Principles of D&O excess of loss insurance and challenges in claims processing

Most large companies have it and in the event of major losses, the spotlight is always put back on it: excess of loss insurance. It is also currently under discussion again due to the Wirecard case since, according to media reports, the insured sum of the D&O primary insurer, Chubb is almost used up. As soon as the US insurer has paid out the entire sum insured to the tune of EUR 15 million, the other insurers involved in the D&O insurance tower of Wirecard AG, the “excess of loss insurers” are responsible. But what purpose exactly does excess of loss insurance serve, what special features must be observed and what challenges does it present to brokers and policyholders in the processing of claims? In order to answer these questions, we have compiled below an overview of the purpose, structure and principles of excess of loss insurance. We also provide a brief insight into the Finlex claims practice on the challenges in claims processing.

Purpose and structure of excess of loss insurance

The maximum insured sum that an individual insurer can portray for a D&O risk does not usually exceed EUR 20 million; this amount is often even significantly lower. However, as has been observed in recent years, among other things, using the example of the D&O claim for the diesel affair, major damages quickly exceed this sum. Defence costs alone can quickly reach the double or triple-digit million range in extensive claims against several management bodies. For large companies, the sum insured offered by an individual insurer is therefore generally not sufficient. Their goal of still being able to purchase sufficient insurance cover is achieved thanks to excess of loss insurance.

With excess of loss insurance, the entire D&O risk is split “vertically” among several insurers. Several layers of insurance are stacked above the primary insurer, resulting in an insurance tower in which various insurers are involved, but which fundamentally hedges the same risk.

The primary insurer forms the basis on which the insurance tower is built. As the first insurer to have to respond to a claim, the primary insurer bears the greatest risk, which is why the premiums for the primary insurer are generally higher. If the insured sum of the primary insurer is used up, the 1st excess of loss insurer comes into play, who then makes an underwriting decision and, if necessary, provides insurance cover. If this sum insured is also exhausted, the 2nd excess of loss insurer comes next, etc. Thus, a claim can gradually deplete the entire insurance tower until the top of the tower is reached.

In addition to the “vertical” split of risk, there is often also a “horizontal” risk split (open co-insurance). Several insurers participate side by side in a layer or in the primary coverage of the insurance tower. If many insurers are found to be co-insurers in the respective D&O risk or are excess of loss insurers, insured sums of half a billion or more can be reached.

Principles of excess of loss insurance

Prerequisites for the excess of loss insurers’ duty of subrogation

In principle, the insured sums that are covered by excess of loss layers are connected to the capacities of the primary insurer and the potential preceding layers. The cover under excess of loss insurance is therefore generally only available after the underlying layers have been exhausted. However, the circumstances precisely under which the excess of loss insurers become liable for payment depend on the specific insurance conditions. For example, it may be stipulated here that the excess of loss insurer is only liable for payment if the capacities of the primary insurer have been exhausted within the scope of an insurance event. It can also be agreed, however, that even in the event of a new insured event occurring during the term of the contract, the excess of loss insurer is liable for payment if the insured sum of the primary insurer or of the previous excess of loss insurer is already used up due to another insured event (drop-down).

Consistent cover via “following form” contracts

It should also be noted that the basic contract – as well as the individual excess contracts – represent legally independent insurance contracts. The individual contracts are therefore also subject to the agreements made by the parties therein. However, since the contracts are intended to provide comprehensive cover for the same risk, it must be ensured as far as possible that the cover is uniformly designed throughout the tower and that all participating insurers make a consistent underwriting decision in the event of a claim. For this purpose, excess of loss insurance is usually taken out on the basis of “following form” contracts. This means that the excess of loss insurer offers insurance cover under the same conditions as the basic contract, unless otherwise stipulated in the excess of loss insurance contract.

Nevertheless, there are always clauses within the scope of excess of loss contracts that cannot be accepted by all insurers in the same form. Reasons for this are, for example, internal underwriting specifications or guidelines of reinsurers to be observed. In addition, the different interpretation of terms by the insurers can lead to different results in individual cases.

Challenges in claims processing

While there are usually management clauses between the co-insurers of a layer that, thanks to corresponding powers of attorney, ensure that the policyholder only has to submit declarations and notifications to the leading insurer, there is usually no such management clause between the various excess of loss insurers of an insurance tower. This means that each excess layer separately examines and assesses the contractual issues for its own insurance contract.

Overall, the legal independence of the contracts – as well as the lack of a “cross-layer” management clause – means that the obligations of the policyholder towards each insurer must be fulfilled independently. This has significant consequences for the broker managing a claim because the duties and obligations of the policyholder and the insured persons to be met are multiplied by the involvement of excess of loss insurers.

This is of practical importance, for example, in the case of claims reporting or claims updates, which must generally be carried out against the primary insurer and against each individual excess of loss insurer. Furthermore, each insurer is entitled to obtain disclosures and information about the claim, such that it is not unusual for each insurer to compile its own catalogue of questions and thus significantly increase the work and time required for brokers, policyholders and insured persons.

The coverage dispute under the law can also become very complex in individual cases. For example, insurers may have different views on the topic of coverage. The instructions or approvals issued by the insurers may also differ, e.g. when it comes to the appropriateness of hourly rates of the lawyers mandated with defending claims or to approvals for settlements.

Today, it is not uncommon for D&O towers to be formed with 10 or more participating insurers. On the one hand, this creates sufficient sums insured for complex major risks; on the other hand, the challenges for the parties involved also grow with the number of insurers involved. There are many pitfalls to consider when designing these multi-layered insurance towers as well as when processing claims. Even in the current D&O case of Wirecard AG, the constraints of excess of loss insurance will certainly play a role. However, large claims such as this also always present an opportunity to put existing clauses to the test and to learn from any problems that may arise for the future.