Protecting your company’s decision-makers.
In today’s litigious business environment, businesses—small or large—must be prepared for potential legal challenges. One of the key risk management strategies businesses can deploy is the purchase of Directors and Officers insurance. In this article, we’ll answer the question:
Why businesses need directors and officers insurance.
D&O insurance has traditionally been associated with larger firms and publicly traded companies. However, in the modern business landscape, small and mid-sized companies are increasingly needing this type of coverage due to the evolving nature of liabilities.
In this comprehensive guide, we’ll delve into the reasons why D&O, insurance cover has become a must for businesses and explore its significance in different risk scenarios.
Understanding Directors and Officers Liability Insurance
D&O insurance is a liability form of insurance broken down into three layers, commonly called sides.
Side A Coverage
Side A coverage in a D&O policy provides first-dollar protection to the insured individuals. This means that coverage is triggered without payment of retention or deductible for the benefit of directors, officers, managers, and other insured persons under the policy.
Side A protects the personal assets of the insured persons when the entity or insured company is unable or unwilling to pay for litigation costs including legal fees and settlements.
Side B Coverage
Side B coverage provides reimbursement of the expenses incurred in D&O litigation by the company when indemnification is permitted. Under Side B, the policy is protecting corporate assets from financial losses incurred in paying legal fees, court costs, settlements, and awards.
Side C Coverage
Side C is often known as Entity Coverage, as it protects the insured company or entity when claims are made against the entity, in private companies. Side C in a public company policy is restricted to securities claims.
Stand-Alone Side A
There is a separate policy often sold as part of a larger D&O coverage program known as Stand-Alone Side A. It can also be referred to as a “difference in conditions” or DIC policy.
The purpose of having an extra layer of protection as Stand-Alone Side A is to provide an extra measure of coverage solely for the insured persons; directors, officers, managers, and other leaders.
The traditional reason why Stand-Alone Side A has been purchased is to protect the insureds in the event of company bankruptcy. The reasoning is that in bankruptcy, the bankruptcy trustee often seizes the D&O policy as an asset of the company, leaving the Ds and Os without protection.
Today that concern still exists and is a good reason for stand-alone protection, but extra Side-A protection DIC helps fill in gaps in coverage and provides higher limits of protection for board members and the company’s leaders. And often this form of coverage offers the insured person first-dollar protection.
Increased threats faced by small and mid-sized firms
According to a study published by Advisen, an insurance industry data provider, small businesses accounted for 70% of all D&O insurance claims over the past decade.
During this period, claims increased by a staggering 300% for small businesses, compared to a 200% rise for large companies, underscoring the growing importance of D&O liability insurance across the spectrum of business sizes.
Key Risk Scenarios
D&O insurance plays a critical role in protecting companies and their directors and officers from a range of legal actions and claims. Some of these include:
Breach of fiduciary duty: This refers to scenarios where investors might sue a company alleging that its officers had personal connections with a third-party contractor, and other officers and directors failed in their duty of care in approving the project without appropriate vetting.
Non-compliance with workplace laws: Cases of wrongful termination, discrimination, or harassment could lead to lawsuits against the company and its directors and officers.
Intellectual property theft: If a new executive is accused of stealing proprietary technology or trade secrets from a former employer, they, along with your company, could face lawsuits for unfair competition and trademark infringement.
Misrepresentation: If a company breaks a promise made to suppliers or stakeholders, it could face legal action for damages.
Investor Suits: If a company is funded by Venture Capital, Private Equity Firms, or other investors, claims often arise from missing expectations. When investors put money into a company they don’t expect to lose it, and when they do, lawsuits often arise.
These scenarios underscore the importance of D&O coverage for any company that has relationships with vendors and customers, seeks venture capital funding, or whose directors and officers may be targeted by litigants over their management of company affairs.
Rising Antitrust Risks
While antitrust actions are often associated with large corporations, the directors and officers of public companies, non-profit organizations, and private mid-sized companies must also be mindful of antitrust risks. These can take the form of legal and regulatory actions from government entities, competitors, suppliers, and contractors.
Under the Biden Administration, there is anticipation of more robust enforcement activity, particularly in areas like corporate governance and disclosures around social or environmental issues.
Common private claims often relate to employee “lift-out” claims or contractual interference. Both of these dynamics can result in expensive litigation and are usually challenging to settle due to legal costs and their contentious nature, highlighting the need for effective D&O coverage.
Best Practices and the Role of D&O Insurance
While risk can never be entirely eliminated, best practices can be instituted to mitigate exposure. These include understanding non-disclosure and non-compete agreements, verifying that new employees haven’t brought proprietary information, conducting due diligence relating to potential intellectual property issues, and validating product or service assertions.
In parallel, having a robust D&O insurance policy can provide a safety net for potential legal confrontations. However, securing appropriate coverage can be complex due to the potential exclusions related to antitrust law, unfair competition, and broad interpretations of tortious interference.
It’s crucial to work with an insurance broker and carrier specializing in Directors’ and Officers’ insurance and to fully understand the nuances of coverage.
Moreover, engaging underwriting and claims teams early in the proposal process can provide a clearer understanding of the coverage’s intent before a claim occurs. By exploring various claim scenarios, businesses can be better prepared and informed about their coverage, aiding a smoother negotiation process.
Online vs. Traditional D&O Broker, Which is Better?
If you’re searching for a D&O insurance policy, you’ll see many providers at the top of a Google Search that offers quotes on directors’ and officers’ liability insurance in as little as ten minutes.
Is this the right route to take? Or, is going the traditional route of working with a broker better?
I am of course biased in answering this question. After all, I am an insurance broker who specializes in helping private companies secure coverage for Directors and Officers and other forms of coverage, so take my advice here with a grain of salt.
Understanding that bias, I believe that getting a quote in 10 minutes has its limitations. The policy you’ll get is not specifically tailored to your needs or issues. It may contain insufficient protection in some areas which puts you at risk when a claim arises, and it may contain more protection than you need, which means it’s more costly.
On the other hand, working with a skilled broker who understands directors’ and officers’ insurance will result in a more tailored approach to protection. On top of getting a more customized policy, you’ll also get suggestions on how to structure coverage and then get protection beyond just D&O for other risk elements of your company.
Now, one issue to be upfront about is that digital brokers and online sources that can execute a quote in 10 minutes do have an advantage of speed. Traditional brokers, like myself, will ask for an application to be completed so we can go to the marketplace for options and this will take some time.
Another advantage of going the traditional broker route is that with some additional time, you’ll likely see more options and better recommendations than taking the faster route to get just one quote. After all, do you want just one option? Or do you want to see what the market has to offer?
If it’s the latter, then working with a traditional broker will give you that, and then some.
In today’s increasingly complex business landscape, D&O insurance has become an essential part of a comprehensive risk management strategy. Whether your business is small, mid-sized, or large, understanding and investing in the right D&O coverage is crucial to protect your company and its key decision-makers from potential legal action.
It’s about creating a safer, more secure business environment where business leaders can perform their roles effectively without the looming threat of personal litigation.
Navigating through the maze of D&O insurance can be complex, and you shouldn’t have to do it alone.
As a specialist in this field, I’m available to help you understand your options, work through the nuances of coverage, and ensure that you have the right insurance protection for your unique business scenario.
Please feel free to reach out to me to discuss your D&O insurance needs and set up a time for an in-depth conversation about how you can best protect your company and its leaders. Remember, the right guidance can make all the difference.
Let’s start that conversation today.