D&O Insurance Explained
Directors and officers liability insurance, often called D&O insurance is a form of management liability insurance and in the small and medium-sized business market, is regularly packaged with two other management liability forms into a single policy to form a management liability portfolio policy. Those two other forms of coverage are employment practice liability and fiduciary liability.
Today, I want to focus just on D&O insurance since it is commonly misunderstood.
D&O insurance protects the personal assets of directors, officers, managers, and supervisors for the potential liability they assume in their roles in a company for errors, mistakes, breach of duty, neglect, omissions, misstatements, or misleading statements. That is broadly speaking the definition of a “wrongful act” which is what D&O insurance covers.
Why should companies consider buying D&O Insurance?
D&O is essential to protecting entrepreneurs from the risks they face in operating their business. It doesn’t matter if your firm is a startup with just a few employees or a mature stage firm with a few hundred employees, D&O is an important coverage.
If my firm is seeking investment capital why is D&O essential?
It is common for investors to require firms to have or purchase D&O insurance prior to them making an investment. If you’re seeking investment capital, having D&O in place before a funding round makes sense. It tells the investment community you’re serious and that they are protected.
What does a D&O Policy actually cover?
I’ve gone into this question in more detail and you can see that video here
In simple terms, a D&O policy has three sides to it, and those sides are normally identified by A, B, and C.
Part A covers the company’s insured persons (directors and officers) for claims where the company is unable to indemnify those persons. That inability to indemnify may be caused by the company’s by-laws, or most commonly the company cannot provide indemnification due to company insolvency. The good news is that Side A or Part A claims are not subject to the retention.
Part B covers the company for its indemnification obligations and reimburses it for those sums spent on protecting the directors and officers. Part B is subject to a retention.
Part C is also known as entity coverage and covers the company itself for certain claims where the company is a named defendant. In public companies, Part C covers securities claims.
Extensions of Coverage
As mentioned earlier, many private company D&O policies are written as part of a management liability portfolio, so broadening protection to include employment practice liability which will cover the directors and officers from claims alleging wrongful employment acts such as discrimination, harassment, wrongful termination, hostile work environment, and more.
Also, including Fiduciary Liability within the management portfolio will protect trustees of any ERISA-based plans the company has such as a 401k plan, from claims which allege a breach of a trustee’s fiduciary duty under ERISA. You can see more about fiduciary liability insurance here.
What are the risks?
Entrepreneurs live and work in a fast-paced world. Decisions are often made in split seconds and while leadership always tries to do their best, mistakes will happen. The mistake could be inconsequential, it could be significant. If it’s significant and affects earnings, customer relationships, regulatory standards, or your firm’s relationship with creditors or investors, you may suffer a lawsuit as a result.
No one is immune from accidentally making a mistake, an error, a misstatement, or an unintentional misleading statement. It happens. The consequence is what you can’t control and the potential claim costs, legal expenses, settlements, fines, or penalties could sink the company and your leader’s personal assets. To me, it’s not worth the risk.
How do you obtain D&O insurance?
Generally, an application is going to be needed at some point in the process so we advise doing that upfront. We try and take some of the pain out of that by deploying a unique smart form portal for our clients, but an app is needed.
Also required will be financial statements for established firms, pro forma statements, and/or a budget for a startup. If you have investors a cap table will be helpful and in some cases your investor pitch deck. For EPLI coverage we will often need a copy of your employee handbook as well.
From there we go to market to solicit proposals from various underwriters and to be frank, it may take up to two weeks to get a quote back. If you’re under time pressure we’ve accommodated rush projects in the past.
How much does D&O insurance cost?
That’s a tough one to answer because it’s different for every industry, size of the company, life stage, and limits purchased.
But for example purposes, we recently wrote a tech startup with zero revenue and about $5M in funding. The limits were $1M and the premium was $4,500.
Another recent placement was for a financial services firm with a $25M AUM the D&O was combined with E&O insurance and the limit was $1M and the annual premium was $15,000.
A mid-market firm with annual revenue in the $25M ballpark purchased a $1M limit and the premium was $7,500.
Here’s the bottom line
D&O insurance is critically important for startups and growing businesses of all sizes. The coverage it provides is not provided under any other policy forms your company is purchasing. I’ve mentioned a couple of times your owners, officers directors, and managers are putting their personal assets on the line if a claim occurs and they’re caught in the cross hairs. It’s just too risky to not have this protection.
Have other questions or issues regarding D&O or any other form of business insurance? Why not give me a call or drop me an email, my direct dial is 845-474-2924 and my email address is email@example.com – thanks!