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By Carl E. Metzger
Directors and officers' liability (D&O) insurance provides a critical layer of protection from the risk of personal liability for anyone serving as a director or officer of a company. Understanding how D&O insurance really works, however, is not easy. To many, the policies seem arcane, and it is hard to figure out the actual coverage. What follows are answers to eight common questions about D&O insurance.
A: Young private companies historically went without D&O insurance until they became much larger businesses or went public. That practice has changed. Now, even many early-stage companies with relatively small operations have some level of D&O coverage in place.
Why? First, the coverage itself being offered by the major D&O insurance carriers is better and cheaper (relatively speaking) than it used to be because the marketplace for D&O insurance has become more competitive and better developed. Second, the directors of even small companies are seeking increased protection from the threat of personal liability.
A: There is no formula or litmus test applied in the D&O insurance industry. Many early-stage private companies carry between $1 million to $5 million in limits, with more mature companies with broader operations typically carrying $10 million or more. This range is substantial, and ultimately the answer for any particular company will depend in part on how much risk a board of directors is - or is not - willing to assume.
Key factors that should go into the analysis include: the sufficiency of the company's assets to cover fully its indemnification obligations owed to its directors and officers; the volatility and litigation risk profile of the company's business and industry; the scope and size of the company's operations; the company's future prospects and expected growth; the likelihood of significant transactions, such as merger or acquisition activity, an initial public offering or even a dissolution or bankruptcy; and the history of the company's relations (and disagreements, if any) with its business partners and significant shareholders.
A: The price of private company D&O insurance varies substantially, depending upon the company size. For a modest-sized company, $3 million of coverage can cost in the range of $14,000 to $20,000 annually.
The insurance carriers who are underwriting the coverage will base their pricing in part on the same kinds of factors as those addressed in Question 2 above, as well as on the coverages included within the D&O policy. Finally, the pricing per million dollars of coverage decreases with higher limits of additional coverage, since the likelihood of those limits being subject to a claim also decreases.
A: Historically, D&O policies simply provided the traditional "breach of fiduciary duty" coverage for a company's directors and officers. While you can still purchase that limited form of insurance if you choose, the typical private company D&O insurance policy offers broader protection in two principal respects.
First, the insurance typically is extended to include coverage for a wider group of insureds. Often, the company itself is an insured, as well as all employees, for certain types of claims. Second, the insurance offers coverage for a broader array of claims against such insureds, most notably including employment practices-related claims.
These facts mean that the coverage under a typical private company D&O policy actually has been expanded to provide protection against many forms of corporate liability. While this may be good for the company, it has the impact of diluting the coverage available solely to the directors and officers. Companies should carefully consider the true scope of their coverage and the need to secure higher overall coverage to provide adequate protection for the individual directors and officers.
A: While insurance carriers have standard form policies to begin with, the terms and conditions of D&O policies can be negotiated to improve the scope of coverage. Some leading insurance carriers have done a better job than others at updating their form policies to reflect coverage enhancements that have become commonplace in the current, competitive marketplace.
Even so, your insurance broker and legal counsel may have recommendations for how the form policy can be further modified to benefit the insureds. Such coverage enhancements often can be negotiated without any additional premiums.
Finally, no form policy can address the unique characteristics that certain companies present. A particular company's policy may need to be amended to account for an unusual corporate structure or a variety of other special considerations.
A: Getting help is important. In all likelihood, the company already has an insurance broker that it has worked with to secure other types of insurance, such as general liability, property and worker's compensation. Not all brokers, however, have expertise in negotiating top-quality D&O insurance.
The company should find out from its existing insurance broker exactly what experience it has with placing D&O insurance. References should be asked for and checked.
It is not uncommon for a company to retain a specialist for securing D&O insurance, while maintaining its relationship with its original insurance broker for other, more routine coverages.
If maintaining two broker relationships sounds too complicated to manage, then the company should switch its entire insurance program to a broker that has the expertise to ensure that the D&O insurance is negotiated correctly.
A: D&O insurance adds another, separate layer of protection for directors in addition to their rights to indemnification from the company. D&O insurance does not reduce or change the company's indemnification obligations. In the event of a claim against a director or officer, D&O policies typically will respond first to pay for that claim (including costs of defense, such as attorney's fees). The company is required to pay only the policy deductible.
In this manner, D&O insurance becomes a source of funds to pay for liabilities that the company otherwise would have under its indemnification obligations. This obviously is helpful to protect the company's assets, but it also helps protect directors and officers when a company lacks sufficient assets to fulfill its indemnification obligations.
If the D&O insurance coverage is unavailable for any reason (such as a coverage exclusion), directors can still rely on their indemnification rights to the extent that the company can pay for such liabilities.
A: Yes. D&O insurance policies provide coverage not just for the current directors and officers of a company, but also for the former directors and officers. However, there are two important caveats.
First, coverage for former directors and officers is only for claims that concern events occurring before the director or officer left the company and that relate to the individual's capacity as a director or officer. Second, coverage for former directors and officers continues only to the extent that the company continues to purchase D&O insurance in the future.
In other words, there must be a current D&O policy in place at the time the claim is asserted and under which the claim can be submitted. Insurers refer to this as "claims made" coverage. If the company does not continue its D&O coverage in this manner, then the former directors and officers will not have coverage available to them.
Companies that are being sold or are going out of business - an issue for many private concerns - will generally want to purchase a multi-year run-off D&O insurance policy (sometimes called "tail" coverage) that provides coverage for the former directors and officers after the company is no longer independently in business.
Companies typically purchase this coverage (with the full premium paid up front) for a six-year policy period. This time frame allows for the statute of limitations to run out on all possible claims.
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