Demystifying The ABCs Of D&O Insurance

Despite all the nuances and intricacies of D&O insurance, nothing generates more questions than the simple ABC insuring agreements. We’ve previously provided a general D&O guide here, but in the interest of any lingering confusion, here’s an over-simplified example of the ABCs, in plain English, that everyone can easily understand.

There’s a wallet on your desk with $100. In this example, you’re the company and those are corporate funds.

  • I'm suing you (the company), give me the $100 ($30 for your legal fees and $70 for the settlement) - Side C
  • I'm suing your (corporate officers), give me the $100 (remember you're financially obligated to protect them) - Side B
  • Now take the wallet and throw it in the garbage (the company is bankrupt), OR lock the wallet in a safe (the courts aren't allowing you access to corporate funds). I'm suing your CEO again, give me the money. You can't, you have nothing to give - This is Side A
  • Finally, your directors, concerned that the insurer could decline to cover the Side A claim above want extra assurance that they won’t have to pay any litigation personally – Side A DIC (difference in condition)

The name “directors and officers insurance” is a bit misleading. As you may have noticed, 2/3rds of a D&O policy actually protect the corporate funds. This ensures the company can continue to meet its financial obligations and fund ongoing operations. The Side A insuring agreement is the only insuring agreement that provides true, direct coverage to the corporate officers in order to protect their personal assets. For that reason, in order to reduce costs, some companies do opt for Side A only coverage, however this approach leaves the company out to hang in the event of any lawsuits. When structuring side A coverage, many companies include a layer of Side A DIC insurance, which is simply excess (and better) Side A coverage that acts like a sort of swiss army knife, providing a myriad of benefits as discussed here.

All D&O policies contain a retention (which is essentially a deductible). Using the examples above, the insurer would step in to collect $5 from you (the retention) and pay the remaining $95. While the side C and side B retentions are usually the same, in some cases, Side C may carry a higher retention. Given that there are no corporate funds available during a Side A claim, Side A coverage does not contain any retention. Another misunderstanding revolves around the application of the retention itself. A policy with a $20 Million limit and $2 Mill retention, does not have an actual limit of $18 Million, this is a common misconception. Using another example, let’s assume the total cost of litigation and settlement was $25 Million. In this example, the company would pay the first $2 Million retention, and the carrier would pay the full $20 Million limit thereafter. It’s also important to remember that the policy limit is shared among all “sides”, so a Side C claim against the company will reduce the overall coverage available for any subsequent side B or C claims during the same policy year. Furthermore, D&O policies that contain packaged EPLI insurance or Fiduciary liability may have a single shared limit for those claims as well, which can also further erode the overall available limit, which is why we generally advise on maintaining split limits for all coverages.

Lawsuits also don’t have to be successful to create financial damage. Even frivolous claims and claims brought without merit can damage a company’s balance sheet. In the above examples we assume a settlement of $70 with the company incurring $30 in legal fees, for a total of $100. However, even if the lawsuit is unsuccessful and the company prevails in court, it still would have lost $30 (vs the $5 retention it would lose if the company maintains D&O insurance).

Lastly, when it comes to the actual policy terms themselves, it’s important to note that each insuring agreement will contain different policy terms. This is most apparent when reviewing policy exclusions which may only apply to certain insuring agreements, such as Side C claims only. Generally speaking, the coverage under Side A is the broadest, followed by Side B, then Side C (claims only brought against the entity). For public companies, Side C claims are limited solely to securities claims, whereas public company D&O policies provide very broad coverage for wide range of lawsuits against the corporate entity.

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