Insurance isn’t generally one of people’s favorite topics because they have trouble understanding it. That holds true for most board directors as well. Insurance is filled with legalese. It’s difficult to understand and it’s filled with additions, conditions and exclusions. Since it’s not something board directors deal with every day, and sometimes not at all, some boards may wonder, “Why bother with directors and officers (D&O) insurance at all?”
Every organization, regardless of type or size, should have a D&O insurance policy, regardless of ownership. The reality is that D&O insurance claims are frequent and expensive. Just as boards are aware of their responsibility to protect the organization against other types of risk, they should be equally concerned about protecting themselves against liabilities that may affect them and their families.
What Types of Claims Fall Under Director and Officer Insurance?
Entities and individuals may sue directors and officers for many different reasons. The vast variety of claims may account for the frequency of claims.
Chubb Insurance stated in their 2016 private company risk management survey report that over 25% of companies had filed a D&O claim within the previous three years. The average loss for those claims was $387,000. For the companies that reported not having D&O insurance coverage, average reported losses were $400,000.
Hartford Insurance cites a Towers Watson survey that showed that public, private and nonprofit companies all face D&O litigation risks.
Here is a listing of the common claims that fall under D&O insurance:
- Negligent management
- Inadequate disclosure in financial reports or statements
- Breach of contract claims
- Antitrust claims
- Regulatory claims
- Breach of fiduciary duty resulting in financial losses or bankruptcy
- Misuse of company funds
- Failure to comply with workplace laws
- Theft of intellectual property and poaching of competitor’s customers
- Lack of corporate governance
It’s also important for directors and officer to understand that illegal acts or profits are generally not covered under D&O insurance.
Who Does Directors and Officers Liability Insurance Cover?
A D&O insurance policy covers the personal assets of directors and officers, as well as their spouses, if they get personally sued by any of the following for actual or alleged misdeeds in managing a company:
- Certain other parties
How Directors and Officers Insurance Offers Protection
According to attorney Kevin LaCroix, the policy definition of “claim” refers to “a written demand for monetary, nonmonetary or injunctive relief” as well as “a civil, criminal, administrative, regulatory or arbitration proceeding for monetary, nonmonetary or injunctive relief.” This definition clarifies that a D&O insurance policy can provide protection for directors and officers in an array of circumstances even when a lawsuit isn’t formally filed.
D&O policies provide insurance protection when a suit names the directors and the companies. In the event of a lawsuit, these policies cover legal fees, settlements and other costs.
D&O insurance policies cover various types of lawsuits. Suits may be brought forth by shareholders, managers, creditors, competitors, customers or regulatory agencies. It’s also common for lawsuits to name board directors and officers when a company is going through a bankruptcy.
D&O Insurance and Antitrust Claims
The federal and state governments have antitrust laws that regulate the conduct and organization of corporations. The intent of antitrust laws is to promote fair competition to protect consumer choice. Directors and officers should be knowledgeable about antitrust laws and how D&O insurance protects them against antitrust claims because mergers and acquisitions are common in public corporations. Mergers and acquisitions hold the potential to lessen competition and create monopolies. These issues may increase the potential for an antitrust claim. Companies that fail to purchase D&O insurance have no coverage for this type of claim.
It’s vital that directors and officers understand what their D&O insurance policies cover, as well as what they exclude. Many D&O insurance policies exclude coverage for antitrust claims. Some companies offer it but try to discourage corporations from purchasing the coverage. Directors and officers may be able to work with insurance agents to negotiate a D&O policy that includes antitrust coverage when insurance companies refuse to cover it.
Antitrust claims are common under D&O policies. They cover things like restraint of trade, unfair or deceptive trade practices, and unfair competition. A common element in antitrust crimes is collusion, which means to have a secret or illegal arrangement that intends to cheat or deceive others. Examples of this are price fixing, bid rigging and market allocation schemes.
Commercial insurance companies also commonly exclude coverage for intellectual property, professional services, contractual liability or other matters. Corporations that need these types of insurance coverage may need to shop around to find insurance companies that specialize in these areas. Some insurance companies are willing to add these types of coverages with a premium that is relative to the risk.
Differences in D&O Insurance Coverage for Private and Public Companies
Directors and officers should be aware that commercial insurers view private and public companies differently. That’s because each type of company carries different types and degrees of risk. Insurance companies are likely to offer broader insurance coverage for private companies with fewer limitations than policies for public companies. Directors and officers should be aware that insurance companies may limit their coverage to securities claims.
Final Tips on D&O Insurance Policies
It’s vital that directors and officers know that D&O claims are frequent and can cost their companies hundreds of thousands of dollars. D&O claims may place the company’s assets at risk, as well as those of directors, officers and their families.
Directors and officers need to educate themselves on the terms and definitions contained in their D&O policies to ensure that they have the proper types of insurance and that they have adequate liability limits. Directors and officers should also be aware that insurance policies begin with a basic policy wording and that wording can be modified by additions, conditions and exclusions. They must be aware of any gaps in coverage that could put the company or themselves at risk.
It’s prudent and wise for boards to electronically file their D&O insurance policies within the security of a board portal as part of a total Enterprise Governance Management system so that it’s available to board directors at all times.
Attorneys and insurance providers provide valuable consultation regarding the risks that directors and officers face involving their duties on the board.