Directors' & Officers' Insurance
Businesses often hear that they should buy directors' and officers' (D&O) insurance, but they don't always understand what it is or why they may need it. Below is a primer on what D&O insurance is, and how to acquire it.What is Director's and Officer's (D&O) liability insurance?
D&O insurance protects corporate directors and officers for certain claims made against them, and reimburses the business for the cost of indemnifying its directors and officers. A typical D&O policy covers officers and directors for claims made within a stated period for actions they or the corporation took or failed to take in their official capacity. D&O insurance is primarily intended to cover claims brought by shareholders, including securities fraud claims, and employment-related claims. A corporation can also add coverage for some additional claims against the business itself, which is called "entity coverage."What claims against a corporate entity itself can be covered by a typical D&O policy?
Until recently, a typical D&O policy did not cover corporate liability. Instead, it merely reimbursed the expense the business incurred in indemnifying officers and directors. However, D&O insurers now offer separate entity coverage for securities claims made against the corporation itself. Some broader coverage may also be available for an additional fee.Should a public company buy D&O insurance?
Most large corporations can pay large judgments or settlements even if they are uninsured. However, D&O insurance provides some additional protection. First, it will cover officers and directors for claims that the business will not or cannot indemnify, such as damages in a securities fraud case. Further, companies may dispute if or how much they must indemnify a director or officer, which can cripple a defense until an agreement is reached. This is especially important if a director's or officer's interests and the corporation's are in conflict. Second, the limit on D&O insurance may help cap the amount a corporation will have to pay a plaintiff; plaintiffs' attorneys usually recognize when they will not be able to obtain a larger settlement than the available insurance, and will be motivated to settle for that amount or less.How much D&O insurance does a business need?
The amount of insurance must be tailored to each company, but a rule of thumb is that no public corporation should have less than $10 million in coverage. The amount of coverage needed should be discussed with your business's insurance broker and attorney.How is D&O insurance sold?
The price, terms, and conditions of D&O insurance policies are always negotiable. A knowledgeable insurance broker who specializes in placing D&O policies can help get a good deal for your business by canvassing the market to determine which insurers will offer it, and can work with corporate counsel to negotiate the best price and terms possible. Your business' lawyer should have some ideas about appropriate terms, and information about which insurers are easiest to deal with when claims are made.How can my business review its current D&O policy coverage?
All D&O policies contain certain terms - 1) promises to provide certain insurance to covered persons and entities, 2) the amount of retention per claim, 3) the coverage limit, 4) the time period in which claims must be made in order to be covered, 5) exclusions limiting the scope of covered claims, and 6) the terms and conditions that govern how claims will be handled. Reviewing these areas will help the business understand its current policy status, and where it may be lacking.
- Insuring Agreements – Almost all D&O policies make at least two promises: (A) to cover officers and directors directly for certain claims based on actions they took or failed to take in their official capacity if the corporation does not indemnify them ("A-Side Coverage"); and (B) to reimburse the corporation for the expense incurred to indemnify officers and directors for the same claims ("B-Side Coverage"). A-Side Coverage usually will not apply unless the corporation is financially unable to pay for the indemnification. For an additional fee, all D&O insurers will cover the corporation itself for securities law actions.
- Retention Amount – A retention is like a deductible that applies to each claim. The company must first pay the retention amount before the insurer's coverage will apply. A common retention amount is in the range of $250,000. It is important to ensure that there is no retention with respect to A-Side Coverage; although it is reasonable for a corporation to pay the first $250,000 in expenses associated with a claim, this kind of retention would severely burden individuals entitled to A-Side Coverage in case of the corporation's financial incapacity.
- Coverage Limit – All D&O policies state the policy coverage limit, including costs of defense. While other types of policies can include a duty to defend as well as a duty to indemnify up to a stated amount per claim, D&O insurance policies do not impose any duty on the insurer to defend the claim. Paying the costs of defending the claim therefore diminishes the amount available to pay a settlement or judgment.
- Coverage Period – D&O insurance is "claims made" insurance, which means it covers only claims actually made during the period stated in the policy.
- Exclusions – D&O coverage is sharply restricted by exclusions narrowing the scope. A policy will usually contain at least a dozen exclusions in its basic form, and additional exclusions added by endorsement. For example, an exclusion included in every D&O policy is the "actual fraud" exclusion. This does not run contrary to the major reason that companies purchase D&O insurance, which is protection from securities fraud claims. While it is generally against the law to indemnify people for deliberate fraudulent or criminal acts, it is not against the law to advance to those accused of fraud the costs of defending themselves, or to settle claims where fraud is alleged but not proven. Therefore, the typical D&O policy excludes coverage for fraud claims after there has been a final liability determination for actual fraud. Your business' broker and attorney can advise you about how to try to narrow the exclusions.
- Other Terms and Conditions – Most D&O policies have many other provisions. They should expressly require the insurer to advance defense costs after the retention is exhausted. Other common provisions that should be negotiated away where possible include arbitration clauses or other procedural hurdles preventing an insured from prompt recourse to the courts.
This publication and the information included in it are not intended to serve as a substitute for consultation with an attorney. Specific legal issues, concerns, and conditions always require the advice of appropriate legal professionals.