Blog Allocation of Defense Cost

Allocation of Defense Cost

Written by Joe Weipert—Senior Vice President April Yearby—Vice President, Agency Co-Owner

October 25, 2020 · Commercial Lines

While it seems straightforward, allocation clauses carry significant terms you should know before purchasing a policy.

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Allocation clauses exist in various insurance policies, including D&O (Directors and Officers), E&Os (Errors and Omissions) and PL (Professional Liability) coverage. It is advisable to read through your policy and ensure you are adequately covered for all key risks. This includes determining how much the carrier will allocate towards your defense during a lawsuit. While it seems straightforward, allocation clauses carry significant terms you should know before purchasing a policy. Below is a brief look at the allocation of defense costs and why it is important.

What is Allocation of Defense Cost?

An insurer is obligated to pay the cost of defending your case in court when facing a lawsuit. This is why you purchase coverage in the first place. It should protect you from the cost of litigations and compensations. For instance, if a company director or officer is sued for misconduct, negligence, or any other compensable offense, the D&O coverage should pay for their defense, including lawyer fees. Allocation of defense cost is a clause that specifies how the insurer will pay for the policyholder's defense. It entails what liabilities are covered and where the insurer would be legally obligated to pay the defense cost. Two common scenarios arise as follows:

a) Shared Defense Costs

If you have more than one insurer, a scenario may arise where both insurers are expected to contribute towards the defense cost. For instance, your company can purchase D&O coverage for all directors and officials who may have Professional Liability coverage purchased from other carriers. In this case, the principle of equity and good conscience will apply to determine how much each carrier will contribute.

b) Covered And Uncovered Costs

Allocation of defense cost clauses will determine what liabilities are covered and what the insurer will pay if you are sued. The insurer is only obligated to pay for costs specified in the policy. If your issue involves covered and non-covered costs, you will have to settle the rest with your own money or another policy.

Why Is It Important?

Allocation of defense costs can get confusing even for the courts, especially when the case involves multiple insurers. For instance, if different carriers insure a company during different periods, all insurers may be called upon to share the defense cost. Most courts will use a pro-rata basis to calculate how much each insurer should pay based on the months they provided coverage. Other times, the court uses its equitable jurisdiction, so the defense cost is shared equally among the different insurers. Here are some reasons why the allocation of defense cost is important:

  • It determines what parties and actions are covered by the policy
  • Calculates how much the insurer will pay towards the defense of the insured
  • Determines how involved insurers will share the cost of defense

Summary

Allocation of defense cost in D&O, E&O and PL is a subject of confusion among most policyholders. Insurers tend to use these clauses to bargain down the amount paid, especially for mixed cases. As a policyholder, it is essential to read allocation clauses carefully and identify what the insurer will pay when you have both covered and non-covered claims.