Directors and Officers Liability Insurance

18 - 1Copyright 2008, The National Underwriter Company

Directors and Officers Liability Insurance

What is it? Coverage developed to protect individuals who serve as

directors and officers of corporations For financial losses arising from wrongful acts Forms differ from insurer to insurer

Chapter 18Risk Management For Financial Planners


Types of entities needing D&O coverage Publicly traded corporations

Shares are traded publicly on a stock exchange

Privately or closely held corporations Owned by one or a small group of individuals – or a family Shares not offered to the general public

Not-for-profit organizations Organized to serve a community, charitable or fraternal purpose




Responsibilities of directors and officers Directors are elected by an entity’s shareholders

Collectively known as the board of directors May be recruited from outside the entity

Community leaders Experts in a particular area

Director may also be a corporate officer




Responsibilities of directors and officers Sarbanes-Oxley Act of 2002

Sets new standards for accounting and financial reporting Mandates that chief executive officer and chief financial officer

certify financial reports Heightened scrutiny of directors who are not independent of the

corporation D&O underwriters now include review of Sarbanes-Oxley

compliance when underwriting the coverage




General categories of exposures Fiduciary duty

Directors owe the organization a high degree of good faith, candor and loyalty

Directors may face personal liability if they have breached this fiduciary duty

Negligence Liable for losses that arise from negligence in their actions as

board members Business judgment rule

Provides a shield against liability for those who act in good faith in making business decisions

It would not shield a director who was grossly negligent or acted outside the his/her duty as a director




General categories of exposures (cont’d) Bad faith (unauthorized conduct)

Not shielded by the business judgment rule when they engage in bad faith actions or fraud




Other categories of claims Employee claims

Employment discrimination Basis is discrimination that arises from an employee’s membership

in a protected group

State and federal laws prohibit employers from making employment decisions on the basis on an individuals

Race National origin Gender Age Religion or creed Disability

These are the protected groups D&O policy may include coverage for employment related practices

liability (ERPL)




Other categories of claims (cont’d) Claims from outside the organization

Customers, vendors and competitors Financial damages Personal liability

Various governmental agencies For violation of certain laws

ERISA Environmental laws

Theory of Deepening Insolvency Keeping the business going and masking financial problems Financial mismanagement / misstatements about the business is

finances




Business uses Corporate indemnification

Mandatory indemnification An absolute statutory requirement that directors and officers

Be indemnified for their expenses to defend proceedings brought against them

As well as settlements and judgments arising from such actions

Permissive indemnification Corporation is permitted but not required to indemnify a director or

officer Where indemnification is not mandatory




Business uses (cont’d) Why buy D&O insurance

D&O polices fund the personal liability exposures of individuals as well as paying the corporation’s expenses to indemnify those individuals

Organization may not have sufficient funds to pay for defense and settlement

It responds to claims for pure financial loss D&O excludes coverage for damages arising from

Bodily injury Property damage Personal liability




Business uses (cont’d) Terminology refresher

Bodily injury – direct injury, sickness, disease or death Financial loss – financial damages, settlements, judgments, and

defense costs Property damage – physical injury to tangible property along

with the loss of use of the property




Advantages Facilitates the recruitment of outside directors May be the only protection directors and officers have in

the event of an organization’s insolvency No corporate indemnification if funds are not available

Protects the assets of the corporation that might otherwise be needed to indemnify officers and directors for judgments and settlements costs

Not-for-profits simply do not have enough funds available to indemnify




Advantages (cont’d) Premium cost could be miniscule when compared to

costs of defense or settlement D&O insurers could recommend risk management

consultants or legal firms that specialize in director or officer claims

D&O policies provide that insured organization will control the defense of claims Insureds will want to play a prominent role in their defense

Lengthy process of application may lead to risk management initiatives that otherwise might be overlooked




Disadvantages Investment in a policy that may be rarely used Lengthy time to complete application No standard D&O policies

Risk manager must carefully review the coverage

D&O insurance is a specialized practice area Requires agents, brokers and underwriters who are experienced

in the area

Cost of defense included within limits of liability Policy may have to be stretched to cover defense costs and

settlements




Disadvantages (cont’d) D&O policies will not respond to all claims Organization will control defense of claims

Must engage legal counsel Resources are tied up in their defense They cannot simply just turn a claim over to the insurer and let

them handle everything




General attributes of most D&O policies Coverage grants

Coverage A (Side A Coverage) Coverage for losses not subject to corporate indemnification No (or small) retention or deductible

Coverage B (Side B Coverage) Funds claims that are subject to corporate indemnification Deductibles ranging from a thousand to hundreds of thousand of

dollars

Aggregate limit of liability The most that will be paid in any policy period Defense cost included in the limit of liability Careful analysis needed in choosing proper limit of liability




General attributes of most D&O policies Claims-made coverage

Policy applies to claims made and reported during the policy period or discovery period

Discovery period – Time after policy is canceled or non-renewed that insured is given to discover claims that arise from wrongful acts during the policy period

Claims made and reported coverage Policy applies to claims made and reported during the policy

period

Occurrence based coverage Policy that applied to the occurrence that caused the damage

will respond regardless of when the claim is filed




Claims reporting requirements Require organization to notify insurer in writing of any

claim within a certain timeframe of when the claim was received

Circumstances that may result in a claim Insureds must also notify insurer of any occurrence or

circumstance that may reasonably be expected to result in a claim Including reasons for expecting the claim Designed to make underwriters more aware of potential claims

so subsequent policies can be priced more effectively Serves to allocate claims to the most appropriate policy period




Definitions Claim

Written demands for monetary relief or non-monetary relief for civil, criminal or arbitration proceedings

Also for injunctive relief, regulatory proceedings or regulatory investigations

Director or officer Insured person, executive, individual insured Past, present and future directors, officers, trustees and

governors of the organization




Definitions (cont’d) Insured

Individual insureds and the organization (or entity)

Loss Damages, settlements, judgments, interest on judgments and

defense costs Excludes fines, penalties, taxes, punitive damages

Wrongful act Breach of duty, neglect, errors, mistakes, misstatements,

misleading statements and acts or omissions




Definitions (cont’d) Exclusions

Those that deal with corporate governance Gaining in fact of any profit or advantage to which the insured was

not legally entitled Payments to directors or officers without the previous approval of

the shareholders Deliberate criminal or fraudulent acts of the insured

Those that are uninsurable or better insured elsewhere Bodily injury Pollution liability Property damage Violations of ERISA Personal injury




Definitions (cont’d) Limit of liability

Coverage limit Includes defense costs

Aggregate Limit Caps the amount the insurer will pay for all claims within a policy

period

Control of defense Insured and not the insurer controls the defense of claims Insured may not admit to or assume liability without consent of

insurer Insurer may want to monitor the defense and participate in it and

the settlement negotiations




Definitions (cont’d) Panel counsel

Pre-approved list of defense attorneys attached to and part of policy

List of specialists in particular areas of law Fee levels that are reasonable and set in advance




Discovery provisions Unilateral discovery

Extended discovery period is guaranteed to be available only if policy is non-renewed by the insurance company

Bilateral discovery Extended discovery period is available if either the insured or

insurer non-renew the policy Changing carriers

New carrier should be asked to provide “prior acts coverage” New policy will cover claims for wrongful acts committed before the

new policy began New carrier may attach a retroactive date

Limits the coverage date to wrongful acts that occurred between the retroactive date and the policy’s expiration date




Changes in the organization Mergers and acquisitions should be reported to the D&O

carrier Policy may be invalidated upon completion of the deal




Other insuring agreements Coverage C (Side C) – Organization entity coverage

Coverage for the entity itself

Not-for-profit entity coverage Entity coverage Not-for-profits may lack financial assets to successfully defend a

suit Insuring agreements may also offer to advance defense costs




Other insuring agreements (cont’d) Publicly traded entity coverage

Restricted to entity coverage for securities violations or statutes regulating securities, including their purchase and sale

Securities claims often involve a drop in price or allegations of misleading information that encouraged the purchase of that stock




The allocation issue Part of a claim is covered and part is not

Defense and settlement cost must be allocated

Claims that involve covered and uncovered parties Covered parties – Directors and officers Uncovered parties – Corporation or organization and its

employees

Claims that involve covered and uncovered allegations




Coverage for claims arising from Initial Public Offerings (IPO’s) Private companies IPOs – First offering of stock when

going public Existing public companies – additional shares of stock or

secondary offering Private company D&O – may exclude coverage for IPOs

Underwriters need to review and analyze information that is developed to sell these shares

Prospectus




Coverage for claims arising from Initial Public Offerings (IPO’s) (cont’d) Some private company’s D&O policies may offer

securities coverage Limited coverage for claims from certain types of securities Underwriter must offer a coverage proposal as long as:

Company notifies underwriter of the IPO in advance Provides additional details Pays the premium in advance




The application Attached to and part of the policy Representations made in the application form the basis

for the coverage Material misrepresentations may void the policy

Duly authorized officer of the organization signs the application Warrants that the information is true and correct



Directors and Officers Liability Insurance

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