D&O Insurance Guide
Directors & Officers Liability insurance (also referred to as D and O insurance) is a complex, often misunderstood insurance product. However it is also a critical coverage for many organizations, both small and large alike. Below, we have put together a brief guide in order to help companies and their directors better understand the intricacies of (and value provided by) these highly specialized policies.
What Is D&O Insurance?
In its most simple terms, D&O can be viewed as errors and omissions coverage for board-members. It provides defense costs (attorneys fees), damages and settlements, for mistakes and accusations made against executives for their business decisions. Policies are comprised of a number of basic insuring agreements and coverage components:
- SIDE A (DIRECT COVERAGE): Also referred to as executive insurance, this insuring agreement provides direct coverage to the directors and officers when the company cannot indemnify them, either due to insolvency or due to laws barring indemnification such as during a derivative claim.
- SIDE B (CORPORATE REIMBURSEMENT): Provides balance sheet protection by reimbursing the corporation after it indemnifies its directors or officers for a claim.
- SIDE C (ENTITY COVERAGE): Coverage for claims asserted against the entity itself. While Public company D&O coverage restrict such claims solely to securities claims, private company D&O insurance provides broad coverage for claims made against the entity.
- EPLI (OPTIONAL): Employment practice liability insurance provides protection against employment related claims which account for a significant percentage of claims made against private companies and non profits. These claims include wrongful termination, failure to promote, sexual harassment, and others.
- CRIME INSURANCE (OPTIONAL): Crime insurance provides reimbursement to the entity for losses it sustains resulting from employee fraud, executive theft, theft of funds, and more.
- FIDUCIARY INSURANCE (OPTIONAL): Protection for executives and plan administrators against claims asserting mis-management and mistakes made while administering employee benefit plans.
How Is D&O Coverage Purchased?
Directors and officers liability insurance can be structured to the interests of each organization depending on their risk profile and coverage needs. These coverage options require companies to make important decisions when structuring coverages. Some of those considerations include:
- PACKAGED VS STAND ALONE: D&O can be purchased as a stand-alone policy, with no additional components or packaged with EPLI, crime and/or fiduciary insurance. When packaging coverages, policies can assign one blanket limit to all coverages, or assign each coverage its own dedicated limit. While dedicated limits will result in higher premiums it also provides better coverage by appropriately isolating each coverage.
- ONE SIDE OR ALL SIDE: Directors and officers insurance can be purchased for Side A, B and C (which is the most common approach) or for Side-A only claims with the entity opting for no corporate reimbursement or entity coverage. While side-A only policies may provide broader direct coverage for the officers at a slightly lower premium, this can be a risky approach, as the majority of claims fall under Side B and Side C coverage.
- EXCESS & DIC COVERAGE: In order to increase policy limits and/or broaden coverage, additional policies can be placed “on top” of underlying policies, similar to an umbrella. These policies can be 1) follow form, with the same terms and definitions, or 2) “difference in condition” in order to provide broader coverage.
- SPECIAL COVERAGES: In addition to the above policies, companies with specific concerns may opt to seek additional specialty coverages such as employed lawyers insurance, IDL (independent director liability) coverage, investigation coverage or reputational insurance.
Directors and officers insurance policies are mazes of terms, conditions and definitions that require careful review. Policy audits should be performed in order to ensure that its definitions sufficiently align with 1) other policies such as any E&O or cyber insurance policies, 2) appointed directors/officers as defined in the corporate charter, 3) additional entities including any domestic and foreign subsidiaries. It should be noted that, performing a foreign audit and coordinating proper coverage for foreign entities can be a delicate balance requiring careful attention. Often the placement of separate foreign coverage is recommended.
What Types Of Claims Are Covered?
- Customers can file claims related to contractual disputes, false advertising, misleading product information and privacy violations (related to debt collection practices and marketing).
- Suppliers can file suits for damages suffered by failed promises of increased orders.
- Competitors can assert claims asserting negligent business interference, false advertising, or claims asserting employee poaching to obtain trade secrets.
- Creditors and bankruptcy trustees can file claims in an effort to recoup losses asserting breaches of fiduciary duties and/or misrepresentations made when applying for credit.
- Shareholders and investors can assert fraudulent inducement, misrepresentations made in private placements and/or breaches of fiduciary duties.
- Employees can file false claims act claims, or, more commonly, employment related claims such as individual suits or class actions asserting sexual harassment or wrongful termination and/or violations of wage and hour laws.
- Regulators and government agencies can bring investigations and enforcement actions for numerous violations such as FTC actions for consumer protection laws and SEC or DOJ investigations for violations of the FCPA act. In addition to any resulting fines and penalties, the costs to comply with investigations alone can be significant.
What Does D & O Insurance Exclude?
While exclusions can vary significantly from carrier to carrier, most policies contain exclusions for the following claims (among others)
- INSURED VS INSURED: In order to eliminate coverage for infighting, claims brought or maintained by one insured against another are excluded.
- PRIOR ACTS / RETRO-ACTIVE DATE: Being that coverage is written on a claims made policy form, it is important to understand how such coverage operates. In short, claims arising from wrongful acts that occurred prior to the retroactive date (or issuing of the policy) are excluded, unless coverage is included for “full prior acts”.
- PROFESSIONAL SERVICES: Claims related to, or arising from the errors, omissions and negligence while providing professional services. Coverage for such claims is more appropriately placed through an E&O policy. Careful review should be given to this exclusion, as overly broad wording has the potential to eliminate coverage entirely.
- CONTRACTUAL EXCLUSION: Claims arising from any oral or written contracts.
- FRAUD, DISHONESTY & ILLEGAL PERSONAL PROFIT: Intentionally fraudulent acts committed by executives, and claims alleging illegal personal profit are always excluded. However coverage will remain in place for “innocent insureds” that were unaware of such fraud.
- INFORMAL INVESTIGATIONS: While coverage may be included for informal regulatory/administrative investigations naming individual directors or officers, informal investigations against the entity itself are almost always excluded.
- EMPLOYED GC: While some policies may in fact include in-house counsel as a named insured, policy terms and conditions often severely restrict the adequacy of such coverage. Companies interested in purchasing proper coverage for their GC’s should purchase separate employed-lawyers insurance.
- "OTHER COVERAGE" EXCLUSIONS: Claims that are intended to be covered elsewhere are always excluded by a D&O policy, this includes: bodily injury claims that should be covered under a general liability policy, cyber related claims, and professional service related claims that should be appropriately covered by a separate E&O policy.
Who Should Purchase Directors and Officers Insurance?
Any company that has investors or manages employees or products has a liability exposure. And just about every company can benefit from a D&O policy. Some companies however operate in a particularly high risk environment compounding the need for directors and officers liability, such as:
- Public companies (of all sizes) and financial institutions
- Mid sized private companies
- Companies seeking funding through crowdfunding, private equity or debt. As well as any companies planning an IPO or active with mergers and acquisitions.
- Companies with distressed financials, undergoing a restructuring and/or those emerging from bankruptcy
- High growth companies and companies looking to expand into new products, countries or sectors
- Companies particularly affected by economic movements/downturns
- Companies in certain industries such as: Manufacturers and brands, technology companies, financial firms and institutions, healthcare, and life-science companies.
- In addition to the above risk factors, directors and officers insurance provides a number of advantages including: the ability to attract qualified directors and appearing more professional to investors when approaching a deal.
Recent Trends Increasing The Importance of Executive Insurance
- Newly announced DOJ's Yates Memo now requires misconduct disclosure in order to receive cooperation credits. The Department Of Justice is also implementing the Yates memo to enforcement actions.
- Cyber related litigation is expected to increase in the form of consumer class actions and shareholder class actions and/or derivative claims
- SEC is targeting smaller companies and pursuing more actions through administrative law judges
- Litigation financing is gaining attention and expected to fuel future lawsuits against corporations and their directors.
- Compliance officers are under greater scrutiny
How Do Policies Differ?
D and O insurance terms differ significantly. Some carriers agree to control the defense (taking the burden off of the company and broadening coverage), while others require the company to control the defense. Some policies contain particular exclusions such as “false advertising exclusions” which can severely limit or preclude coverage that is critical for companies like brands and manufacturers. For companies with investors/shareholders, many carriers contain a “majority shareholder exclusion” which precludes coverage for claims brought or maintained by shareholders with more than 5% ownership. These are just a few very simple examples, however there are too many to list. Entire books have been dedicated to the topic of analyzing D&O policies. While these exclusions are typically easy to identify and avoid, much of the exclusionary language is contained deep in the policy language itself, within the terms and definitions. This makes it very difficult for companies to understand what they are purchasing and nearly impossible to perform proper coverage comparisons. It also highlights the importance (and value) of partnering with an experienced broker.
- DO HOMEOWNERS POLICIES PROVIDE D&O INSURANCE? Simply put, no, they don’t.
- HOW MUCH DOES D&O INSURANCE COST? Policies cost less than many might assume. Policies can range from 1k per year for very small businesses or non profits to 15k for small public companies on up to 100k plus for larger organizations. But often companies may be able to eliminate duplicate coverage from other policies to help offset that cost a bit.
- DOESN'T MY COMPANY'S INDEMNIFICATION AGREEMENT PROTECT ITS OFFICERS? Yes, however, there are situations in which your company may not be able to indemnify you, such as when it is insolvent or prevented from doing so by law.
- CAN A CLAIM PIERCE THE CORPORATE VEIL? Corporate veils do protect companies…to a certain extent. But court rulings can be unpredictable, and in certain situations corporate status can be bypassed effectively exposing the directors and officers’ personal assets. Claims asserting fraud, claims asserted by creditors that suffered from “gross under-capitalization”, and claims related to the commingling of assets are all examples of claims that can result in a piercing of the corporate veil. Companies that are "closely held" are also more likely to encounter such claims.
- AREN'T WE PROTECTED BY THE BUSINESS JUDGEMENT RULE? The business judgement rule has long provided a certain layer of protection to officers when making business decisions. However, without getting overly technical, many recent court cases indicate that the business judgement rule does not provide the same level of protection that it had years ago.
- WHAT SHOULD WE LOOK FOR? There are too many considerations to list here, however premium should only play a small role in that decision - simply seeking the lowest premium will often yield bad results. When shopping for d and o insurance, the most important considerations should be: the broker’s experience, the policy language and the carriers’ reputation.