D&O Insurance Guide for Directors and Officers

Running a company is extremely responsible. You make important decisions each and every day. Indeed, these choices define the future of your business. But have you ever considered the personal danger involved? One wrong decision with the best intentions may be in the form of a lawsuit. This is exactly why D&O Insurance exists. In fact, it is an important safety net for you and your other leaders. This is the guide which will walk you through some of the things you need to know.

We will discuss directors and officers insurance. Furthermore, we’ll understand why it is so important. Ultimately, you will know how it protects your personal wealth from any legal threats. Let’s enter in on it, and claim your state of peace.

What Exactly is D&O Insurance?

Think of D&O Insurance like a unique pair of bulletproof vest. It is a type of liability insurance. Specifically, it covers the directors and the officers of a company. It includes the company itself, as well. The policy offers protection from claims of “wrongful acts.”

These are allegations that have been made against you in your managerial capacity. For example, a lawsuit may result from a business decision. It is intended to cover legal defense costs. Moreover, it can also cover for settlement and judgment. Without it, you may have to rely on your own pocket.

The Core Purpose of Directors and Officers Liability Insurance

The main goal is simple. It provides protection to the personal assets of the leaders. Your home, your savings, investing. All were potentially at risk in a lawsuit. Directors and officers liability insurance therefore lies between a claim and your personal wealth.

It helps you make sure that you are able to lead without hesitation. In other words, you can make bold and necessary decisions. You will not face the threat of personal financial ruin. Therefore, it’s a crucial instrument for good corporate governance. This gives the leader time to get on with leading.

Who Needs This Essential Coverage?

You may think this is something only for huge corporations. Their’s a misconception to that effect. In fact, businesses big and small need it. This includes public companies, private firms and even non-profits.

• Public Companies: They have high risks from shareholders. For example, any decrease in stock price can result in a lawsuit.
• Private Companies: They are subject to claims from competitors, customers and regulators. Finding affordable business insurance is a crucial bit of the businesses’ puzzle, and D&O is a part of that puzzle as well.
• Non-Profits: Board members are typically volunteers and therefore have similar liabilities. In fact, they can sued for mismanagement of funds or failure of their duties.

Why is D&O Insurance a Non-Negotiable Today?

In the modern world, the legal landscape is complex. As a result, the danger of being sued is greater than ever. Consequently, having D&O insurance is not a luxury. It has become an integral necessity for modern businesses. Let’s explore why.

“The price of greatness is responsibility.”

– Winston Churchill

This quote sums up the burden on leaders perfectly: D&O insurance helps you to deal with that responsibility without burdening yourself with all the risk.

The Rising Tide of Lawsuits

Litigation is on the rise. For example, shareholders, employees, and customers are more willing to sue. Regulatory bodies are also more aggressive. They research corporate behavior very closely. Indeed, the U.S. Securities and Exchange Commission (SEC) actively pursues actions against corporate leaders for making misstatements or fraud.

A minor error can be the cause of hugely expensive legal battles. Defense costs are alone sometimes staggering. They can easily get into the hundreds of thousands of dollars. Unquestionably this is a burden not many individuals can handle.

Attracting and Retaining Top Talent

Executives of the highest standards are smart. They know the risks involved on a personal level. As a result, they will often not be willing to be part of a board or executive team, without proper D&O insurance in place.

Providing such coverage tells you that you value your leaders. It also shows you are committed to let them on the path of protect. In short, it is a powerful recruitment tool. It helps you to attract and retain the best talent in your industry.

Protecting Your Precious Personal Assets

This is the best direct benefit. Imagine you could seen named as in a lawsuit. Your personal bank accounts placed in a freeze. In addition, a lien may placed on your home. This is a nightmare situation for anyone.

Directors and officers liability insurance avoids this. It is what pays for your legal defence. If an agreement is reached, the policy can provide payment for that as well. It makes sure you’re not killed by a work-related lawsuit that destroys your personal financial life. In fact, it is as important to your financial health as a good State Farm life insurance policy is to the future of your family.

The Anatomy of a D&O Insurance Policy: The Three “Sides”

D&O insurance policies are not a one stop shop. They are normally structured with three parts. Specifically, these are referred to as Side A, Side B and Side C. Understanding each of these “sides” is essential to understanding how your coverage works: Each part gives us a different civilization protection.

Side A Coverage: Direct Protection for Directors & Officers

Side A is where the most personal part of the policy. It affords coverage direct coverage for directors and officers. This coverage kicks in where the company can’t.

For instance, a company may prohibited by law from indemnifying you. This frequently occurs in the event of bankruptcy. The company simply may not have the money. In these situations, Side A follows in. It compensates for your defence costs and loses directly.

What Does Side A Cover?

Side A is commonly referred to as “personal asset protection.” In essence, it includes legal fees, settlements, and judgments. It is your first line of personal defense in situations when the company can’t or won’t do anything to help.

When is Side A Triggered?

It’s triggered when the promise of the company to protect you (indemnify) fails. This may attributed to state law restrictions. Or, it could be due to the financial insolvency of the company.

Side B Coverage: Reimbursing the Company

Side B is also known as “company reimbursement” coverage. This is the most used part of a D&O insurance policy. But it works in a more indirect manner.

First, the company pays for the defense of its directors and officers. It uses its own money to pay for legal fees. Then, the company makes a claim with the insurer. Side B coverage subsequently pays repayment to the company for those expenses.

How Side B Works

Imagine that a shareholder sues one of the directors for a bad decision. The bylaws of the company say it will protect its directors. So, the company hire lawyers for the director. Once the case is settled, the company requests the insurance for the money back. This is Side B in action.

The Importance of the Indemnification Clause

This process depends on the “indemnification” clause of the company. This is a formal commitment in the company’s governing documents. It says the company will cover legal costs of its leaders. Side B coverage, therefore, helps to fulfill this promise.

Side C Coverage: Entity Securities Claims

More modern is side C. It is also referred to as “entity coverage.” This is part of the policy protecting the company itself. However, it is usually only limited to specific types of claims.

Most often Side C is applied for securities claims. For example, if the company is a public company, it can sued by shareholders. They may make false accusations regarding the company’s financial status. Similar to how one would be diligent while examining a Humana dental insurance plan for its particular coverages, man needs to be aware of the limits to Side C.

Protecting the Company Itself

While Side A and B deal with the individuals, Side C deals with the corporate entity. A lawsuit will often mention the directors and the company by name. In this case, Side C supplies money to defend the company in these cases.

Examples of Side C Claims

A common Side C claim is a fall in stock after the announcement of earnings. Shareholders could sue the company. They would allege that they were misled by the company. Side C coverage would then help pay for the company’s legal defense. This coverage is very critical for public companies.

What Kinds of Claims Does Directors and Officers Insurance Cover?

You now know the structure of a policy. Next we will examine the real-life events that give rise to claims. The definition of “wrongful acts” is broad. Indeed, it covers a lot of potential management missteps. This is why D&O insurance is so precious.

Breach of Fiduciary Duty

Directors and officers have a legal obligation. They have to work in the best interests of the company and shareholders. This is their “fiduciary duty.” For this reason, a failure to fulfill this duty is a common claim.

Understanding these arms of fiduciary responsibilities are a cornerstone of good leadership and resources such as the Harvard Law School Forum on Corporate Governance offer deep foundations on understanding these responsibilities.

For example, a director may approve a merger that gives them some personal benefit. If it is detrimental to the company, shareholders can sue. They would claim breach of the duty of loyalty. Similarly, someone like a leader who is negligent could sued for causing breach of duty of care. This is a more complicated risk taking than you might find with classic car insurance, but the principle behind covering certain risks is identical.

Misrepresentation and Inaccurate Disclosures

This is a huge area of risk. In particular, it is making false or misleading statements. These could be in financial reports, press releases or other public documents. Investors can be dependent on this information.

If the information is incorrect, they can lose money. They can then sue the leaders who approved the statements. For example, overstating company revenue is a very obvious instance of misrepresentation. It can result in dire legal and monetary consequences.

Employment Practices Liability

Sometimes, D&O insurance will overlap with another policy. This is referred to as Employment Practices Liability Insurance (EPLI). Claims from employees are extremely common. They may include wrongful termination, discrimination or harassment.

While many companies purchase stand-alone EPLI policies, some D&O insurance policies provide some coverage for such claims. It is important that you constituents your policy details. Just as you’d compare a United Healthcare insurance PPO and HMO, you need to compare D&O and EPLI insurance.

Actions from Regulatory Bodies

Government agencies are powerful. They can investigate and punish companies and its leaders. Think Environmental protection agency (EPA) and the Federal Trade Commission (FTC). An investigation alone can produce huge legal bills.

Your D&O insurance can pay for the defense of against these regulatory actions. This is a very important protection. Of course, it helps you answer government queries without exhausting your resources.

Lawsuits from Shareholders

Shareholder lawsuits are one of the main reasons for D&O insurance claims. This is especially the case with public companies. These suits may filed by an individual shareholder. Alternatively, they can be “class action” lawsuits from a large group.

These claims tend to follow bad news. For example, a product recall, a failed acquisition. The share price may decrease sharply. Shareholders could then sue and allege mismanagement as to their losses. A strong D&O insurance policy is the best approach to protection.

Key Exclusions in a D&O Insurance Policy

No insurance policy covers everything. Therefore, D&O insurance contains important exclusions. It is very important to understand that which is not covered. Ultimately, this avoids surprises when you have to make a claim. Knowing these limits are also important as knowing the coverages.

“Risk is subtracting from the unknown” Warren Buffett

– Warren Buffett

This wisdom is perfectly applicable here. Understanding what your policy covers with regards to exclusions is part of understanding what you are doing. Let us go through the most common ones.

The “Conduct” Exclusion: Fraud and Illegal Profit

Insurance is intended to insure against mistakes, not against crimes. Therefore, D&O insurance policies will not cover acts of deliberate fraud. They exclude also the cases where a leader made an illegal personal gain.

However, the policy will often contribute to defense costs. The insurance will pay until the ultimate judgment finds the person guilty. If found guilty, the director may have to pay back those defense costs. The details vary by policy. Some of the other policies, such as professional liability insurance, have similar conduct exclusions.

The “Insured vs. Insured” Exclusion

This is a standard exclusion. It stops one person insured (such as a director) from suing another person insured (such as another director), and having the policy cover the costs of it. In other words, the policy is not intended to resolve internal disputes.

It also has the advantage of preventing the company from suing its own directors and officers to trigger a claim. On the other hand, there are some important exceptions. For example, this exclusion may not applied in bankruptcy cases.

Bodily Injury and Property Damage

D&O insurance: insurance is for financial losses. It does not cover claims for bodily injury and property damage. Instead, these risks are insured by way of other policies. A General Liability policy or an Commercial Auto insurance policy would cover those claims.

For example, if a company’s product does some physical harm on a customer, that is a General Liability issue. It is not a D&O claim. It’s important to have a package that covers your business insurance.

Prior and Pending Litigation

Your policy will not cover lawsuits that were already in motion when you purchased it. It also won’t cover claims for prior knowledge of facts prior to the policy commencing. This is called the “prior and pending” exclusion.

When applying for coverage, you are responsible for disclosing any issues that you know of. Hiding a possible claim can make your entire policy void. Honesty is very important during the application process.

Choosing the Best Directors and Officers Liability Insurance

Selecting the proper policy is a critical duty. In essence, you need to find a fit between the coverage and your company’s particular needs. It’s not about getting the cheapest price. It is about finding the most effective of protection.

Assessing Your Company’s Unique Risk Profile

Every company is different. Depending on your risk profile is managed by numerous factors. Accordingly, you have to analyze them carefully. This analysis will help drive the selection of coverage.

Industry-Specific Risks

Some industries are more risky than others. For example, technology and biotech companies tend to get tripped up in intellectual property lawsuits. In contrast, healthcare companies are subject to rigorous regulation. Your industry will dictate the kinds of claims which you are most likely to encounter. This is true with all insurances from motorcycle insurance to complex D&O policies.

Company Size and Structure

Are you a public or private business? Public companies need higher limits. This is due to the fact that they face securities class action lawsuits. Different risks exist with private companies. For example, they could be the target of more suits from competitors or creditors. The number of directors and officers is also important.

Determining the Right Coverage Limits

How much coverage do you need: This is a tough question. There is no magic formula in reality. You should look at companies in your industry that are similar in size. See what limits they carry.

A good insurance broker can help in this regard. They have access to data of claims and settlements. Therefore, they can help you select a cutoff that is good enough for your risk level. Underinsuring can be a very expensive mistake.

Understanding Deductibles and Retentions

Most policies include a deductible or a self-insured retention (SIR). This is the amount the company has to pay before the insurance begins to work. In most cases, a higher deductible also indicates a lower premium.

However, you will need to be certain that your company can afford the deductible. For the Side A Coverage, in itself the deductible is often $0. This way individuals will protected immediately. This is an important detail to check. Much like there are ways you can help to lower your car insurance cost there are ways you can adjust the deductibles the more the logic remains the same.

The Application Process for D&O Insurance

Getting D&O insurance does require a detailed application. Specifically, the insurance company wants to understand your business totally. And they use this information to decide your risk and determine your premium.

What Information Will You Need?

Be prepared to give a lot of details. For example, insurance companies will request your company’s financial statements. This includes balance sheets and income. You will also need to provide a list of all the directors and officers.

They will want to know about the structure of ownership. In addition, they’ll ask about any plans for mergers, acquisitions or IPOs. It is important to provide clear and accurate information. Just like you might require documents while seeking temporary car insurance, D&O application terms need ample documentation.

The Importance of Full Disclosure

You have to be totally honest in your application. Hiding a potential problem is an awful idea. If the insurer finds out you misrepresented facts then they can cancel your policy. Moreover, they could even repudiate a claim in future.

This is called rescission. It means that the policy is considered as if it did not exist. This would leave you wide open. It is always the better approach to highlight possible issues in the beginning. The insurer can still provide coverage perhaps at a higher rate or including an exclusion. That is much better than having no coverage at all.

How Much Does D&O Insurance Cost?

The cost, or premium, for the D&O insurance is quite varied. In fact, there is no standard price. It can range from a few thousand dollars a year on a small non-profit to millions for a large public corporation. The final price, as is determined by the insurer, finally depends on the insurer’s consideration of your risk.

Key Factors Influencing Your Premiums

Several important factors contribute to the cost of your directors and officers insurance. In particular, an understanding of them can help you to manage your costs. It also allows you to understand your quote.

Company Revenue and Assets

Large companies typically pay more. They have more assets and revenues. This means that there is more at stake in a lawsuit. Consequently, the potential settlements and judgments are higher. The more risk the insurer charges more to cover this larger risk.

Industry and Claims History

As was said, your industry is important. High-risk industries such as tech or finance are paying more premiums. Your own claims history is also critical for your company. For example, if you have a history of D&O claims in the past, your premiums will be much higher. A record without a blemish will help you get a better price.

Public vs. Private Status

Public companies pay very high prices for D&O insurance, compared to private insurance. This owes to the massive risk of shareholder class action litigation. The Sarbanes-Oxley Act, an important piece of U.S. federal law, introduced a higher degree of accountability for public companies, which meant a higher degree of D&O risk and premiums as well. These types of suits could result in huge settlements. Therefore, there is much greater insurance risk.

Coverage Limits and Deductibles

This is a direct trade-off. The better the coverage limit you are choosing, the higher your premium will be. Conversely the higher the level of deductible you are willing to pay, the lower your premium will be. You need to find the right balance in terms of what your company can spend and can afford to lose. It’s a strategic decision, like between term life insurance vs. whole life insurance.

Final Thoughts: Is D&O Insurance Truly Worth It?

Having gone into all these details, the answer should be obvious. In short, the answer is yes, D&O insurance is absolutely worth it. It is an indispensable tool to protect your leaders and your company.

It is not an expense. Instead, it is an investment. An investment in confident leadership. In an investment to attract the best talent. And most importantly, an investment in ensuring the personal financial futures of the people running your business. The risk of not having it is just too high. A suit of litigation can be devastating.

“The best time to repair the roof is during the sun.”

– John F. Kennedy

This quote is a perfect analogy. You must have your D&O insurance protection in place before a crisis strikes. Waiting until you are sued is too late. Therefore, take immediate action to design a safe shield around your leadership team. Your company’s future might well depend upon it.

Frequently Asked Questions (FAQs)