Questions and Concerns Surrounding Side A Insurance

Questions and Concerns

Surrounding Side A Insurance

Panelists:

John E. Failla, Proskauer

Michael Morales, Everest Specialty

Joseph Girdusky, Allied World

October 1, 2014

http://www.everestre.com/en-us/home.aspx

QUESTIONS AND CONCERNS

SURROUNDING SIDE A INSURANCE

• The Panelists:

-John E. Failla

Partner, Insurance Recovery and Counseling Group,

Proskauer Rose LLP

-Michael Morales

Vice-President, Claims

Everest Specialty Underwriters

-Joseph Girdusky

Assistant Vice President

Allied World Assurance Company




Agenda

• Introduction and Emerging Trends

• Summary of Side A DIC Insurance

• Claims Nuances and Emerging Issues

- Challenging Scenarios

Drop Down Due to Anticipated and Unanticipated DIC Situations

Unintended Circumstances Involving the Interplay

Between Side A DIC Coverage and Conventional D&O Coverage

• Related Securities Class Action and Derivative Claim

• Criminal and Regulatory Matters

• Practical Guidance


INTRODUCTION AND EMERGING TRENDS

• Side A Insurers are now paying large losses

• Substantial Exposure to Defense Costs

• Plaintiffs’ attorneys now routinely ask about Side A Coverage

• Increasing frequency of Regulatory and Criminal matters targeting

directors and officers

• Significant settlements of Shareholder Derivative Lawsuits

- News Corp. $139 million

- Oracle $122 million

- El Paso/Kinder Morgan $110 million

- Broadcom $118 million

- HealthSouth (Richard Scrushy) $2.876 billion

- Southern Peru Copper $1.262 billion

- UnitedHealth Group $900 million (nominal value)


SUMMARY OF SIDE A DIFFERENCE IN

CONDITIONS (“DIC”) INSURANCE

• Policy Provisions Are Not Uniform – Wide Diversity of Products

• Three General Types of Side A Policies

- Excess Side A Coverage

- Side A Difference in Conditions (“DIC”) Coverage

- Independent Director Liability (“IDL”) Coverage




• Excess Side A Policies

- Excess coverage for non-indemnifiable Loss

• Side A DIC Policies

- Designed to be the Ultimate Backstop for Transferring Risk of

Personal Liability for Directors and Officers

- As a Result, Side A DIC Policies Generally Provide Very Broad

Coverage

Provide both Excess Side A Coverage Upon Exhaustion of the A-B-C

Tower and Broad Difference in Conditions Coverage

DIC Coverage also drops down into the underlying A-B-C program if a

Loss is not paid by the underlying A-B-C insurers for any reason, including

the underlying insurer's failure, refusal or financial inability to pay the Loss.




- Side A DIC Policies typically contain terms to effect broad coverage

Typically are non-rescindable in whole or in part

Typically are not limited by presumptive indemnification – policy applies

even if company refuses wrongfully to indemnify or is permitted to

indemnify

Broad trigger for regulatory, investigation and criminal matters

Exclusions are generally limited

Pollution exclusion, ERISA exclusion, insured v. insured exclusion

often limited and sometimes eliminated

Conduct exclusions often contain narrower trigger and do not bar

coverage for Defense Costs

Consent and notice provisions often relaxed




• Independent Director Liability (“IDL”) Policies

- Cover only independent outside directors and not officers

- Provides even broader coverage than Side A DIC policies

- DIC coverage that drops down but is not exhausted by payment of

company losses or losses incurred by officers

-May contain even narrower exclusions than other DIC Policies

Some do not include conduct exclusions (fraud, personal profit) for

independent directors

Insured v. insured exclusion often eliminated


CLAIMS NUANCES AND EMERGING ISSUES

• Misperceptions About Side A DIC or IDL Coverage

- Drops down only in four or five enumerated circumstances listed in

the policy

- Shareholder derivative claims are the only real exposure

- Largely follows the form of the Side A coverage in the A-B-C Tower

- Need not be considered until the A-B-C Tower has paid limits or

determined coverage

• These are misleading perceptions.

- Extraordinarily broad coverage terms of Side A DIC policies give rise

to numerous claims-handling issues that are unusual and not typically

encountered under traditional D&O policies


CLAIMS NUANCES AND EMERGING ISSUES

• Does the Side A Loss involve a drop down due to an anticipated or unanticipated DIC situation?

• Does the Side A Loss arise from unintended circumstances or unique issues involving the interplay of the underlying A-B-C Tower and the Side A coverage?

• Issues Arising From Related Securities Class Action and Derivative Action

• Criminal Matters and Governmental or Regulatory Investigations

Side A DIC

Claim Issues


DOES THE SIDE A LOSS INVOLVE A DROP

DOWN DUE TO AN ANTICIPATED OR

UNANTICIPATED DIC SITUATION?

• Anticipated DIC Drop Down Situations

• Must Be a Non-Indemnifiable Loss

-Bankruptcy or Insolvency of Underlying Insurers

-Exhaustion of Underlying Policy Limits Through Payment of

Loss

-Failure or Refusal of Underlying Insurers to Provide Coverage

Side A Claims-Handling Dilemma

Engage the A-B-C Insurers to Pay the Loss to Preserve Side A

Limits

Or

Pay the Loss Promptly to Avoid Prejudicing the Insureds and

Subrogate Against the A-B-C Insurers





• Unanticipated DIC Drop Down Situations

• Must Be a Non-Indemnifiable Loss

-Differences in coverage provisions between the underlying

A-B-C D&O policies and the Excess Side A DIC coverage

Side A Carve Backs in Underlying A-B-C Policies (professional services

exclusion, pollution exclusion)

Loss definition

Less restrictive or eliminated Insured v. Insured Exclusions

Less restrictive Conduct Exclusions

-Loss Resulting From International Exposures

FCPA Claims and Other Loss From Foreign Entities and Operations

Presumption of Indemnification Doubtful





Loss Resulting From International Exposures

• Loss Resulting From International Exposures and Foreign

Subsidiaries or Affiliates May Result in Unanticipated Side A

Exposures

• Increasing Frequency of Foreign Subsidiaries, Affiliates, Joint

Ventures

• Increasing shareholder and Government Claims in many foreign

jurisdictions

• Increased focus of government regulators on international

regulatory and criminal enforcement – FCPA, antitrust, money

laundering, securities regulation






• Presumption of Indemnification Does Not Apply In Several Other

Countries

- UK – company may not indemnify a director against liability to the company

(but can regarding third parties) in connection with any negligence, default,

breach of duty or breach of trust, and cannot cover defense costs for legal

proceedings in which he or she loses

- Brazil, India, China, Russia, South Korea, UAE, Argentina – law is silent or

unclear as to whether company assets may be used to indemnify directors

and officers

- Japan Italy, Israel, Singapore, South Africa – indemnification permitted upon

director being exonerated

- Germany – right to indemnification dependent on final adjudication that

director did not act in breach of his or her duty to the company






• Local foreign policies may be less robust - low limits and more

restrictive terms

• Two tier board structures (e.g., Germany) may erode underlying limits

more quickly

• Master Side A DIC Policy covering full umbrella of directors and

officers of all corporate entities will likely be more robust and offer

broader coverage with less restrictive exclusions

• Absence of advancement or indemnification, reduced coverage under

local underlying policies, increase in liabilities in foreign jurisdictions

increases Side A and DIC exposures and creates unexpected claim

issues


DOES THE SIDE A LOSS ARISE FROM UNINTENDED

CIRCUMSTANCES OR UNIQUE ISSUES INVOLVING

THE INTERPLAY OF THE UNDERLYING A-B-C

TOWER AND THE SIDE A COVERAGE?

• 1. Related Class Actions and Shareholder Derivative Actions

- Challenging scenario when settlement demands in underlying suits

exceed the limits of liability remaining under the A-B-C D&O policies

Potential disputes as to settlement amounts assigned to the securities

class actions (indemnifiable loss and entity coverage) and to the derivative

claim (Side A Loss)

Potential disputes as to order in which those policies’ limits must respond

(e.g., whether Side A claims, such as derivative claims, or Side B and C

claims, such as class actions, must be paid first)

Potential disputes as to relative payments and order of payments, if any,

by the A-B-C Tower Insurers, the Side A DIC Insurers, and the Insureds

- Priority of Payment Issues and Settlement Strategies

- Settlement Allocation and Valuation Issues






• Priority of Payment Issues and Settlement Strategies

• Different settlement strategies for settlements of a securities class action

and a related shareholder derivative lawsuit

Both settlements occur at the same time

Priority of payment provision - the A-B-C insurers should pay the

derivative settlement first before using the remaining A-B-C limits

to pay the class action settlement.

Preserves the Side A policy limits for other losses, but reduces

the amount of the A-B-C policy limits available for the company's

settlement of the class action lawsuit.

Pass-through settlement structure presents potential conflicts

among policyholders, A-B-C insurers and Side A DIC insurers






Settle only the class action first and attempt to settle the derivative

action later

Attempt to access the full A-B-C limits for the company settlement

of the securities class action to maximize the Side B and Side C

coverage for the company settlement

Use the Side A DIC limits for the settlement of the derivative

action

Maximizes available insurance coverage

May pose certain risks – if the derivative lawsuit cannot later be

settled for an amount within the remaining Side A limits, the

directors' and officers’ personal assets will be exposed to the

uninsured and non-indemnified derivative settlement amount.


HYPOTHETICAL CASE INVOLVING THE INTERPLAY

OF THE UNDERLYING A-B-C TOWER AND THE SIDE

A COVERAGE?

• Hypothetical Securities Class Action and Derivative

Action Case

-Side A-B-C Tower of $75 million

-Excess Side A DIC Tower of $25 million

-Settlement of related securities class action and derivative

action

Total settlement $100 million

• $75 million for settlement of class action

• $25 million for settlement of derivative action




A COVERAGE?

• Possible Outcomes

- 1. Payment of Full Insurance Limits and No Company Payment

• A-B-C Insurers Pay $75 million

• Excess Side A DIC Insurers Pay $25 million

• Company and Directors and Officers Pay $0

- 2. Apply Priority of Payments Provision in A-B-C Policies

• A-B-C Insurers Pay $25 million for Derivative Claim First (Individual

Side A Loss paid first)

• A-B-C Insurers Then Pay $50 million for Class Action Settlement

(Remaining Limits)

• Shortfall of $25 million – Coverage Uncertain

• Range of Possible Outcomes




A COVERAGE?

• Settlement Shortfall of $25 million – Possible Outcomes

1. $0 Payment by Side A DIC Insurers and $25 million Payment by Company

Not Covered by Side A DIC - Class Action Loss Is Indemnifiable

2. $25 million Payment by Side A DIC Insurers and $0 Payment by Company

Exhaustion of Underlying Limits

Remainder of Class Action Settlement Properly Allocated to

Individual Director and Officer Defendants Under Certain Allocation

Principles

3. Between $0 and $25 million Payment by Side A DIC Insurers

Remaining $25 million Class Action Settlement Allocated Between

Company and Individuals Under Best Efforts or Relative Legal

Exposure Tests

Leads to Payment of Some Portion of the $25 million by Side A DIC

Insurers (amount allocated to directors and officers) and Payment of

Remainder by the Company – Highly Uncertain






• 2. Criminal Matters, Governmental and Regulatory Investigations

Examples

Indemnification Issues

Side A Exposures






• Growing perception that civil litigation is an ineffective deterrent:

(Dismissals & Corporate Indemnification of Individuals)

-Responsible Corporate Officer Doctrine: (Indirect

Participation) (Food & Drug Industries), (‘the crime of doing

nothing”)

-Foreign Corrupt Practices Act/U.K Bribery Act

-FIRREA

-Operational Crimes: (Deepwater Horizon, Penn State)

-Criminal Antitrust: (More targets; longer prison sentences)

- Insider Trading


DOES THE SIDE A LOSS ARISE FROM A

CRIMINAL MATTER OR A GOVERNMENTAL

OR REGULATORY INVESTIGATION?

• Side A DIC Claim Implications

• Claim includes any criminal proceeding against Insured Persons

• Conduct Exclusion: Narrow conduct exclusion & a narrow indemnification

statute = Potential Side A Exposure

- Factors:

- (1) scope of the wording

- (2) the trigger event/timing

- (3) scope of defense costs coverage (IDL, Payback provisions)

• Fines & Penalties: Exceptions to the Exclusions

- Civil penalties for a non-intentional violation of FCPA

- Subject to public policy limitations & terms of any plea agreement






• Certain Criminal and Regulatory Statutes or Settlements May

Preclude Indemnification, Thereby Increasing Side A Exposure

• Uncertainty of Evolving and Potential Future Criminal and

Regulatory Proceedings against Individuals Complicates

Resolution of Side A Claims

- Holdbacks for Future Loss Arising from Criminal and Regulatory

Claims

- Carve-outs From Claim Releases


PRACTICAL GUIDANCE

• Purchase Side A DIC Coverage From Experienced Insurers

• Terms and Conditions Must Be Negotiated Aggressively

• Cooperation, Information and Participation From the Earliest

Stages of the Claims Process


JOHN FAILLA PARTNER, INSURANCE RECOVERY & COUNSELING GROUP

Mr. Failla has more than twenty years of experience focusing on

insurance recovery for business policyholders.

In the past few years alone, he has helped clients recover more than a

billion dollars from their insurers through litigation, alternative dispute

resolution or negotiation in a wide range of issues, including directors and

officers’ liability, mutual fund claims, complex financial fraud recoveries,

property and business interruption claims, secondary life insurance

transactions and privacy, cyber-risk, and data security claims.

Mr. Failla regularly advises members of corporate boards and corporate

officers on emerging liability risks and ways to improve their insurance

coverage. He also advises and counsels clients on risk management and

underwriting issues, negotiating insurance policy language, and

structuring commercial and captive insurance programs.

Mr. Failla is a graduate of New York School of Law and a Fellow of the

American College of Coverage and Extracontractual Counsel.

t: 212.969.3141

[email protected]


http://www.proskauer.com/

MICHAEL MORALES Vice-President, Claims Everest Specialty Underwriters [email protected]

• Mike is a Vice President of Everest National Insurance Company and leads the

Everest Specialty Underwriters (ESU) Claims organization. The ESU focus is on

the professional lines markets, specifically directors and officers and errors and

omissions products for the primary insurance market.

• Prior to appointment to his current position in 2009, Mr. Morales was Vice

President of Claims for the Financial Institutions Group of AIG Domestic Claims, a

member company of American International Group, Inc (AIG). He also served as

a Divisional Vice President and Product Manager for the Professional Liability

Underwriting Division of AIG member company National Union Fire Insurance

Company of Pittsburgh Pa.

• Mr. Morales has over 25 years of insurance experience in the underwriting and

claims disciplines and has served the insurance needs of professional service

providers nationwide.


JOSEPH GIRDUSKY ASSISTANT VICE PRESIDENT - PROFESSIONAL LINES AT ALLIED WORLD

Joseph Girdusky is an Assistant Vice President within Allied World’s

Directors & Officers Liability claim unit.

Mr. Girdusky began with Allied World more than 7 years ago and

currently handles a wide range of complex and high exposure D&O

claims, including public, private and NFP matters, on a primary and

excess basis.

In addition, Mr. Girdusky manages two TPA programs involving

D&O, E&O and EPL matters.

Prior to joining Allied World, Mr. Girdusky worked at several other

insurers, including AIG, Zurich and Empire Insurance Company, for

more than 10 years handling a wide range of professional lines

claims.

Before entering insurance, Mr. Girdusky worked for more than 5

years in the retail banking industry.

(646) 794-0536

[email protected]




Q & A


Questions and Concerns

Surrounding Side A Insurance
