Allocation clause (D&O)
A clause setting how defense costs and settlement amounts are split between covered and uncovered parties and counts, a classic source of disputes between insurer and insured.
A single lawsuit often targets both covered defendants, the directors, and defendants who are not covered, or not fully, such as the company when the policy does not cover the entity, or covered counts alongside excluded ones. Defense costs and settlement amounts, however, are incurred as a whole. The allocation clause determines the share the insurer bears. Possible solutions range from allocation in proportion to the respective legal and financial exposures, negotiated or set by an expert, to rules more favorable to the insured: full payment of defense costs as long as part of the claim is covered, or a rule under which the insurer can reduce its share only to the extent the presence of uncovered elements actually increased the settlement cost. Some policies set a predetermined allocation percentage, which removes the debate at the price of an approximation. Without a clause, allocation becomes a dispute within the dispute, delaying payments when the insured needs them.
Textbook case: a shareholder action targets the company, not covered, and its three directors, covered; it settles for 20 million. Under proportional allocation, the insurer might pay only half; with a clause setting 80 percent of costs and settlements as allocated to the directors, it pays 16 million without debate.
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