Assessing Potential ESG Gaps in D&O Insurance Programs
ESG initiatives are creating emerging exposures for public companies at a rapid rate. Greenwashing claims, emission litigation, cyber/privacy failures, and lawsuits related to diversity and inclusion failures are creating disclosure challenges and fueling litigation. Additionally, the SEC’s newly developed climate and ESG task force, and newly proposed cybersecurity rules signal tighter ESG oversight resulting in an increased potential for regulatory enforcement. Litigation can also be unpredictable and difficult to avoid, as evidenced by the recent Starbucks lawsuit which alleges Starbucks own D&I policies aiming to increase diversity, also inadvertently surmounted to discrimination (due to its race-based decision making). Given the current risk environment, corporate officers should carefully review their existing D&O insurance programs with these initiatives in mind. When assessing coverage, there are a few exclusions policyholders should pay particular attention to.
- Pollution Exclusion: As discussed a bit more in depth below, broad pollution exclusions preclude coverage for a much wider range of claims than simply the contamination of soil, water or property. They can extend to emissions into the atmosphere, violations of environmental regulations and a wider range of pollution related claims.
- Employment Practices Exclusion: Some D&O policies attach exclusions for “employment practice wrongful acts” which, as part of the definition, will often exclude claims alleging discrimination. Depending on the policy’s language, this exclusion has the potential of precluding coverage for any resulting D&I triggered securities claims or derivative litigation alleging the company failed to adequately implement its diversity and inclusion commitments as made in a company’s proxy statements.
- Bodily Injury/Property Exclusion: These exclusions are generally defined very broadly which also preclude coverage for claims involving “invasion of privacy” which can negate coverage for cyber/privacy failures. A number of carriers are also beginning to attach specific cyber liability exclusions which can be even more problematic.
While some carriers have already removed (or will agree to remove) these from their policy forms, companies with certain risk characteristics, those operating in certain sectors, and/or those with prior litigation, may find some of these unavoidable. In such circumstances, policyholders should attempt to soften the policy language as much as possible. Some of those options would include:
- Amending the preamble of the exclusions from; “for, based upon, arising from, in any way directly or indirectly related to, or in any way involving”, simply to “for” said claims. Such an amendment effectively narrows their application, requiring a direct causation.
- Narrowing the language contained within the exclusion itself. A broad pollution exclusion for example, may preclude coverage for the “release, escape, seepage, migration or disposal of any pollutant into or on real or personal property, water, or the atmosphere, or any regulation, order, direction, or request to test for, monitor, clean up, remove, contain, treat, detoxify or neutralize any pollutant”. In this particular policy form, pollutant is also defined broadly as “any substance located anywhere in the world exhibiting hazardous characteristic…including any air emission, odor…any solid, liquid, gaseous, contaminant, smoke, soot, fume, chemical or waste materiel”. In this example, any lawsuits or regulatory actions related to the release of (or statements pertaining to) a company’s carbon emissions would likely be excluded, among a wider range of other potential claims. Narrowing the policy language to remove some of the bolded terms above could mean the difference between a covered and uncovered claim.
- Negotiating a carve back for securities claims and non-indemnifiable claims in order to ensure coverage is in-tact for any resulting securities litigation and/or derivative litigation. This is an enhancement most carriers should be willing to accommodate.
In addition to the specific exclusions above, D&O policies also contain fraud exclusions which exclude coverage for intentional wrongdoing. With greenwashing claims including allegations of fraud, company directors should understand their scope of coverage should such claims arise. While the fraud exclusion clearly excludes coverage for any resulting settlements, D&O insurers do agree to provide defense costs until guilt is established. In the interest of ensuring those defense costs will in fact be provided, policyholders should ensure that the insurer agrees to provide defense costs until that guilt is established in the form of a final, non-appealable adjudication, in the underlying action. While this language is fairly standard within the industry, some carriers may only agree to provide coverage until there is a final judgement, which can jeopardize coverage. It’s also important to remember, many insurers reserve the right to recoup those defense costs following a finding of guilt. Company directors seeking the broadest coverage for non-indemnifiable claims should consider implementing a layer of Side A DIC D&O which often waive the right to recover any defense costs provided, even in the event of a guilty verdict. Due to the fact that many Side A DIC policies contain very few exclusions, they are also useful in bypassing the above exclusions in situations where the underlying carrier refuses to accommodate any requested amendments.
Some public companies placing coverage for the first time may also encounter prior acts exclusions which would preclude coverage for any claims alleging wrongful acts having occurred prior to the specified date. While these are rare, they are more common among companies with higher risk profiles. Due to the statute of limitations and due to the fact that these claims can often take years to materialize, directors and officers should avoid prior acts exclusions at all costs. On the same token, given the long tail nature of these claims, it’s imperative that corporate officers recognize when a claim is first made. Failing to recognize an SEC inquiry for example can wind up jeopardizing coverage. If the regulatory inquiry in question qualifies as a covered loss under the D&O policy and is not reported to the carrier in a timely manner, coverage could later be declined should it ultimately result in litigation during a following policy term.
In light of the growing risk of derivative litigation, corporate officers should review the overall scope of Side A D&O being provided by their underlying public D&O policy. Coverage for class certification fees, plaintiff attorneys fees, special litigation committee costs, books and records costs and entity nominal defendant coverage are amendments that are readily available in the current marketplace but often must be requested by the policyholder. With regulatory oversight increasing, policyholders should also carefully assess the scope of their policies’ regulatory coverage. Is coverage being provided for both formal and informal investigations? Does the policy require that inquiries specify the wrongful acts of named individuals? Is the policy providing affirmative coverage for costs related to document production, and fines and penalties (per the most favorable jurisdiction)? Do requests for injunctive/non monetary relief qualify as claims? Lastly, with some insurers requiring supplemental underwriting information pertaining to the company’s ESG policies and disclosures, corporate officers should remember that their underwriting responses and statements do become part of the application. Any misstatements made during the application process can negate coverage for any claims made against the entity and/or any directors or officers who were aware of the false statements at the time they were made.