The first impression of D&O insurance may be that it only offers liability coverage when a board director or officer unintentionally makes a mistake. In fact, it offers coverage for more individuals than that and it affords insurance coverage for many more circumstances than you might think. Insurance claims adjusters often have to get involved with very complex claims issues, such as those that involve mergers and acquisitions.
If there’s any doubt as to the importance of director and officer insurance, we can look back at the financial crisis of 2008 and see how the misdeeds of financial institutions support the need for D&O insurance. Yet another issue that has increased exposures to directors and officers is the evolution of corporate governance practices in light of the financial crisis. While D&O insurance covers far more than most people think, directors and officers must be aware of their actions as they pertain to what D&O insurance policies will and won’t cover.
How the Financial Crisis of 2008 Affected D&O Insurance
During the financial crisis of 2008, many boards of directors were caught unaware of their corporation’s fraudulent practices. Large numbers of corporations that got into trouble were banks and other financial institutions, but there were also large numbers of other types of businesses that also got into financial trouble.
As bankruptcies soon became commonplace, many companies were forced to write off large, uncollectable debts. Consumers tightened up and stopped buying goods and delayed making major purchases. People stopped traveling or pared down their vacation plans. It was a chain reaction that affected nearly every industry, including real estate, tourism, cars and luxury items. Numerous companies were forced into bankruptcy.
These situations left shareholders, creditors and employees with the only option of claiming a dividend in bankruptcy, which often paled in comparison to the total amount of money they had lost. For many, their only recourse was to file a claim against the company’s D&O insurance policy, which was the sole remaining asset.
Evolution of Corporate Governance Leads to Issues That Increase D&O Exposure
In addition to amassing economical and societal changes, the financial crisis led to the evolution of corporate governance principles, which have also had an impact on director and officer insurance policies. The financial crisis led to increased regulatory scrutiny and change.
New securities laws and regulations now require greater disclosures and increased communication and transparency to shareholders and the public. To remain in compliance, corporations must revise their audit protocols and internal controls. They’ve had to make changes in board composition to accommodate non-executive directors and to allow for greater diversity. Corporate boards must now disclose the details of remuneration packages and follow proper authorization procedures.
These and other changes have caused board directors and officers to take on a greater degree of personal liability over issues of mismanagement and nondisclosure. These are a sampling of the reasons for the importance of boards of directors to acquire D&O insurance policies.
According to Allianz, a major insurance company, they’re seeing increased exposures in the following areas since the financial crisis:
- Aggressive plaintiff litigation strategies
- Increased loss severity
- Increased regulatory scrutiny
- New plaintiffs emerging
- Increased financial restatements
- Significant D&O claims payments
Basics of D&O Insurance
D&O insurance policies protect directors, officers and their spouses from alleged wrongdoing in the scope of their duties. The policy also protects these individuals’ assets and estates, as well as a company’s assets. A director and officer insurance policy also reimburses companies for claims they pay to third parties to protect their directors and officers.
Many of the decisions that directors and officers make may be subject to allegations of harm. Some of the more common types of risks are employment practices and other issues related to human resources. Financial reporting can be the cause of a D&O claim such as reporting errors, inaccurate disclosure, inadequate disclosure or misrepresentation in a prospectus. Directors and officers may be accused of making decisions that exceed their authority, which are covered under a D&O policy. Lawsuits may also be brought about by shareholder actions or accusations of failure to abide by laws and regulations.
While directors and officers serve their corporations dutifully, they have much to lose from a personal standpoint.
What D&O Insurance Policies Don’t Cover
Director and officer insurance policies cover many different people and issues, depending on the circumstances surrounding a claim. As with other types of insurance policies, D&O insurance policies won’t cover certain illegal, criminal or intentional acts. Some examples include:
- Intentional non-compliant acts
- Illegal remuneration
- Personal profit
- Property damage and bodily harm (with certain exceptions)
In addition, director and officer insurance policies won’t cover claims where legal action had been taken when the policy began, if claims were made under a previous policy, or for claims that are covered under other insurance policies. A notable exception for claims covered under other policies is with regard to professional indemnity. In some cases, a professional indemnity policy would be the first payor and the D&O insurance might pay a claim as a secondary insurer if the claim exhausted the limits of the professional indemnity policy.
D&O insurance policies make another important distinction of which board directors and officers should be aware. Claims are often brought against companies and multiple individual directors. In some cases, the company and some of the directors may be found innocent of wrongdoing, while one or more other directors may be found guilty of a non-covered claim. In this type of circumstance, the innocent directors would be fully covered by their D&O insurance policy, even if the acts of their co-defendants were intentional, criminal or fraudulent.
Claims against D&O insurance companies are often multifaceted and highly complex, with no easy answers. Even the best-intentioned board directors and officers can make mistakes, especially given the evolution of corporate governance. Directors and officers, along with their spouses, have much at stake from a personal and a professional standpoint. Before accepting a seat on a board of directors, directors and officers should ensure that the company has a D&O policy and ask a trusted attorney to review it on their behalf. The risk of allegations is high. The cost of claims is also high enough that directors and officers shouldn’t underestimate the importance of a D&O insurance policy.