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Hard-to-find punitive damage coverage is tricky business

Policies written offshore to insulate products, lawyer says


Obtaining punitive damages coverage when a state declares such damages to be uninsurable can be tricky, but observers say some underwriters are willing to write the policies, albeit offshore.

Some states, including California and New York, hold that punitive damages generally are uninsurable as a matter of public policy. But punitive damage wraparound policies have been available for more than a decade from a handful of underwriters in the Bermuda market, market observers say.

Coverage is written offshore for a simple reason, a policyholder attorney said.

“The reason these products are offshore is to insulate the insurance products and the insurance company from the prohibitions that exist in some states regarding the insurability of punitive damages,” said Joshua Gold, a shareholder at Anderson Kill & Olick P.C. in New York.

“I think most insurance commissioners will tell you this is an improper end run around the public policy that prohibits insuring punitive damages,” Mr. Gold said. “The counterargument from insurance companies that are offshore and policyholders is there is freedom of contract to enter into commercial risk transfers.

“There's no question these draw the ire of some insurance regulators and departments,” Mr. Gold said. “I think people try to be very low key about these contracts.”

In fact, six Bermuda entities that provide wraparound punitive damages coverage would not comment for this story.

The details of policies differ, but the coverage wraps around underlying liability policies, including general, employment practices, and directors and officers liability.

“They're all customized. You really have to do your due diligence,” said Philip DiMeglio, director at broker Lockton Cos. International (Bermuda) Ltd. in Hamilton, Bermuda.

“They're fairly straightforward,” said Bob Hessel, senior managing director at broker Beecher Carlson in Atlanta. “Typically, there is going to be a U.S. insurer issuing a liability policy. It could be umbrella; it could be employment practices; it could be any number of types of coverage. The policy will be issued domestically. Usually, the company will have an offshore affiliate, typically in Bermuda, that will issue the punitive wraparound policy. While it's a separate policy and it provides coverage for otherwise uninsurable punitive damage loss, the payments don't stack. You don't get two limits; you get one,” he said.

Mr. DiMeglio said that while limits vary, “usually the max is $25 million. I've never seen a punitive wrap policy go beyond that.”

He added that rates generally vary from 10% to 30% of the domestic premium.

There are other approaches to covering punitive damages, particularly where state law allows such coverage, observers say.

“Typically, we see the alternative to punitive damage wraparound, which is some kind of mechanism that is built into the policy that addresses coverage for punitive damages,” said Gary Seligman, of counsel at Wiley Rein L.L.P. in Washington. “Typically, some type of language in the definition of loss or damages addresses the law applicable to the insurability issue. In those types of policies, the current trend seems to be either in the policy form itself or by endorsement to include a most favorable jurisdiction-type provision.”

“In some states, punitive damages are not insurable under any circumstances, and sometimes prosecutors will force a defendant to waive insurance rights,” said Gary Thompson, a partner at Reed Smith L.L.P. in Washington. “Barring those two things, the insurability of punitive damages is a matter of private contract.

The general liability policies offer coverage for punitives. Typically, the main policy form will exclude coverage for punitives, but then there will be an endorsement stating that punitives are covered to the fullest extent covered by law.”

“I think all of my clients are able to achieve coverage for punitive damages through their general liability program,” Mr. Thompson said.

Even where insuring punitive damages is permitted, not all types of actions in which punitives could arise are covered by insurance, Beecher Carlson's Mr. Hessel said.

“My sense of it is that most of the punitive damage awards in terms of percentages are in areas where insurance wouldn't be involved anyway—such as business disputes, contractual disputes. That would be a very significant portion of the punitive awards,” Mr. Hessel said. Cases in which a party is potentially exposed to punitive damages often don't go to litigation, but settle instead, he noted.

In addition, wraparound punitive damages coverage may not be attractive to all buyers.

“They've been around for about a decade,” said Mr. Gold. “Only certain policyholders buy these. If you're a midsized business, I doubt you've ever heard of these.”

“Most of these policies have alternative dispute resolution clauses, so you're probably going to have a very hard time finding out any public disclosure about them,” he said.

“There's no clear documentation of what claims have been paid,” said Mr. Hessel. “It's a very small number.”

Yet demand for the coverage remains steady, Lockton's Mr. DiMeglio said. “This product does continue to hold significant value for our clients that want affirmative punitive damages coverage.”