Directors & Officers Insurance

What is Directors & Officers Insurance?

Directors & Officers Insurance, often called “D&O insurance” for short, protects a business’s directors and officers, and their personal finances, against lawsuits for failing to perform their duties properly. Depending on the policy, coverage generally extends to the costs of legal defense, civil financial penalties, and settlements.

Who is a Director or Officer?

Directors and officers most commonly include the following stakeholders:

• A director is someone who makes important decisions for your business; for example, the CEO, treasurer, president, vice-president, or anyone on the board of directors.
• An officer is someone with responsibility for the day-to-day running of your business. This could be a line manager, the COO, or anyone in a senior position who oversees daily operations.

Typically, D&O policies cover primarily these individuals. However, some policies will extend coverage beyond the directors and officers, to include other key business stakeholders such as advisors, attorneys, and accountants of the business.

What are the Legal Obligations of Directors and Officers?

Your business’s directors and officers have legal obligations to meet and fiduciary responsibilities they must fulfill. We can break these down into three key areas:

• Duty of care
  Directors and officers must make decisions for their organization in good faith, exercising the diligence, care, and skill that any “reasonably prudent person in their position” would.
  
• Duty of loyalty
  Directors and officers must act in the best interests of the business as a whole and declare any potential conflicts of interest.
  
• Duty of obedience
  D&Os must make sure that the business (a) complies with all applicable laws and regulations, (b) adheres to its own policies, and (c) works towards its stated mission. 

In the day-to-day running of a business, it’s not hard for a director or officer to overlook something important or make an honest mistake, leaving themselves and their organization exposed to a costly lawsuit (see What Is the Cost of a D&O Lawsuit? below).

What Does D&O Insurance Cover?

Depending on your insuring agreement, the scenarios covered by a D&O policy may include:

• Errors in your business’s financial reporting 
• Inaccurate disclosures (e.g., misrepresented the business’s financial status to banks or creditors when requesting a loan)
• Business insolvency (e.g., caused by mismanaged finances)
• Allegations of violations of federal or state laws and regulations applicable to your business
• Intellectual property theft and trade secrets may be covered, usually with a sublimit
• Engagement in or failure to prevent or rectify employment malpractice (e.g. wrongful termination, harassment in the workplace, or discrimination in hiring practices across the institution)
• Shareholder allegations of conflicts of interests on the part of directors and officers acting for personal benefit rather than for the benefit of the business as a whole (e.g., allegations of misuse of company funds)
• Cybersecurity incidents are a relatively new source of D&O lawsuits against private companies, too. Industry observers expect to see an increase in D&O claims related businesses failing to protect themselves adequately against hacks and data breaches. Notably, many cybersecurity scenarios require a separate cyber insurance policy.

There’s a common misperception that only big, publicly traded companies need to worry about claims against directors (made by shareholders). In reality, all organizations are vulnerable to D&O insurance exposures. D&O insurance policies offer liability insurance coverage for the directors and officers of nonprofit, for-profit, and privately held businesses. 

Private businesses, in particular, have to contend with D&O claims made by customers and consumers, competitors, shareholders, governmental or regulatory bodies, creditors, and even vendors. Research has found that over a ten-year period, a private company has:

• A more than 10% chance of a receiving a lawsuit filed by a creditor
• A more than 40% chance of a shareholder lawsuit
• A 10% chance of being sued by a customer

D&O insurance providers don't, however, cover every risk your business faces under just one policy.

What litigation costs are covered?

The exact amount of coverage will vary by policy, but the D&O policy should generally provide relief from all of the following:

• Legal defense fees
• Losses associated with a lawsuit (this may include settlements out of court as well as civil fines or penalties awarded against you)
• Expenses related to criminal or regulatory investigations of your business

What are the different types of D&O coverage?

D&O insurance agreements come in three different types, called “Sides.” Each one provides a different model of coverage.

• Side A coverage
  Protects the personal assets of directors and officers if a company is unable or unwilling to cover their losses in a D&O case. Applicable examples of scenarios in which companies may not indemnify directors include derivative lawsuits, federal or state laws precluding indemnification, and or bankruptcy. Under a Side A policy, the directors & officers are the insured(s).
  
• Side B coverage
  Protects directors’ and officers’ losses when their company does pay for those losses. The policy protects the company’s corporate assets and the insurer reimburses the business’s legal costs. Under a Side B policy, the company is the insured.
  
• Side C coverage
  Protects a company’s corporate assets. Under a Side C policy, also known as “entity coverage,” the company is the insured. Importantly, losses contributed toward a Side C claim may reduce the remaining limits available to protect individual directors and officers (e.g., under Side A Coverage).

D&O Insurance policies are generally packaged a Side A only or as a traditional D&O policy including each of Side A, B, and C. The type of coverage and policy limits that best suit your organization depend on your business model, your company’s history, and its overall financial health. This is something to discuss with your broker or insurance carrier. 

What Does D&O Insurance Not Cover?

Most insurance carriers will not cover directors’ and officers’ costs if they are found to have intentionally engaged in criminal wrongdoing, including fraud or making illegal profits. Policies do generally include a “severability clause” that maintains protection for individuals who were not implicated in or aware of wrongful acts. So while D&O insurance can help protect you against allegations of wrongdoing, it is absolutely not a license to engage in any illegal or non-compliant activities.

Additionally, lawsuits between directors and officers who are currently still serving in your company (e.g., if one senior manager sues another while both are still employed at the company) are also usually not covered. This is typically referred to as an “Insured vs Insured” exclusion. Claims like this are seen as potential vehicles for corruption and are therefore not covered under standard D&O policies.

Examples of other types of claims that are not generally covered under D&O policies include:

• Bodily injury and property damage
• Product liability
• Pollution
• Employee benefits and ERISA violations. (Businesses looking to obtain coverage for these types of plans should consider Fiduciary Liability Insurance)
• Professional services
• Contracts
• Harassment and discrimination
• Workplace torts 
• Violation of privacy law

What is the Cost of a D&O Lawsuit?

A D&O claim can be extremely expensive for a small business. A 2016 survey by Chubb, an insurer, found that 26% of private companies had experienced a D&O loss in the preceding three years and that the average reported loss was $387k.

While the exact cost of potential liabilities depends upon the nature of your business and of the potential allegations, it is clear that D&O allegations are sufficiently common and liabilities are sufficiently large that small business owners should be paying attention.

Very few D&O lawsuits get as far as the courtroom. The vast majority end in financial settlements, which can be extremely costly. This is especially true for smaller businesses without enough resources to pay the agreed amount, leaving their directors’ and officers’ personal finances exposed.

How Much Does D&O Insurance Cost?

Insurers will determine your D&O premiums based on a number of characteristics about your business, including:

• The type of coverage you want or need
  For example, Side A, covering just your directors and officers, or Sides B or C, which cover the company as well.
  
• Your industry
  There are certain risks associated with manufacturing, for example, that drive up the cost of D&O coverage.
  
• The length of time you’ve been in business
  A well-established, financially healthy business will usually get lower premiums than a start-up with debts.
  
• How many employees you have
  Employing more people may be associated with a greater risk of an employment-practice lawsuit
  
• Any history of claims made against your company
  Previous lawsuits filed against your business may indicate that you’re a higher risk for more.

According to Investopedia, you can expect to get $1 million of coverage for between $5,000 and $10,000 per year if your annual revenue is less than $50 million.

D&O Insurance: Frequently Asked Questions

1) Do I need D&O insurance if I already have professional liability insurance?

Yes. D&O insurance is a type of professional liability insurance, but not all professional liability insurance (e.g., professional indemnity insurance or insurance for errors and omissions) covers directors and officers if they are sued for acting in violation of their duties. Speak to your broker about getting a D&O add-on to the coverages you already have.

2) Does D&O insurance cover directors and officers even after they’ve left a company?

Yes. Directors and officers can be held liable for their actions at the time of a business transaction and afterwards, too; therefore a D&O insurance policy covers them for their actions in that role even after they no longer hold it, usually for a limited period of time as specified in the policy.

3) Does D&O insurance cover employees in addition to directors and officers?

Sometimes. Usually, only named directors and officers as well as supervisors and managers are covered by D&O insurance. Counterpart’s D&O coverage is an exception to this rule, as it extends to all your business’s key stakeholders, including employees at the lower levels. 

Final Thoughts

Some of the most common reasons given by small and medium-sized businesses for not purchasing D&O insurance include:

• Assuming that a private or family-owned business does not need it
• Thinking that the risk of a major financial loss is very small
• Believing that they’ll never be sued by one of their own employees
• Mistakenly assuming that their directors and officers are covered by other insurance policies they already hold

As this article explains, D&O insurance is an important protection product for small business owners to consider. Together with other policies, such as employment practices liability insurance and fiduciary insurance, D&O insurance can help reduce your risks. Speak to your broker about the needs of your business and how management liability coverage from Counterpart can offer protection.