Understanding D&O Insurance

What keeps directors up at night? Many worry about personal liability from their board service. In a 2011 survey, 76 percent of CEOs surveyed said they were not confident for-profit boards had adequate insurance coverage, and 70 percent said the same about nonprofit boards. Only 59 percent of respondents said their board had directors and officers (D&O) liability coverage. (Source: Survey, Chartis and The Chief Executive Group)

D&O policies will pay legal defense costs and settlements for directors’ and officers’ personal liability for actual or alleged “wrongful acts” committed in the course of their official duties. Policy definitions vary, but “wrongful acts” usually include actual or alleged acts, errors, omissions, neglect or breaches of duty, misstatements or misleading statements. Even if you have D&O coverage, does it fully protect your directors and officers? Understanding your risk exposures and what your policy covers can help you avoid potentially costly coverage gaps. Some things to look for include:

• Exclusions. Typically, policies exclude: 1) claims for bodily injury, property damage and personal injury, such as libel, slander and emotional distress. Your general liability policy covers these risks, 2) “prior incidents” and “prior litigation,” or incidents reported in earlier coverage periods and litigation begun before the policy period, 3) ERISA liability, which results from administering pension and welfare plans, 4) pollution or environmental impairment liability, and 5) coverage for punitive damages. Other exclusions vary more. For example, some policies specifically exclude securities actions; some exclude coverage for fraudulent, dishonest or criminal acts. Publicly traded firms buy D&O coverage, in part, to protect directors and officers from these types of claims. If your policy contains these exclusions, you will want to negotiate with your insurer to have them removed.
• Coverage for regulatory actions. D&O insurance policies can cover costs if a regulatory agency investigates the organization for some types of wrongdoing. However, some policies exclude coverage for specific activities, particularly in the financial services field. And some policies might specify coverage for regulatory activities by named agencies. This could imply the policy limits coverage to actions by named agencies only, warned attorney and D&O blogger Joseph Monteleone of Tressler LLP in New York.
• “Preclaim” costs. D&O policies traditionally do not cover costs an organization incurs when investigated as a “party of interest” or in an informal inquiry, as opposed to when it is the target of an investigation. Some insurers now offer coverage for preclaim costs in certain situations, reported Business Insurance magazine (8/7/11).
• Securities suits brought outside the U.S. Will your policy cover investigation and defense costs incurred in a foreign jurisdiction, as well as any potential settlements? This coverage could prove important to multinational firms, as other countries beef up their securities regulation.
• Advancement of loss. Whether a policy actually covers a claim can remain undecided until the case is resolved. For example, many claims against directors and officers allege fraud, which many policies exclude. Meanwhile, defense and investigation costs accrue. If your insurer reimburses insureds for legal defense costs before settlement, it might stipulate that the insured reimburse the insurer if the claim turns out to be uncovered.
• Severability. Wrongful acts can void coverage, so you will want your policy to have a severability clause, which clearly states that the wrongful act of one director or officer will not be imputed to any other director or officer.
• Entity vs. insured exclusion. Older D&O policies often have an “insured vs. insured” exclusion, which excludes coverage for claims brought by one insured against another. This could include suits brought by the corporation against insured directors and officers (or ex-directors and officers), if your policy covers the corporate entity. The newer wording specifically eliminates coverage for suits by the corporate entity against its own officers and directors.
• Coverage for bankruptcies. Chapter 11 filings often trigger shareholder suits against the corporation’s directors for breach of duty or fraud. When a company goes into receivership, ownership of the D&0 policy and its proceeds can come into question. Entity coverage under the policy can also reduce the limits available to defend directors and officers. Policies can be amended to fix these coverage gaps.

The complexity of claims against directors and officers makes D&O one of the most challenging areas of coverage. Every corporation’s situation and policy needs individual analysis.