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How Allocation and Carve‑back Clauses Can Restore Coverage in Directors and Officers (D&O) Liability Insurance Disputes

Directors and officers (D&O) litigation increasingly involves mixed claims — some covered (e.g., management liability), some excluded (e.g., criminal acts, intentional fraud). When insurers deny coverage citing exclusions, two policy mechanisms can restore or preserve protection for insureds: allocation clauses and carve‑back clauses. This article explains how each works, why they matter for U.S. boards and management (especially in New York, San Francisco, Chicago, Los Angeles and Dallas), and practical drafting and negotiation strategies that counsel and risk managers should use to maximize coverage.

Quick overview: why allocation and carve‑backs matter now

  • Class actions, securities suits and regulatory investigations frequently include both covered and excluded allegations. Courts and arbitrators often decide how to allocate defense costs and settlements between those allegations.
  • Without a favorable allocation or a carve‑back, D&O carriers may deny defense or indemnity entirely — exposing companies to large out‑of‑pocket legal fees and settlements.
  • Market conditions since 2020 have increased premiums and tightened wording; negotiation of specific carve‑outs or allocation language has become a key differentiator among carriers such as AIG, Chubb and Travelers. See carrier D&O overviews: AIG, Chubb, Travelers.

Sources and market commentary:

What are allocation clauses vs carve‑back clauses?

Allocation clauses (aka "allocation of loss" or "severability of defense costs")

Allocation language sets rules for how defense costs and settlements are split between covered and uncovered claims when a single claim or interrelated series of claims contains both insured and excluded allegations.

Common allocation methods:

  • By legal theory / count: Allocate costs based on which counts/theories are covered.
  • By factual overlap (interrelatedness): If allegations are interrelated, insurer may argue entire claim is excluded; allocation language limits that risk by requiring a fair and reasonable allocation.
  • Time‑on‑risk / time‑apportionment: Used for multiple policies across different periods.

Carve‑back clauses (aka “insured vs insurer carve‑backs”)

A carve‑back is an express exception to an exclusion. For example, a policy might exclude claims alleging fraud, then include a carve‑back stating the exclusion does not apply to defense costs unless and until there is a final adjudication or admission of fraud.

Typical carve‑backs:

  • Defense carve‑back: Insurer must defend until final adjudication of excluded conduct.
  • Settlement carve‑back: Provides coverage for settlement of mixed claims to the extent that settlement could reasonably have resolved covered claims.
  • De minimis carve‑back: Small percentages of excluded claims are treated as covered to avoid complete denial.

How these clauses restore coverage — practical mechanics

  • Allocation clauses force the insurer to pay a portion of defense costs immediately for covered parts of the claim, even if the complaint includes excluded allegations.
  • Carve‑backs prevent the insurer from invoking exclusions to deny all coverage at the outset — they preserve defense obligations until fraud or criminality is finally established.
  • Together, they reduce risk of “one‑allegation” exclusions wiping out entire limits and speed dispute resolution so insureds can litigate core business claims without self‑funding defense.

Example scenarios (U.S. practice)

Scenario A — San Francisco tech startup ($5M D&O limit)

  • Complaint alleges negligent disclosure (covered) and intentional misrepresentation (excluded).
  • With a defense carve‑back, the insurer (often a market leader like AIG or Chubb) funds defense costs for the covered portion until final ruling on intent.
  • Typical annual D&O premium for a private tech company with a $5M limit in major markets such as SF often ranges broadly from $25,000 to $75,000 depending on revenue and prior claims.

Scenario B — New York mid‑cap public company ($25M limit)

  • Securities suit alleges both fiduciary negligence (covered) and fraud (excluded). Allocation language requires insurer to pay a pro rata share of defense costs attributable to covered allegations.
  • Large public company D&O premiums vary substantially — for NY‑listed mid‑caps, annual premiums for $25M tower layers can run $250,000 to $1,000,000+, depending on industry and exposure (see market commentary).

(These ranges are indicative market references observed across U.S. markets; actual quotes vary by carrier, risk profile and retention. See carriers and market sources above for product descriptions.)

Drafting and negotiation tips for insureds in the USA

  • Negotiate a defense carve‑back to apply until a final adjudication, not merely a criminal indictment or SEC allegation.
  • Seek “fair and reasonable” allocation language — require independent expert determination or arbitration if insurer refuses to agree.
  • Include presumptive coverage language for defense costs where there is a reasonable basis for coverage; shift burden of proof to insurer to show allocation or exclusion applies.
  • Limit insurer control over settlement decisions tied to exclusions — tie right to consent to settlements only when exclusions are conclusively proven.
  • For companies in high‑litigation U.S. centers (NYC, SF, LA, CHI, Dallas), insist on express carve‑backs for regulatory investigations, which often morph into private securities suits.

Sample clause language (for negotiation)

  • Defense carve‑back: “Notwithstanding any exclusion herein, the Insurer shall advance and pay Defense Costs for any Claim alleging both Wrongful Acts and Excluded Conduct until there is a final, non‑appealable adjudication or a written admission establishing such Excluded Conduct.”
  • Allocation clause: “If a Claim includes both Covered and Excluded Matters, the Insurer shall allocate Loss, including Defense Costs, between Covered and Excluded Matters on a fair and reasonable basis; if the Parties cannot agree, the allocation shall be determined by neutral accounting/arbitration.”

Table: Allocation vs Carve‑back — key differences

Feature Allocation Clause Carve‑back Clause
Primary purpose Split costs between covered & excluded parts Create exception to an exclusion (usually for defense)
Trigger Mixed claims / interrelated allegations Presence of an exclusion (e.g., fraud)
Typical effect on limits Preserves some limit for covered claims via apportionment Prevents total denial until exclusion proven
When insurer pays Immediately for allocated covered share Immediate defense funding until final adjudication
Negotiation focus “Fair and reasonable” method, neutral arbiter Scope of carve‑back, “final adjudication” standard

Practical steps for in‑house counsel and brokers (checklist)

  • Review current policy for any allocation or carve‑back language; if absent, prioritize adding at renewal.
  • Obtain sample policy forms and endorsements from carriers (AIG, Chubb, Travelers) and compare wording.
  • Build a litigation funding plan: retain bridge funding or ERISA trust line if carrier invokes exclusion.
  • Pre‑negotiate arbitration or expert determination procedures for allocation disputes.
  • Coordinate with outside counsel to document non‑fraudulent facts early to support coverage positions.

Case law and regulators (U.S.) — why language matters

U.S. courts have split on allocation disputes; outcome often hinges on precise policy wording and factual record. Careful drafting reduces reliance on uncertain judicial interpretations — a practical necessity in hubs like New York and Delaware where corporate litigation is concentrated.

For further reading on carve‑outs, exclusions and negotiating tactics, see these related guides:

Final takeaways

  • In today’s U.S. D&O market, allocation and carve‑back clauses are among the most powerful contract tools for preserving coverage when claims mix covered and excluded allegations.
  • Negotiation should focus on defense carve‑backs that survive until final adjudication, and on clear, enforceable allocation mechanisms — especially important for companies headquartered in New York, San Francisco, Chicago, Los Angeles and Dallas.
  • Work with brokers and carriers to secure specific language; monitor market price/availability trade‑offs — stronger carve‑backs can increase upfront premium but substantially reduce catastrophic uninsured exposure.

External references

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