INSURED V. INSURED EXCLUSION – WHAT IS IT ALL ABOUT IN THE COMMUNITY ASSOCIATION’S DIRECTORS AND OFFICERS POLICY
By Joel W. Meskin, Esq., CIRMS
Copyright © 2009
The directors & officers policy is a critical piece of the community association insurance puzzle. The community association world includes condos, homeowner associations, timeshares and other entities. These entities have two items in common.
- Membership is based on real property ownership – a condo unit, a single family home, a timeshare interval or a similar “individual property interest.”
- The second element in the equation is that these individual members have a “common interest” with the other members of the association – the common areas, pools, other amenities and the common conditions, covenants and restrictions on the individual and common property.
Due to the nature of these associations and the shared common interest, they require a method to manage the common interests. In the normal course, this management is done by a group of volunteers. This group of volunteers is normally a board of directors elected or appointed pursuant to the association’s by-laws to manage the association. The board is authorized pursuant to the association governing documents to do what is necessary to manage the common interests. These board members are required to use their “business judgment” to manage. As shocking as it may be, the boards are often challenged for their decisions. In order to encourage individuals to volunteer for these positions, the association needs to obtain directors and officers insurance to protect them when their decisions are challenged.
As with any insurance policy, the directors and officers policies have certain exclusions. One of the key exclusions found in a directors and officers’ policy is what is referred to as an “Insured v. Insured” exclusion. Contrary to most perceptions of insurance consumers, exclusions are not randomly inserted in a policy. Rather, exclusions are inserted so as to eliminate risks that may otherwise make a policy unaffordable to consumers and to avoid risks that were not intended to be included in a policy for public policy type reasons. In the directors and officers policy, a historical issue that led to the inclusion of the “insured v. insured” exclusion was “collusion.” This exclusion originated in the for-profit directors and officers policies and was carried over into the community association context as the policy was created.
The typical situation that motivated this exclusion was where a board of directors made a decision that the board itself realized was in hindsight a bad decision and as a result there was some form of loss to the association. As a result, the board itself decided to sue it or one another to trigger the directors and officers insurance policy to pay for this mistake (otherwise defined in the policy as a “wrongful” act). The intent of the policy was to defend or indemnity the board when the board’s decision was challenged by others and not to protect the board from its own identified wrongful acts. In the insurance world, this would lead to what is otherwise known as a “morale hazard.” Similarly, the policy does not contemplate actions by the entity itself against the directors and officers for imprudent decisions or unexpected consequences of everyday decisions.
In the community association context, these concerns do exist, but generally the decisions being made are not of the same financial consequence as with for profit or public corporations. Challenges to the community associations are not generally of the collusive type, but rather genuinely challenges by association members or third parties. There are two general types of “insured v. insured” exclusions found in the community association context. One is what we characterize as a pure “insured v. insured” exclusion and the second is a hybrid exclusion often referred to as an “entity v. insured exclusion.
The first example below is an insured v. insured exclusion where for all intents and purposes, any action between two “insureds” as defined in the policy would not be covered.
The Company shall not be liable to make payment for Loss or Defense Costs (except where otherwise noted) in connection with any Claim made against the Insured arising out of, directly or indirectly resulting from or in consequence of, or in any way involving any Claim by, at the behest of, or on behalf of the Organization and/or any Individual Insured; provided that this Exclusion shall not apply to:
(1) any derivative action on behalf of, or in the name or right of the Organization, if such
action is brought and maintained totally independent of, and without the solicitation,
assistance, participation or intervention of any of the Insureds; or (2) a Claim that is brought and maintained by or on behalf of any Individual Insured for contribution or indemnity which is part of or results directly from a Claim which is otherwise covered by the terms of this Policy
The second example if more of a hybrid exclusion where it is more limited to actions by the “Organization” or “Entity” against other insureds, but does not limit actions between “Individual Insureds.”
The Insurer shall not be liable to make any payment for Loss in connection with a Claim made against any of the Insureds brought or maintained by or on behalf of the Insured Organization, except a Claim that is brought and maintained totally independently of, and totally without the solicitation, assistance, participation, or intervention of any officer, director or trustee of the Insured Organization.
The second example of exclusion is truly focused on addressing the historical intent of the “insured v. insured” exclusion by preventing the concerns of collusion and the concern or morale hazards where the insured is attempting to create a warranty against its poor or imprudent business decisions. The coverage is to protect the board not “from itself” but from non-insureds. This is similar to the exclusions on a homeowner policy where the “family members” can not recover under the homeowner’s policy by suing one of its other family members. Specifically, while a son can sue his parents when he injures himself by slipping on the front steps, the parents will not be covered for this loss under their homeowner’s policy. The logic should be clear here as it clearly avoids collusion (not that any insureds would ever consider insurance fraud)
The issue that has to be addressed is whether these exclusions are good for community associations. At first glance, insureds do and should want as broad an insurance policy as possible. On the other hand, insureds, including community associations want and should want to have affordable coverage while obtaining broad coverage. The key is a basic cost benefit analysis. Let’s say that all Insured v. Insured exclusions are removed from the policy. The benefit seems at first glance to be a no-brainer – isn’t it always good to remove exclusion? Let’s look at some of the “costs” in the cost/benefit equation:
- Removing the exclusion will make the policy more susceptible to claims which will impact the coverage in general as additional claims are covered and premiums are increased.
- Does the association want to provide the renegade board member with coverage when the association determines it is necessary to bring an action against him or her to prevent him or her from doing something that the remainder of the board determines is not in the best interest of the association? This would include creating a litigation war chest for that board member or the community manager when the association sues either.
- Does the association want to cover in-fighting between board members? Are these disputes in the best interest of the community association to pay for board members from being able to handle their duties and obligations?
In the community association context, many carriers have gone with the second type of exclusion which precludes the actions that fall within the “collusive” nature where the board is suing itself, but not limiting the actions between individual insureds, because these really have not be a chronic issue, but which protect board members when that renegade board member sues another board member who is doing what he or she believes is in the best interest of the community association.
In conclusion, the “Insured v. Insured” exclusion is not a random addition to the policy, but in the community association context, hybrid exclusion has been developed in many policies to protect the ultimate issues and concerns from an actuarial standpoint.
Author: Joel W. Meskin, Esq., CIRMS, Vice President for Community Association Products, McGowan & Company, Inc.
The author would like to acknowledge the research assistance for this article by Shannon Hoffman, Underwriter for McGowan & Company, Inc.
Circumstance that increases the probabilityof occurrence of a loss, or a larger than normal loss, because of an insurance-policyapplicant’s indifferent attitudeafter the issuance of policy. For example, he or she might be careless in locking the doors and windowswhen leaving home. In common usage, morale hazard indicates that the insuredpartyunconsciously changestheir actionsor behaviors, as opposed to a deliberate change in order to cheat the systemor benefitfrom his or her circumstances. BusinessDictionary.com
The typical community association directors and officers’ definition of “Insured” will include within its definition “Individual Insureds” and the “Organization” or “Entity.” The “Individual Insured” will normally include past, present or future directors and officers, committee members, volunteers, employees and community managers. The “Organization” will be the association itself.