Directors and officers have two sources of protection in the event that claims are made against them for alleged wrongdoing: (1) indemnification from their company and (2) insurance. “Because there can be gaps in indemnification, companies should purchase insurance to make sure their people are protected,” says Christine Williams, a senior vice president and U.S. D&O practice leader with Aon Risk Solutions.
“A D&O policy affords coverage for any claims that are brought against a director or officer as a result of a wrongful act or omission committed by the director or officer in their capacity as such,” says Williams. “In light of potential gaps in indemnification and because of the ability for directors and officers to be sued, D&O has developed as a second source of financial protection for those sitting on the board of a company.”
Smart Business spoke with Williams and Kevin J. Pastoor, managing director, Aon Risk Solutions, about how to get the most comprehensive D&O coverage at the best cost.
Why is it necessary for companies to invest in D&O insurance?
A company can usually indemnify its directors and officers for defense costs, settlements, judgments and other costs incurred. However there are potential gaps in indemnification.
Indemnification itself is often inadequate, as it may not be available if the company has become insolvent and has no resources to pay the expenses incurred. It may also be against public policy considerations or statutory regulations to indemnify individuals in certain circumstances. In addition, a current board of directors may be unwilling to indemnify former directors and officers for alleged wrongdoing or misconduct.
Indemnification alone may not be enough for directors and officers in today’s regulatory and litigation environment.
What should companies look for when purchasing D&O insurance?
First and foremost, look at the financial stability and integrity of the insurance companies that are underwriting the risk. Typically, you want to look at criteria like A.M. Best and Standard & Poor’s ratings of A or better. Your broker’s financial security group should regularly review the financial condition of insurers. For example, during the financial crisis, some insurers were experiencing downgrades.
Also, pay attention to the claims-paying ability of the proposed insurers. How have they historically handled claims? Do they have the financial strength to pay claims? Then, take a look at the proposed structure of the D&O liability program.
How can a company determine which type of coverage is appropriate for its business?
There are many variations of D&O insurance available in the marketplace. The broker and client typically work together to ensure that the policy is tailored to meet the client’s specific needs.
A standard D&O policy covers three insuring clauses, referred to as A, B and C. Clause A covers directors and officers to the extent that the company is unable or unwilling to indemnify them. Clause B covers the company’s obligation to indemnify its directors and officers, subject to retention. Clause C covers the legal liabilities of the company associated with securities claims.
The second piece of the puzzle is determining the appropriate size of the retention. Companies should consider the strength of their balance sheet when determining the retention size, because a higher retention for B and C side coverage may allow them to achieve a lower premium.
What are the keys to obtaining the most comprehensive coverage at the best cost?
Clients cannot negotiate coverage directly, so you need to make sure your broker is acting as an advocate and differentiating your business and risk profile to the insurers. The concept of pre-underwriting the risk with the client and developing a risk profile for utilization by underwriters is recommended. A good broker will encourage one-on-one meetings to develop relationships with insurance companies, and those relationships will help in the event of a claim.
Differentiating your company is critical. A company can be classified as a financial institution and consequently be considered to be a difficult risk by the underwriting community. However, a specific financial institution could be a straight-forward asset manager versus a very complicated hedge fund or banking institution with multiple operations.
Another key consideration is how you structure the breadth of coverage. You want to get the insurers comfortable with the risk profile in order to obtain a broad breadth of coverage. The broker should focus on the breadth of the terms and conditions available while also developing long-term relationships between a client and its insurers.
How does a company’s risk profile affect the purchase of D&O insurance?
If a company has a fluctuating stock price, or if clients are withdrawing their assets from the company, insurers will deem that to be less favorable. From a risk profile perspective, insurers will look to charge an appropriate premium.
At the end of the day, insurers simply want to understand the scope of the risk so that they can provide acceptable terms and conditions to the insured with an appropriate premium.
Christine Williams is a senior vice president and a U.S. D&O practice leader with Aon Risk Solutions. Reach her at firstname.lastname@example.org.
Kevin J. Pastoor is managing director of Aon Risk Solutions. Reach him at (248) 936-5346 or email@example.com.
Aon D&O events for the first quarter of 2011 will be held in New York, Cleveland and Los Angeles, and for the second quarter in Philadelphia and Pittsburgh. These events will focus on the D&O outlook for 2011. For more information on Aon D&O events, contact Kristen Jones at firstname.lastname@example.org.