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What Is D&O Insurance For Liability Risk?

Preamble

This content is independent of any content coming from insurance brokers or insurers or law firms. Commercial insurance is rarely taught in schools, and when it is it’s mostly done through the lens of brokers or insurers. There are many misconceptions around D&O Insurance, just like many topics in commercial insurance, due to bad habits acquired through over reliance on insurance brokers or insurers or information providers who are lobbied by them. It is also important to note that insurance has both an operational aspect and a legal aspect, on which we put weights of 95% and 5% respectively in terms of importance to protecting a business and its investors (the point is that going to court to enforce coverage defeats the purpose of buying insurance, so you want to make sure that whatever insurance you buy protects your business right and pays out fast on large losses).

D&O Insurance Explained

D&O insurance, also known as Directors and Officers Liability Insurance or Management Liability insurance, is a hedge against a specific set of loss scenarios related to liability risk. It provides financial protection for the individual directors and officers of an organization as well as the organization itself as a legal entity in case of liability tied around any alleged or actual mismanagement of the organization. One important consideration is that the organization and its directors and officers may not be at fault but can still be subject to lawsuits or monetary demands that are frivolously launched against them. 

History Of D&O Insurance

D&O stands for directors and officers. D&O insurance was created right after the 1929 economic crash because many company directors and officers at that time were being subject to lawsuits due to their companies’ failures. Such individuals had to incur out of pocket expenses to defend themselves and to settle lawsuits against them. The insurance industry saw it as an opportunity to create a new product of which objective would be to financially protect the individual directors and officers in case they were brought to court or faced any sort of litigation.

With that said, the breadth of coverage offered by D&O insurance today is very different than what it was back in the 30s. The product went through various changes and evolved around meeting regulatory requirements as well as requirements from directors and officers themselves or their legal representatives given past experiences and court rulings. Part of the evolution was also due to increased competition within the insurance industry amongst insurance brokers and companies leading to more offerings in terms of what D&O insurance would cover. For example, it is now standard practice for D&O insurance to protect the company, as a separate legal entity, that is represented by the individual directors and officers, which was not the case back in the 30s. With that in mind, let's dive deeper into what D&O insurance covers.

What Does D&O Insurance Cover?

There are three main coverage sections within a typical D&O insurance policy:

1.    D&O Side A coverage, which offers protection for Ds and Os in case they are targeted or named in a lawsuit all while their company is either unable or unwilling to indemnify them for associated costs;

2.    D&O Side B coverage, which offers protection for Ds and Os in case they are targeted or named in a lawsuit however while their company is able and willing to indemnify them for associated costs;

3.    D&O Side C coverage, which offers protection for the company itself as a legal entity in case it is targeted or named in a lawsuit whether alongside individual directors and officers or not.

It is important to note that financial protection includes defence costs, indemnities, as well as other expenses, and the insurance policy should clearly define the types of expenses that are covered as well as how they are paid by the insurance company along with a timeline for such payment. Note that the policy itself will have various definitions, exclusions, and terms and conditions impacting coverage, it is therefore of high importance for the policy to be analyzed word by word and reworded in order for relevant loss scenarios tied to liability risk to be covered, as opposed to loss scenarios that cater to an insurance company’s original intent of the wording. Also note that each insurance company uses its own terminology whether in the form of insurance policy section titles, definitions, or exclusions and other terms. This typically adds confusion to insurance brokers as well as the buyers.

D&O insurance policy content
Sample Content of a D&O insurance policy.

D&O Liability And Claims

D&O liability risk entails hundreds if not thousands of loss scenarios. It is therefore important to focus on what is relevant to the organization and its Ds & Os. Loss scenarios that can be protected against or claimed under a D&O insurance policy include monetary demands, legal investigations, or lawsuits from:

·     Shareholders (including Derivative suits)

·     Creditors

·     Governments

·     Clients

·     Employees

·     Service providers

·     Law firms representing plaintiffs (including class action lawsuits)

The large majority of D&O claims are a result of poor financial performance.

Does D&O Insurance Cover Former Directors?

YES, it does. However just like any desired coverage it is important to ensure that it is clearly stated within the insurance policy. Many D&O insurance policies would cover past directors for up to three or four years from them having left the insured company.

Does D&O Insurance Cover Employees?

Let’s break down this question into two parts.

Part 1 is the question of whether an employee of an entity that gets sued will be protected under a D&O insurance policy. The answer is YES, the policy should certainly include employees as part of the definition of Insured or Insured Persons since this can easily be done by many insurers and is standard practice for them. Each insurance company has their own way of wording the D&O insurance policy, so it is important to review it word by word. 

Part 2 is the question of whether Ds & Os would be covered under a D&O insurance policy in the event of a lawsuit brought about by an employee. The answer is IT DEPENDS. Various insurance companies include employment practices liability insurance coverage as an add-on to their D&O insurance coverage, so buyers should make sure of such add-on if they want employment related suits covered. That said, it is equally important to analyze the wording provided by the employment practices liability insurance coverage in order to ensure desired coverage is met.

Is Cyber Liability Covered Under D&O Insurance?

This depends on the wording of the D&O insurance policy. It is important to make sure that the policy is reworded to include relevant loss scenarios of the buyer which could include cyber liability scenarios. Beware of policies that include cyber coverage as an extension of coverage in return for a minimal premium charge. This is done to lure buyers however the wording of the policy would not actually protect against any meaningful forms of cyber losses.

What Does D&O Insurance Not Cover?

Here are some items that most D&O insurance policies will not cover:

·     A loss that happens before an agreed upon retroactive date of the policy

·     A fraud or malicious conduct that is proven to be intentional

·     A loss that can be covered under a different type of commercial insurance policy (ex. pollution liability, bodily injury, property damage, etc.)

·     An insured legally pursuing another insured under the policy

D&O Insurance Exclusions

It is important to note that exclusions within a D&O insurance policy differ from one insurance company to another even though there are some common exclusions that are standard within the insurance industry as mentioned above. The point is that each exclusion should be reviewed and/or reworded in order for the D&O insurance policy to be tailored to the buyer’s profile. This can only be done when the insurance coverage is reviewed to match the specific relevant loss scenarios of the buyer. What happens most of the time is that the buyer takes the advice of an insurance broker who is compensated to sell the D&O insurance policy, and even though some brokers show buyers that they are able to amend the insurance through endorsements, most of the time such endorsements have no real statistical impact on the core liability risk faced by the directors and officers as well as the entity itself.

Important D&O Insurance Policy Definitions

The following are keywords that are found in the Definitions section of a D&O insurance policy and that should be analyzed in conjunction with the buyer’s needs:

CLAIM; WRONGFUL ACT; LOSS; DAMAGES; INSURED.

It is important to review and/or reword any other definition introduced by an endorsement to the policy that directly impacts coverage for a core risk relevant to the buyer. Do not forget to ask your insurance broker for a copy of the complete wording including all endorsements, you can also have our team audit those here.

Cost Of D&O Insurance

The annual premium associated with a D&O insurance policy depends on various factors including the nature of the company whether it is a not-for-profit, a private company, or a public company, as well as the size of the company, the industry it operates in, the complexity of its shareholder base and organizational charts, as well as its financial and operational performance.

Typically, the cost of D&O insurance is lowest for small not for profits or small private firms with few shareholders. However, keep in mind that the cost of D&O insurance varies by country, and in the U.S. it may also vary by state. In Canada, it is not unusual to see the D&O premium as a percentage of the limit of liability be less than 0.1% for a CAD 1 million limit of liability, in relation to organizations that are deemed to be the least risky exposure to insurance companies. D&O insurance rates in countries where lawsuits are not common practice will naturally be the lowest, assuming the same level of competition amongst insurance brokers and companies.

How Much D&O Insurance Do I Need?

The limit of liability that is adequate for a specific organization and its directors and officers is one that is based on risk quantification which includes factors inherent to the organization as well as external factors such as past litigation outcomes. In many instances organizations are told by insurance brokers that they need to carry X amount of limit of liability because of their client benchmarking. However, this methodology of choosing the limit of insurance is inherently flawed because buyers usually follow their budgets or their brokers’ advice even though such advice is not data driven nor based on science, so in essence the benchmarks themselves are flawed.

A good rule of thumb is to take the limit of insurance as a percentage of the company's assets or revenues depending on which figure is most appropriate vis a vis the industry it operates in. For example, for an asset manager, using Assets Under Management (AUM) to provide a quick benchmark for the D&O insurance limit is of better use than using the balance sheet asset figure. 1% of AUM or $1 million whichever is lower is typically the starting point for D&O limits for asset managers. The 1% of AUM rule of thumb can be used as a very quick way to get a ballpark figure of the D&O insurance limit up to an AUM of $1 Billion. Above the latter threshold, the correlation between AUM and D&O insurance limit breaks down.

It is highly recommended for any buyer to take the advice of risk experts who are independent of insurance brokers or companies when it comes to choosing the amount of insurance that they would need to buy. 

D&O vs E&O Insurance

D&O insurance is meant to cover losses that stem out of alleged or actual mismanagement of a specific company. Whereas E&O insurance, also known as professional liability insurance, is meant to cover losses that stem out of alleged or actual negligence in the course of providing a service to clients. In fact, the majority of D&O policies exclude E&O type claims.

Think about Liability Risk as having hundreds if not thousands of loss scenarios (ie. an entity can be sued for many different reasons, and each of these reasons constitutes a specific loss scenario). There is no single insurance product that would hedge against all loss scenarios. Instead, insurance companies offer different products, each of which can be used to cover a specific set of loss scenarios if structured and managed correctly.  

D&O Insurance For Financial Institutions

Financial Institutions (FIs) are different from a risk management standpoint because their operational risk has a high correlation with their financial risk, whether it’s credit risk, investment risk, or market risk, depending on the type of financial institution. Since Liability Risk is a part of Operational Risk, the former naturally has a higher correlation with financial risk as it relates to financial institutions. That is why the D&O insurance cover for FIs should be analyzed, reworded, and managed by independent risk experts with advanced financial backgrounds, and using a different set of tools than would otherwise be used for D&O insurance provided to non-FIs. 

D&O Insurance For Public Companies

Since public companies that are listed on an exchange entail a broader type of Liability Risk, the D&O insurance cover should similarly be reworded to include a broad range of loss scenarios that are more relevant to publicly traded companies such as:

·     Higher odds of class action lawsuits

·     The public rallying of investors by law firms looking to profit from suing the company 

Typically, an abrupt downward swing or a persistent downward trend in a company’s stock price would prompt law firms to rally investors for a class action lawsuit against the company. That is why D&O insurance for public companies requires deeper analytics and attention.

D&O Insurance Online Quote

Buying D&O insurance from an online broker should be restricted only to those organizations that are looking to check the box for certain regulatory requirements or contractual obligations. This is because there will be no or little opportunity to reword the D&O insurance policy for it to be meaningful from a risk management standpoint when buying from online sources.

For organizations that are keen on risk management, which is yet to be automated, it is best to go through a risk expert who is independent of any insurance broker or company. If you are looking for a D&O quote, feel free to contact us

D&O Insurance Providers Or Carriers

There are many insurance carriers offering D&O insurance policies. These could be international insurance companies (ex. AIG, Chubb, Allianz, etc.) or regional or local insurers. They typically use their agents and/or brokers, including online platforms, to sell their policies.

D&O Insurance Broker

There are millions of insurance brokers around the world who can get you a D&O quote from one or more insurance companies. However, buying D&O insurance directly through a broker without having the insurance reworded by independent risk experts will result in a low insurance payout when a large loss happens. Also keep in mind that having brokers compete for your business is a good thing as it minimizes your cost. We always have several brokers bid on our clients' D&O insurance or other commercial insurance.

D&O Limit Benchmarking

Limit benchmarking within the insurance marketplace is flawed and should not be relied on by businesses. This is because the benchmarking does not take into account the specific risk factors of each individual business that is included within the benchmarking data set. Businesses should choose their D&O limits based on their own operational risk factors, including but not limited to the industry in which they operate, their size, operational controls and processes, financial condition, and organizational charts. Such operational risk factors impact the probability of occurrence and severity of a specific D&O loss scenario related to the organization, and that is why D&O limit benchmarking provided by brokers should not be relied on.

D&O Lawsuit Coverage

A D&O policy can cover a range of different types of lawsuits brought against individual directors/officers or the organization itself or any of its related entities, which includes payouts for defence costs, indemnities, and other expenses incurred throughout a lawsuit. It is important to reword the policy that gets sold by a D&O insurance broker to effectively cover the loss scenarios that are relevant to the organization (as opposed to those that the insurance company wants to cover).

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