Introduction to the D&O Tower
In the world of corporate risk management, a single insurance policy is rarely sufficient to cover the potential liabilities faced by directors and officers of large organizations. To achieve the high limits required for adequate protection—often reaching into the hundreds of millions of dollars—brokers and risk managers construct what is known as an insurance tower. This tower consists of a primary layer of coverage sitting at the base, with multiple excess layers stacked on top.
Understanding how these layers interact is a critical component of the complete D&O exam guide. The tower structure allows for risk to be spread across multiple carriers, ensuring that no single insurer is exposed to the entire loss of a catastrophic claim. This article explores the mechanics of primary and excess layers, the critical importance of 'follow form' language, and how these policies function during a loss.
Core Components of a D&O Tower
The Primary Layer: The Foundation of Coverage
The Primary Layer is the first policy to respond to a claim. Because it is 'first dollar' coverage (after the retention is met), the primary insurer carries the greatest risk of loss and handles the majority of the administrative work. The primary policy's wording is the most important document in the tower because it typically sets the terms, conditions, and definitions that the excess layers will follow.
Key responsibilities of the primary carrier include:
- Claim Handling: The primary carrier usually leads the defense, manages the panel of lawyers, and negotiates settlements.
- Policy Language: The primary policy defines what constitutes a 'Wrongful Act,' who is an 'Insured Person,' and what 'Loss' includes.
- Retention Management: The primary carrier tracks the payment of the self-insured retention (SIR) or deductible by the corporation.
Because the primary insurer is the most likely to pay out on any given claim, the premium for this layer is significantly higher per million dollars of coverage than the layers sitting higher in the tower.
Primary vs. Excess Layer Comparison
| Feature | Primary Layer | Excess Layer |
|---|---|---|
| Response Order | First to respond after retention | Responds only after lower layers are exhausted |
| Policy Wording | Full, bespoke policy form | Short-form 'Follow Form' document |
| Defense Obligations | Primary duty to defend/pay costs | Usually no duty to defend; pays indemnity only |
| Pricing | Highest premium (High frequency) | Lower premium (Low frequency, high severity) |
The 'Follow Form' Concept
An excess policy is typically a 'Follow Form' policy. This means that the excess insurer agrees to provide coverage based on the same terms, conditions, and exclusions as the underlying primary policy. Without follow form language, a D&O tower would be a chaotic mix of conflicting definitions and exclusions, leading to coverage gaps where one layer might cover a claim while the layer above it does not.
However, 'Follow Form' is rarely absolute. Most excess policies contain a clause stating they follow the primary form 'except as otherwise provided' in the excess policy itself. This allows excess insurers to add their own specific exclusions or sub-limits. For example, an excess insurer might follow the primary form but add a specific exclusion for a pending litigation matter that the primary carrier was willing to cover.
When studying for the exam, it is vital to remember that the consistency of the tower depends on the alignment of these forms. If you want to test your knowledge on policy mechanics, try these practice D&O questions.
The Danger of Non-Concurrency
Exhaustion and Attachment Points
An excess policy 'attaches' once the underlying limits have been exhausted. Exhaustion usually occurs through the payment of judgments, settlements, or defense costs. There are two main types of exhaustion requirements found in excess forms:
- Actual Payment Exhaustion: Many older or stricter forms require that the underlying insurer actually pay the full limit of their policy before the excess layer kicks in.
- Functional Exhaustion: More modern, 'liberalized' forms allow the excess layer to attach if the underlying limits are exhausted by payments from any source (such as the insured paying the gap if an underlying carrier becomes insolvent).
The Attachment Point is the specific dollar amount at which the excess policy begins to pay. For example, if a company has a $10M primary policy and a $10M first-excess policy, the first-excess policy has an attachment point of $10M and provides coverage up to a total of $20M.