referred to in D&O policies as “Side A” coverage. Although Delaware law has expressly allowed insurance to pay losses which the company itself would not be able to indemnify, conventional wisdom has been that a captive insurance entity established by a company might not be treated as a bona fide issuer of “insurance” for such purposes. The concern arises particularly in the case of a corporate derivative settlement in which money is being paid to the company on behalf of its own directors and officers. As noted below, however, an additional concern may arise from the ability of a captive to pay bankruptcy-related Side A losses, which the amendment does not address.
Now the amendment to the Delaware indemnification law (DGCL Section 145(g)) clarifies that captive insurance qualifies as “insurance” and provides a safe harbor for captive insurers that are truly behaving in a manner which is sufficiently similar to third party insurers. Nevertheless, to ensure that companies are not merely using the captive as a pass through to provide for otherwise impermissible indemnification, the legislation has adopted safeguards against potential conflict and abuse, such as payment authorization by a third party administrator or procedures specified in the statute, notice to stockholders related to the dismissal or compromise of derivative litigation, and policy exclusions for specified adjudicated misconduct, such as deliberately criminal or fraudulent misconduct.1
While concerns about the ability to insure Side A in a captive have not previously prevented companies from placing D&O insurance in captives for indemnifiable losses and certain corporate liability exposures (known as “Side B” and “Side C” coverages), doing so has customarily required them to turn to traditional insurance markets outside of the captive for Side A protection. The result for many organizations is that a captive strategy for D&O insurance might not, among other things, yield desired premium savings. Specialized financial risk brokers have long-sought alternatives to traditional insurance to address Side A risk, such as indemnification trusts and access to credit markets via segregated cells; however, while these solutions may be viable for many organizations, they may not be as optimal for others.
One area where concern might not be eased involves the question of whether the captive may pay losses that are non-indemnifiable by reason of a corporate bankruptcy. In other words, would bankruptcy law restrictions on a debtor company’s ability to indemnify losses while in bankruptcy also prevent the captive insurer from paying those losses? The amendments do not speak to this and, even if they did, there can be no assurance that bankruptcy courts will go along with the idea of a captive paying bankruptcy-related Side A claims. Any analysis of a captive strategy should include an assessment of this issue and, thereby, an assessment of issues surrounding captive capitalization and claims funding.
What’s next? The law becomes effective for Delaware corporations immediately upon the governor’s signature. The legislative summary states that the amendments apply “whether or not their captive insurers are licensed in Delaware or another jurisdiction.”2
We strongly urge affected companies evaluating a captive strategy (or re-evaluating due to the legislation) to confer with qualified legal and accounting advisors on the scope and limitations associated with captives in light of the legislation. We also urge companies to confer with qualified insurance brokerage professionals on matters associated with captive feasibility, broader captive considerations and costs, as well as the scope of insurance coverage, including policy wording and manuscripting.
1 Legislative summary,
https://legis.delaware.gov/BillDetail?legislationId=79045
2 Id
Willis Towers Watson hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, Willis Towers Watson offers insurance products through licensed entities, including Willis Towers Watson Northeast, Inc. (in the United States) and Willis Canada Inc. (in Canada).
