Part 1
Explains how both a former and current directors and officers (D&O) insurance carrier may deny coverage when a potential claim doesn’t materialize until after the association changes carriers. Because of this risk, associations and managers must be extremely careful any time a prospective or existing D&O carrier sends an application asking if the board knows of any actual or potential claims. This is a time for extreme caution, not haste.
Recently we have seen some cases in which carriers denied coverage under directors and officers (D&O) liability policies on what normally should have been covered claims. The carrier’s denials arise out of a “Catch-22” that few people recognize. The nature of D&O insurance is such that associations actually can have D&O coverage in effect continuously from one carrier to the next and yet not have coverage when a claim arises. To avoid this outcome, it is essential (1) to tender a claim to the carrier whenever there is even a potential risk of a lawsuit and (2) to be extremely careful when completing an application for new insurance.
D&O insurance is almost always a “claims-made” policy. These policies, theoretically, cover any claim made during the policy period, sometimes even if the incident on which the claim is based occurred before the policy began. However, most D&O policies will not cover a claim, if the association knew of ANY facts or circumstances before the policy began that might give rise to that claim.
D&O insurance provides different coverage from the typical comprehensive general liability (or “CGL”) policy. CGL policies typically cover only those claims that result in bodily injury or property damage and sometimes non-bodily “personal injuries.” CGL policies are typically “occurrence” policies, so named because they protect the insured against claims arising from an “occurrence” during the policy period. They provide coverage even if a claim does not arise until after the policy period ends. It is fairly easy to identify an occurrence and when it occurred, because it usually produces bodily injury or property damage at that time. D&O insurance, on the other hand, usually covers only those claims made during the policy period. With a D&O incident, it is often easier to identify when the claim is made than when the occurrence happened that gave rise to the claim.
Some claims-made policies will cover claims that are made during the policy period even if the occurrence giving rise to the claim occurred prior to the start of the policy period. The catch is that a new carrier will accept such claims only if the insured party had no prior knowledge, when the policy period began, of any facts or circumstances giving rise to that particular claim.
What exactly is a “claim?” Certainly a lawsuit is a claim under any policy, but some policies define a claim as any written threat or demand or even a verbal threat or demand. Whatever the definition, it is easy to understand that no carrier wants to cover a lawsuit that arises out of any facts or circumstances about which the association was aware before the policy began. Many carriers will cover it, if neither the carrier nor the association knew it existed at policy inception, but no carrier will cover what amounts to a known pre-existing liability.
What if facts or circumstances have occurred, but they don’t yet meet the policy definition of a “claim?” Maybe there was a verbal threat, but the policy defines a claim as a written threat. Some claims-made policies consider that a claim was made, if the insured party notifies the carrier during the policy period of the facts that may become a claim. Even if the policy does not provide for notifying the carrier of a potential claim, it is still wise to do so before the policy period ends. If the incident becomes a real claim after the policy period ends, the earlier notice may be enough to trigger coverage, but it will be impossible, if the former carrier’s first notice occurs after the policy ended, because the claim wasn’t made during the policy period, and the carrier will deny coverage.
This is how an association can lose coverage. Assume one owner objects verbally when the association approves a neighbor’s architectural modification. The complaining owner sends no written complaint or anything that the policy defines as a “claim.” Then, things calm down for a period of months, and the association either concludes that the complaint is minor or believes it resolved the problem. The association doesn’t notify the current D&O carrier of the owner’s complaint.
Three months later the association selects a new D&O carrier. The carrier sends an application to the manager to complete, or maybe the broker asks the association board or manager if there are any pending claims, completes the application, and the board or manager signs it. The signed application states that the association has no pending claims nor any knowledge of any facts or circumstances that may give rise to a claim. The board may have forgotten the prior threat, or the board may have changed, and the new board doesn’t know of the prior complaint. Either way, the old D&O carrier got no notice of the potential claim, and the new carrier is told that there are no potential claims.
The new D&O policy takes effect, and the complaining owner surfaces with written threats or litigation. The association tenders the claim to both the old and the new D&O carrier. The prior D&O carrier denies the claim, because it wasn’t made during the policy period. The new D&O carrier denies coverage, either because the association failed to disclose the potential claim on the application, or because the new policy states it will not cover a claim, if the association knew of any prior facts or circumstances that might give rise to a claim.
Part 2
Addresses what associations should do to avoid having both the old and new carrier deny coverage. Part 2 also discusses being alert to “burning balance” policies, in which the coverage limit available to pay claims is reduced by the amounts expended in defense costs.
Never complete or sign an application quickly
Before completing it, the board and manager should review the events of the past year or longer for any incidents or complaints that may become a lawsuit or other claim against the association. New directors should review the correspondence of the past year and ask any employees, the manager and legal counsel if they are aware of any incidents that might give rise to a future lawsuit or other claims. If such incidents exist, the prudent course of action is to notify the current carrier of the potential claims before the policy ends, or at the very latest, before the end of any grace period provided in the policy. Also give notice of any claim or potential claim to the proper party, at the address and in the manner called for in the policy, keep a copy, ask for an acknowledgment and follow up.
The safest course of action for providing notice in the manner required by the policy is to provide the actual policy to the association’s attorney with any information on the potential claims or claims, then ask the attorney to give notice to the carrier. While many insurance policies require that notice be sent to the carrier by certified mail, return receipt requested, this is advisable even if the policy does not require it, as the returned receipt may be the only proof the association may have that it mailed timely notice. If the association finds that it is really up against a deadline, use a fax that provides a confirmation sheet or even email, if you can find an email address for sending the notice. At least try to speak with someone at the claims department of the company, and use the person’s name in any notice of a claim you send to the company. While some carriers allow claims to be submitted through the agents, many times the policy provides that the carrier has not received notice until it is actually received by some employee of the insurance company. If you are anywhere close to a deadline, do not assume that notice to your insurance agent is the same as notice to the carrier.
It is essential that all boards treat the applications for new insurance and changes in D&O carriers with seriousness and great care. The failure to do so can result in paying for uninterrupted coverage and yet being denied coverage when it is needed.
How to end up with less coverage than what might be expected
A second issue that is often overlooked both in D&O and general liability policies is what is sometimes called a”burning balance.” Each association should know if defense costs are part of or paid in addition to the coverage limits. The former is what is called a “burning balance,” because the carrier will deduct any attorneys’ fees and costs incurred to defend a claim from the limits of liability. In other words, under a burning balance policy, the amount available to pay the claims or to settle the case is reduced by every dollar spent in defense. For example, if an association has a $1,000,000 policy, and a large potential claim (or perhaps multiple claims that could be significant in one policy period), and if the association expended $150,000 in defending the claim or claims, it would have only $850,000 left to pay any and all judgments or settlements during that policy period.
If an association is evaluating insurance policies, it needs to be aware that two policies that are identically priced and identical in every respect except for the burning balance are not a comparable value, since the burning balance policy presumably will have less available to pay claims. So, if an association purchases a burning balance policy, it should seriously consider increasing its limits of liability to be sure that there will be enough coverage to pay out any claims that it may encounter.
Also recognize that the limits of liability are the maximum that the carrier will pay in any policy period. So if an association has a $1,000,000 policy and incurs a $300,000 claim early in the policy period, there will be only $700,000 left to pay all other claims that may occur for the remainder of that policy period. Fortunately, major liability claims are rare. However, if an association were to experience a large claim, or multiple injuries or claims arising out of the same incident in any given year, a burning balance could have a serious impact on the association’s ability to defend and pay liability claims.
Associations should evaluate their current policies for “burning balance” provisions and anytime they are comparing policies prior to a possible change in coverage.
Additional Insurance Information Available
For greater details about the issues to consider when evaluating insurance policies, please contact our office.