Delaware Legislation Permits Use of Captive Insurance for D&O Liability

Last week, Delaware amended its General Corporation Law (DGCL) to allow Delaware corporations the ability to utilize captive insurance in lieu of purchasing directors and officers (D&O) liability insurance. Captive insurance companies are owned, controlled and funded by the corporate entity and hence there is no risk transfer to a third party insurer. Prior to the enactment of the Delaware legislation, it was unclear whether a corporation had the ability to utilize captive insurance to protect insured persons with respect to non-indemnifiable liability (e.g., derivative litigation or situations in which the corporation was unable or unwilling to indemnify its directors and officers). While utilization of captive insurance has historically been limited with respect to D&O liability, it has been allowed to provide coverage for indemnifiable loss (the majority of potential claims) as well as coverage for securities claims involving the corporate entity.

The revisions to the DGCL likely constitute a reaction to current challenging “hard market” conditions associated with D&O insurance, characterized by increasing premiums and deductibles, reductions in limits of liability and restrictions in the scope of coverage terms and conditions. The purchase of traditional D&O insurance has historically been permitted to cover alleged breaches of fiduciary liability, among other potential management liability exposures, but now the utilization of captive insurance permits an alternative for risk transfer. Captive insurance utilizes a “fronting” or reinsurance strategy wherein the insured company procures insurance from a third party but ultimately retains the liability via its own established captive entity. Importantly, the option for captive insurance contains exclusions historically reflected within traditional D&O insurance policies. These exclusions include allegations pertaining to personal profit, criminal or deliberate fraudulent acts and known violations of law.

Utilization of a captive for D&O exposures likely works best for companies that already have an established captive insurer associated with other insurance exposures (e.g., workers’ compensations, property or general liability) as there are costs associated with establishing a captive. Potential bankruptcy scenarios also must be considered in the event that that the company has not completely funded the captive. Traditional insurance typically provides that bankruptcy of the insurer does not relieve the insurer of its coverage obligations, which is certainly of benefit to insured persons and the insured entity.

While the option to insure D&O exposure via a captive is intriguing, it remains to be seen whether this new alternative will be actively pursued. Changes in insurance market conditions must also be continuously monitored to determine whether traditional risk transfer to third party insurers constitutes a more efficient solution to D&O exposure on the part of insured persons and the company, which has traditionally been the case.