While the vast majority of Fortune 500 companies carry directors and officers (D&O) liability insurance for risks including securities class-action lawsuits, should you and/or your business carry this coverage?
In an environment where litigation is commonplace, you should consider it, particularly if you face increased exposure due to certain business activities. As a director or officer of a public or private company or of a nonprofit, you can be held personally liable in the event of a lawsuit. To protect both your personal assets and those of the company, it is critical that anyone on a board or in senior management is covered by directors and officers liability insurance.
“D&O provides protection for those individuals acting in their capacity as directors and/or officers for their management decisions and for the organization itself,” says Chris Mower, senior vice president of Aon Risk Services Central Inc.’s Financial Services Group.
Smart Business spoke with Mower about why you need directors and officers liability insurance, how it protects you and what can happen if you fail to purchase it.
How does D&O insurance benefit directors and officers?
It provides coverage to directors and officers in situations where the company is unable to offer personal asset protection. Directors and officers have basic duties of diligence, loyalty and obedience that they owe to shareholders or debt-holders, the organization, and third parties such as customers or business partners. People who serve as directors and officers are exposed to personal liability as a result of their acts or failure to act with respect to these duties.
Organizations typically offer indemnification to their directors and/or officers for these acts or the failure to act to the fullest extent permitted by law. However, this cannot be relied on in all situations. For example, an organization may not be able to indemnify its directors and/or officers if prevented by the corporate bylaws or if it is insolvent and does not have funds to indemnify. Also, in situations such as a change of control, the organization may limit, alter or deny indemnification. The D&O policy is designed to fill these gaps and respond if a claim is made against a director or officer for a wrongful act. The policy provides coverage for defense costs, as well as judgments and settlements.
In what situations does D&O insurance cover a director and/or officer?
The most common exposure for a public organization is a shareholder securities class-action lawsuit. These claims typically allege that directors and/or officers made false or misleading statements or failed to disclose relevant facts to the public that resulted in harm to their shareholders or debt-holders.
Additional exposure results from mergers, acquisitions or divestitures, investor guidance, financial restatements, and unsuccessful business ventures. Directors and/or officers of privately held organizations face liability from minority shareholders, debt-holders, family shareholders, customers and suppliers.
Employment practices (e.g. wrongful termination) are a frequent exposure for a director and/or officer of either a privately held or a nonprofit organization.
A D&O policy will respond if a claim is made against a director, officer or the organization. The policy will be triggered by the definition of claim, which can include a written demand for damages, a formal civil, criminal or regulatory proceeding, or a formal investigation.
A standard policy will provide coverage for defense costs as well as judgments and settlements once the definition of claim has been triggered and the claim has been appropriately noticed to the relevant insurance companies.
How often should you review your coverage?
Changes in applicable case law and marketplace availability require D&O insurance policies be reviewed on an annual basis to ensure every layer of an insurance program will respond as intended in the event of a claim. As the severity of claims increases, any contractual advantage that favors an insurer will be used to deny a claim or reduce payment for loss.
The details of the policy language are critical. A successful collaboration among an organization’s risk management and legal departments, outside counsel and a well-established, global insurance brokerage firm with D&O coverage expertise can ensure a D&O insurance program will respond appropriately.
What are the dangers of not purchasing a D&O policy?
An uninsured claim can have a significant detrimental impact on an individual’s personal financial situation or an organization’s balance sheet. As this insurance provides coverage for directors’ and officers’ personal assets, they can be held personally liable for claims if neither insurance nor corporate indemnification is available.
Since the passage of the Private Securities Litigation Reform Act of 1995, both securities class-actions and derivative claims have become more frequent and severe. In 2008, 227 securities class actions were filed, a 29 percent increase compared to the previous year; moreover, the average value for the class actions settled in 2008 was $36.7 million, excluding defense costs, a 40 percent increase compared to the previous year.
In today’s litigious environment, this coverage is viewed as a must-have for most directors to sit on the board of an organization.
Additionally, most corporate executives believe the insurance is a prudent risk transfer mechanism to protect an organization’s balance sheet.
Chris Mower is senior vice president of Aon Risk Services Central Inc.’s Financial Services Group. He is responsible for business development, consultation and placement of management liability insurance in conjunction with Aon’s retail offices. Reach him at (314) 854-0806 or firstname.lastname@example.org.