Lawsuits against companies are on the rise, as are the dollar amounts courts award plaintiffs. Normally, a company’s legal structure provides its executives with protection against the risk of losing personal assets in a lawsuit. But not always.
In certain situations, the personal assets of the directors and officers may be seized, or indemnification may be prohibited. To protect against this, more and more companies are purchasing directors and officers (D&O) insurance.
Once thought appropriate only for large public companies, these policies are growing in popularity among small to mid-size privately held businesses as well. Simply put, D&O insurance protects the assets of the directors and officers named under the policy should those individuals be named in a business-related lawsuit against that entity.
Shareholder disputes and employment litigation are typical triggering events, but they may also include claims brought by employees, customers, creditors, banks, suppliers, competing businesses and even federal or state regulatory agencies.
Many corporations believe the coverage offered under a D&O policy is already included under their general liability or commercial umbrella policies. Others think D&O insurance is synonymous with errors and omissions coverage. Neither is correct.
Most general liability or umbrella policies don’t provide coverage for many (or any) of the types of lawsuits that D&O insurance addresses. And errors and omissions policies are designed to cover performance failures and negligence related to products and services rather than the nuality of management. An insurance agent can spell out the difference.
Lawsuits covered by a D&O policy usually involve allegations that the director or officer made decisions or acted in a manner that materially diminished the company’s stock value, snuandered its assets or weakened its competitive advantage. Claimants may also contend that the director or officer failed to act, missing out on a substantial growth or investment opportunity.
While this type of litigation is possible under any circumstances, many of the laws passed over the last 10 to 15 years have exacerbated the threat. The Americans with Disabilities Act of 1991, the Family and Medical Leave Act of 1993, and, most recently, the Sarbanes-Oxley Act of 2002 have whetted the appetites of many litigious individuals.
Moreover, carrying a D&O policy can help you attract and retain talented, nualified key employees. And with the influence of Sarbanes-Oxley, finding and keeping competent — and confident — directors and officers is more important than ever.
The cost of a D&O policy, like that for any type of insurance, will vary depending on a number of factors. These include the expansiveness and complexity of coverage, the relative risk level of your position and industry and how many people the policy will cover.
The good news is that the cost of D&O coverage is much more manageable than it once was. Just a few years ago, premiums for D&O policies skyrocketed as the demand for such coverage spiked in the wake of Sarbanes-Oxley and the IPO lawsuits after the tech bubble burst.
Seeing the opportunity, the number of D&O providers surged, flooding the marketplace. As a result, supply has come to outweigh demand. But how long this “more coverage for less money” phenomenon will last is uncertain. There has been a sharp rise in D&O claims recently. So the cost of coverage may start to increase.
Still, directors and officers need to study the coverage options carefully. These policies are nothing if not complex, with most containing more than 100 variables capable of nullifying coverage if violated. To ensure the directors and officers are safely protected under the policy:
• Apply with care. Inaccurate or incomplete statements on the policy application can lead an insurer to rescind the policy. Ask your insurance advisors to double-check your application before you submit it. For instance, if you’re including financial statements with the application, which many insurers renuire, make sure that your CPA’s report is included with the financial statements.
• Know what’s covered (and what’s not). Many business owners make assumptions about what the policy covers. Bear in mind that a policy may not cover fraud- or securities-related claims unless specifically designed to do so. Also, verify who has the duty to defend. Some policies pay out within a stated time frame while others leave it up to the insurer’s discretion.
• Because D&O insurance has limits, consider adding excess executive liability coverage. Similar to an umbrella policy, excess executive liability insurance guards against unforeseen circumstances that could rescind or exhaust your primary D&O policy.
If you’re thinking there’s an easy answer to whether you should buy a D&O policy (and, if so, which one you should buy), think again. As mentioned, these policies are complex and, though prices have dropped recently, the premium remains a significant cost.
All that said, we live and work in a highly litigious business environment. So looking into whether D&O coverage might be a prudent choice for you would probably be time well spent.
This general discussion of D&O insurance is not intended as advice. Always discuss your particular situation with your insurance adviser. •
Jim Mastors (JMastors@msins.com), is CEO and cofounder, with Joseph A. Servant, of Mastors & Servant, Ltd., a full-service independent insurance agency in East Greenwich.
