|D&O insurance rates are going down—and a D&O captive may still be an attractive alternative to the traditional commercial D&O insurance market in the right circumstances. With Meta’s permission, my partner Lauri Floresca discusses the innovative approach Meta has taken by standing up a captive for D&O liability risk. – Priya Huskins|
In 2022, Delaware approved using captives for D&O insurance, paving the way for Meta (the parent company of Facebook and Instagram) to put Side A coverage in its pre-existing traditional captive. Meta is the first Delaware-incorporated company to do so, and it also purchased a “Laser DIC (difference in conditions)” insurance policy for coverage gaps.
We spoke about Meta’s captive and Side A Laser DIC policy with Janaize Markland, Meta’s director of business risk and insurance; Nick Troxell of Allianz Global Corporate & Specialty; and Richard Cutcher for his Captive Intelligence podcast. Here are some takeaways from our conversation.
Want to learn about the basics of D&O insurance?
Why Companies Are Turning to Captives for D&O Insurance
As the market for D&O insurance began to harden in 2019, companies experiencing sticker shock began to look for other options.
Most public companies are incorporated in Delaware, where companies historically weren’t allowed to use their own balance sheet assets to indemnify directors for the settlement of derivative lawsuits. Public companies with big balance sheets tend to self-insure securities class action risk, which is the majority of their D&O exposure, but they continued to purchase Side A insurance because derivative settlements and judgments could not be covered by the company.
Side A insurance was inexpensive since it was typically only used when there was a bankruptcy, and the company’s balance sheet couldn’t fund a class action settlement. However, the plaintiffs’ bar has started to come after companies with big balance sheets for large derivative settlements. This increase, in turn, has driven up the price of Side A insurance by 300%–500% over the last few years for most companies.
Meta, along with other companies, worked to change Delaware law to allow captive insurance as a viable alternative to traditional D&O insurance and succeeded in January 2022.
Meta already had a traditional captive, and it wanted to ensure that when adding D&O coverage, there would be assets dedicated to directors and officers. Its solution was to create two cells—one for D&O and one for everything else. This step provided an extra layer of comfort for directors and officers, ensuring those assets were reserved for their needs.
What Is Laser DIC?
The new Delaware legislation allows captives to cover nearly all exposures normally covered by D&O insurance, but there are a few exceptions. At Woodruff Sawyer, we didn’t want a Delaware company to adopt the solution and then have its board members realize they had less coverage than when they were buying in the commercial market. Therefore, our team scrutinized the captive policies, and Meta’s outside counsel reviewed them to make sure we all knew exactly what the captive could and couldn’t cover.
That’s how we formulated what we call the Laser DIC, with the “laser” reflecting the way the policy provides very specific coverage just for those differences.
Pricing the Laser DIC
On the brokerage side, we had to convince D&O insurers to support this Laser DIC product. Since the coverage is a sliver of what they’re already covering in a commercial Side A product, it should be priced accordingly. If the captive is well funded, it bolsters the argument that the Laser DIC premium should be very low since bankruptcy is one of the exposures the policy covers.
However, pricing is going to be different for every client. Traditional D&O insurance is priced according to the risk profile of a specific company, and the Laser DIC would have some relation to that original pricing.
As carriers get more comfortable with Laser DIC and similar policies, we expect that premiums will continue to improve relative to standard Side A insurance.
Can Other Companies Insure Their D&O with a Captive?
Often, the types of claims we see in the D&O world don’t lend themselves to the captive methodology in reserving and planning for claims. Each company will have a different analysis as to whether it wants to go big on the captive strategy or just have it as a backup or provide some incremental coverage for directors.
The D&O captive is a solution for a very specific set of companies. Companies that are good candidates:
Other companies that may want to consider this solution include:
Ultimately, the decision to use a captive for D&O insurance is a risk financing decision. Where to put it in your stack and the best way to optimize for that pricing are choices that are specific to every company.
Companies considering a captive should pay attention to the capital requirements. In most cases, the structure involves funding 100% of the limit and keeping it tied up for multiple years, so companies need to have a long-term view.
The captive itself would be bankruptcy remote, but directors will want to make sure the captive will have the assets to pay the claim when the time comes. In D&O, that can be five to eight years from the time it is filed, or sometimes even longer.
Get Creative with Your Captive
For companies looking at a D&O captive, there are many ways you can structure it. It’s worth taking the time to do it right. Also, make sure your directors understand what you’re proposing. For example, the Laser DIC product Meta purchased is probably not required, and some companies may choose to forego it. But as a risk manager, you’ll want to make sure your board understands the differences between what is in the commercial market and what the captive is allowed to cover.
And as Troxell from Allianz said, the minimal Laser DIC coverage method is just one way to use a captive. Other companies may want to include more commercial insurance or may need to consider local policy needs. There’s flexibility and creativity in choosing a captive/D&O insurance mix that’s right for your company.
Talk to your Woodruff Sawyer Account Executive to learn more about this strategy and other options.