Directors and officers insurance is a type of claims made insurance policy that protects your directors and officers – and their personal assets – from third party allegations of financial loss.
In addition to protecting senior management, D&O coverage also reimburses your company for defense and claims costs and protects your company if it is specifically named in a lawsuit.
Do I Need Directors And Officers Insurance?
According to a 2020 survey by Allen & Overy and Willis Towers Watson, the trend toward holding officers personally accountable has increased in the past decade.
Directors and officers of an organization may be held personally liable for claims related to or arising from:
- Securities litigation
- Regulatory actions
- Breaches of fiduciary duty
- Claims by employees
- Environmental contamination
- Mergers and acquisitions
D&O claims are increasingly related to corporate culture, cyber liability and climate change which have become more common in the news and social media…
Some survey respondents reported that even if their exposure was minimal, they felt more personally exposed.
Private Company Directors And Officers Insurance
Public company D&O insurance is very common. However, management liability exposures exist regardless of whether the company has outside shareholders or limited partners (LPs).
Privately held businesses and their directors or officers are also personally exposed.
Indeed, approximately 26% of private companies may experience a D&O claim. According to a 2018 report by Chubb, the private companies that did not have D&O coverage experienced losses averaging $400,000.
Senior management may be held personally liable when sued by customers, vendors, employees, shareholders, competitors or government entities or regulators.
Unfortunately, your company’s general liability and umbrella policies will not provide coverage for claims of financial mismanagement or errors and omissions.
What Does D&O Cover?
Directors and officers insurance is a type of errors and omissions coverage for lawsuits seeking damages for financial injury.
D&O protects the personal assets of your company’s officers and the assets of their spouses and their estates.
D&O also protects the balance sheet of the company itself from lawsuits claiming financial injury by LPs, shareholders, state or federal agencies or third parties, such as competitors, vendors or lenders.
A directors and officers insurance policy is broken down into three separate coverage types:
- Side A – Directors and Officers Liability: This coverage protects the personal assets of directors and officers. If a company is unable or unwilling to indemnify its directors and officers, perhaps because of insolvency, a bankruptcy filing or by law, Side A provides protection for company leadership. No retention applies.1
- Side B – Indemnification: This coverage reimburses companies for the cost of indemnifying and defending their directors and officers in a claim. Retention applies.
- Side C- Corporate or Entity Coverage: Covers lawsuits filed directly against the corporation. If your company is sued for financial mismanagement, this coverage protects the company itself. Corporate coverage terms vary depending on whether the company is public, private or not for profit. Retention applies.
Each coverage type has its own terms and limits.
When deciding on the limits of D&O coverage, it’s important to consider that defense costs fall within the limits of insurance. This means that as legal costs mount, they erode the amount of coverage left for any claims payment that could result.
Legal costs can mount, quickly, during financial litigation and shareholder class-action lawsuits. Certain entities, such as special purpose acquisition companies (SPACs) claims and settlements can climb to millions of dollars.
ESG SPAC Insurance
A SPAC, also known as a “blank check company,” is a company with no formal commercial operations other than to raise capital via an initial public offering (IPO) for the sole purpose of acquiring or merging with an unspecified private operating business after the IPO.
When the merger occurs it’s known as the “de-SPAC” event or business combination event… This is the moment the private company becomes a public company.
SPACs and/or de-SPACs are increasingly the target of securities litigation by investors who feel they were mislead by the financial projections and forward looking statements made by either the SPAC acquisition team or the directors and officers of the target company that will become public in the de-SPAC event.
This is the case in all kinds of SPACs, including those in the popular environmental, social and governance (ESG) space. For instance, electric vehicle startup “Nikola” recently settled with the SEC for $125 million to address claims that CEO Trevor Milton made misrepresentations to investors related to EV production capabilities.
For investors to continue to see ESG SPACs as a viable pathway for financial innovations in electric vehicles, energy storage and renewable energy investments, sponsors need to partner with legal and insurance professionals with industry-specific expertise.
By doing so, they can ensure that their financial projections and any cautionary statements are tailored to fit the guidance and risks that are disclosed to investors.
Duty To Defend vs. Indemnity Policy
As mentioned above, defense costs will erode the total amount of coverage you have available to settle a claim… And the way defense is provided is determined by the terms of your policy.
Directors and officers insurance may be written with the “duty to defend” or the “non-duty to defend“:
- Duty to Defend: A policy with a duty to defend means that the insurance company will pay to defend your company and/or your directors and officers against claims, even baseless ones. However, you may have limited say – or no say – in the choice of counsel.
- Non-Duty to Defend: Also called an “indemnity policy”, a D&O policy with non-duty to defend coverage means the insurance carrier will reimburse your company for legal costs of defense. You may choose your own legal counsel. You should understand and agree about what “reasonable” costs of defense means to your insurance carrier as this interpretation will affect what defense costs and expenses are reimbursed.
Pre-Claim Directors And Officers Insurance Coverage
Another consideration in directors and officers insurance is whether your policy will protect you for “pre-claim costs”, or legal costs for addressing a potential D&O issue that don’t rise to the definition of a “claim”.
For instance, a company may receive a notification that it is being investigated by a state or federal agency, such as the SEC. In such a case, the investigation may cost money while the company and its directors and officers respond to requests for information related to the inquiry.
In such a situation, pre-claim coverage for D&O is important.
What Is D&O Tail Insurance?
D&O tail insurance, also known as an “extended reporting period” or “ERP”, is a type of insurance endorsement that can be added to a D&O claims made insurance policy to broaden coverage.
D&O tail insurance extends the period of time that a claim may be filed for an incident that occurred during the policy period, but prior to the policy being canceled or non-renewed.
D&O policies may include a brief extended reporting period of 30 or 60 days… However, more often D&O tail insurance is purchased separately during a time of transition for the company or its executives (such as if you are planning to retire or the company is being sold or wound down, etc.) extending the claims made period by a number of years.
The D&O tail insurance endorsement may be one time or renewable for an additional year or two or five years.
Covering Subsidiaries vs. Affiliates...
It is common for business owners to have interests in multiple business entities that may be related or unrelated to one another.
If you own multiple entities, you should know that directors and officers insurance covers subsidiaries and affiliates differently.
A D&O policy will often cover the parent company and its subsidiaries within the same policy.
However, if you also own affiliate businesses that have common ownership, but are not majority owned by an insured parent company, do not assume that these affiliates are automatically covered by D&O.
Indeed, because changes occur to ownership and business exposures annually, D&O should be evaluated based on common ownership and new entities, if any, should be added to the D&O policy by endorsement.
D&O vs. Management Liability
The terms D&O and management liability are often used interchangeably… However, a formal management liability program is broader than just directors and officers insurance coverage.
Also known as “executive liability insurance”, a management liability policy is a package policy that may include:
- Directors and officers insurance
- Employment practices liability (EPLI)
- Fiduciary liability
- Crime coverage
Each of the above addresses specific exposures that directors, officers and senior management have in their day to day roles for a company and your business situation you may or may not need all of the above.
While each of the above coverages may be written on a standalone basis, by combining them together in a management liability policy your company may be able to benefit from premium discounts and broader coverage.
If you’re concerned that you have a management liability exposure that is not properly covered by your insurance, schedule an appointment with me or give me a call at 203-300-0445. I can help you think through what risks you may have and how to address them in the most efficient way possible.
I look forward to talking with you about your business.