D&O Duty to Defend vs. Reimbursement Policies

If your company’s leaders are named in a lawsuit, who will handle the defense: your company or your insurer? If your company’s directors or officers are sued for wrongful acts, your directors and officers (D&O) insurance will cover the cost of the defense as well as the settlement or other fees. How this plays out, though, will depend on whether you have a D&O “duty to defend” or reimbursement policy.

Duty to Defend vs. Duty to Pay

If a liability policy has a “duty to defend” clause, the insurer is obligated to provide defense for claims. According to IRMI, this duty typically kicks in if there is a potential for coverage. This means the insurer still has a duty to defend if your coverage is in doubt. The duty to defend applies when claims are ultimately found to be baseless. It may also apply when the policy only partially covers claims. An insurer that has a duty to defend is responsible for selecting legal representation and may select in-house counsel.

Insurance policies that work on a reimbursement basis require the insured to arrange for legal defense and select legal counsel. The insurer will reimburse the costs under the terms of the policy. The term “duty to pay” also describes a reimbursement-based arrangement that forms the alternative to the “duty to defend” clause. You may also see the term “non-duty to defend.”

Deductible vs SIR

There’s another significant difference between duty to defend and reimbursement policies: as Insurance Journal explains, most duty to defend policies use a deductible, whereas most reimbursement policies use a SIR. This is important because deductibles and SIRs work differently – even though people often confuse the two terms.

• A SIR (or self-insured retention) is the amount the policyholder is responsible for paying. The policyholder must satisfy the SIR before the insurer becomes involved in the claim.
• The policyholder is also responsible for paying the deductible. However, the policyholder may not need to pay the deductible up front. Rather, the insurer will handle the claim (up to the policy limit and as per the terms of the policy) and then require reimbursement for the deductible from the policyholder or deduct the amount from the settlement.

Which Is Better?

Policyholders usually prefer to have their insurers handle defense. This makes sense in many cases, as the insurer will be experienced with the type of lawsuit in question, whereas the insured may have little to no experience with such lawsuits. Furthermore, the insurer likely has access to expert legal counsel at good rates, whereas the insured might end up paying more for the same (or lower-quality) counsel.

Insurance Journal also notes that with a duty to defend policy with a deductible, the policyholder won’t pay anything out of pocket until the settlement is reached. This may be preferable, as it gives the policyholder more time to prepare for the cost. IRMI also points out another advantage to letting the insurer pay for and handle defense from the start: although insurers may occasionally try to claw back funds for legal fees for claims they’ve determined the policy did not cover, it is more difficult for them to recoup costs they have paid than to withhold costs they have not yet paid.

Despite these advantages to insurer-led defense, some businesses may prefer to control their own defense. Large corporations may be especially likely to have this preference.

Understanding Your Policy

By taking the time to understand your coverage before a claim, you’ll avoid unpleasant surprises.

• What type of defense coverage do you have? Whether your policy uses a duty to defend clause or a reimbursement clause will likely depend on the type of policy. According to Insurance Journal, most private and nonprofit D&O policies work on a duty to defend basis, whereas most public D&O policies work on a reimbursement basis. Also look out for variations, such as policies that assign the insurer the right to defend but not the duty to defend.
• What are the claims reporting requirements? Insurance policies typically require prompt notification of claims or potential claims. Even if your company will need to handle the defense initially, you may need to report the claim and work with your insurer.
• Do defense costs erode the policy limit? This is often the case with D&O insurance. It’s something you should consider when selecting policy limits.

D&O insurance terms are often confusing. Heffernan Insurance Brokers can help you understand your coverage. We provide insurance designed to meet the needs of the technology industry, including D&O insurance. Learn more.