D&O Insurance - What You Need to Know

In our last Savvy Director blog, we explored how a director may incur personal liability because of their board service. Practicing due diligence is all well and good, but a director’s actions or inactions may still expose them to litigation and penalties. That’s why companies provide their directors with protection through indemnification.

Well-crafted Directors and Officers (D&O) insurance provides an additional line of defense. As a director, it’s a good idea not just to confirm that there is D&O insurance coverage in place, but to vet some of the details. Asking the right questions beforehand helps ensure adequate coverage when it’s most needed.

Just in case you didn’t read the previous blog, I’ll repeat the Caveat here. At DirectorPrep we’re not lawyers and don’t offer legal advice. Nor are we insurance experts. While the concept of D&O insurance is straightforward, the details can be tricky. When it comes to those details, your board should always rely on professional advice from the experts.

Still, it’s in your best interests as a director to get a handle on the basics. With that in mind, let’s explore.

What is D&O Insurance?

D&O insurance policies offer liability coverage for a company’s directors and officers to protect them from claims which may arise from decisions and actions taken as part of their duties. Companies usually purchase D&O insurance because lawsuits are very expensive. Not only that, without a D&O insurance program in place, a company will have a lot of difficulty attracting and recruiting the right board members. After all, potential directors would be reluctant to put their personal assets at risk without the protection of D&O insurance.

D&O insurance reimburses the costs incurred by directors in defending against claims for alleged wrongdoing, as well as monetary damages, settlements, and awards resulting from those claims.

If the company cannot indemnify its directors and officers for amounts resulting from these claims, D&O insurance will step in to directly pay those costs. If the company indemnifies the individual for those costs, D&O insurance will reimburse the company. The D&O policy also provides some coverage for the company itself.

Who Needs D&O Insurance?

It’s a common misconception that D&O claims are mostly a public company phenomenon. In fact, public, private, and non-profit companies all face D&O litigation risks.

As a general rule, any organization with a corporate board should invest in D&O insurance. A company doesn’t need millions of dollars in revenue for directors to be personally sued. Smaller businesses with fewer assets need the protection just as much as large, deep-pocketed corporations, and start-ups seeking venture capital or funding from investors often need D&O coverage as protection for investors.

How D&O Insurance Works

D&O insurance can be purchased as a separate policy, but many companies find it more cost-effective to buy a combination policy that bundles D&O insurance with other forms of coverage. Stand-alone D&O policies are often customized contracts that include negotiated endorsements to meet specific needs.

Maybe you’ve heard about D&O insurance in terms of “Side A, B, or C” coverage. This kind of insurance jargon sounds mysterious, but as a director it pays to have a basic understanding of these terms.

Side A. From your perspective as a director, Side A coverage is the most important because it extends your protection beyond the situations where you’re indemnified by the company. It covers you for defense costs, settlement fees, or judgments if the company cannot or will not indemnify them, such as due to insolvency or court order. A well-designed D&O program will have a meaningful amount of Side A coverage that provides directors with first-dollar protection without a deductible.

Side A DIC Coverage. DIC stands for “Difference in Conditions”- more insurance jargon. Side A DIC coverage only provides protection where there is no other protection available, for instance where the company fails to or is unable to indemnify directors, coverage isn’t available under an underlying policy, an insurer denies coverage or the coverage is rescinded, or there’s a delay in the flow of money under indemnity or insurance. When one of these situations occurs, the DIC policy “drops down” to provide coverage. DIC coverage is particularly valuable because it has fewer exclusions than other policies, helping to ensure that directors won’t have to dig into their own pockets for costs such as legal fees.

Side B. This type of D&O coverage reimburses the company for any amounts it paid as indemnification to directors under its bylaw provisions or an indemnification agreement.

Side C. This type of D&O insurance is also called “entity coverage”. It provides financial protection to the company itself by covering its losses when it’s sued together with the directors. The scope of Side C coverage depends on whether the company is public or private – the board should seek expert advice in this area. 

What’s Not Covered?

As with any insurance policy. there are important exclusions in a typical D&O policy. It’s just as important for the board to understand what is not covered as what is. Consult the policy wording to determine the precise extent of these exclusions. 

Conduct exclusions. The conduct exclusion to Side A coverage applies to self-interested, fraudulent, and criminal conduct. It’s become common for Side A policies to provide that the conduct exclusion is triggered only if the relevant misconduct is established by a final, non-appealable judgment in an underlying lawsuit, and that it doesn’t apply to legal fees. Because small differences in language can have critical consequences, this exclusion is one of the most heavily negotiated in policies.

Prior-acts bar. This is a common provision that precludes any coverage for claims involving conduct that occurred before a certain date (often the date the insurer began providing coverage). Since allegations of oversight failures often go back five to ten years, a recent prior-acts date can significantly limit coverage.

Uninsurable fines and penalties. This provision precludes coverage for fines or penalties imposed by regulatory authorities that are uninsurable by law.

Other D&O Coverage Issues

Because D&O policies tend to vary, it pays to familiarize yourself with key coverage issues such as:

Total amount of coverage. There’s no one-size-fits-all answer to how much coverage is appropriate. Factors to consider include the company's size, its industry and regulatory risk profile, litigation trends, and benchmarking against peers.

Amount of Side A coverage. Because Side A coverage is so important for your personal protection, ask about how much of the total amount is dedicated to Side A coverage.

 Dilution of claims. D&O policies often cover multiple groups of insured persons – not only directors, but also officers and the corporation itself. Each policy is capped at a certain amount, and it’s common to prescribe priorities for payouts. As a director, you’ll want to see a provision confirming that the priority is Side A, then Side B, and finally Side C.

Insured persons. How the policy defines “insured person” is important. Both current and former directors are typically included, but you should confirm this. Ask how long coverage is extended after a director leaves the board. The period of liability for statutory obligations varies by jurisdiction, and liability for legal claims may go on for years. Also make sure that you’re covered if you serve on the board of one of the company’s subsidiaries or affiliates.

Insolvency issues. You’ll want to understand how your D&O policy protects you if the company becomes insolvent. When that happens, Sides B and C coverage may be subject to court approval before they can be dispersed. Beware of provisions that could permit the insurer to cancel coverage in the case of insolvency or bankruptcy.

Topping up your D&O coverage. D&O insurance is typically purchased in layers or “towers” - essentially separate policies drawn on in a predetermined order. The primary policy covers claims up to a certain amount. After that, policies further up the tower are drawn on. If you’re looking to join a corporation as a director and it doesn’t appear to have sufficient coverage, the company’s suite of insurance can almost always – for a price – be topped-up by seeking out additional layers from another insurance carrier.

Individual D&O Insurance. Although it’s not a common practice, in some instances – such as in heavily regulated industries where the risk is greater - a director may decide to purchase their own D&O policy if they believe the organization's coverage is inadequate. In addition to giving them additional protection, doing so can provide them with independent legal representation and ensure continued coverage after their board term ends.

Coverage for government investigations. Government investigations are often framed as information-gathering, with an allegation of wrongdoing coming only if and when charges are filed. But defending an investigation can be expensive, so some D&O policies specifically include these costs.

Severability. Policies often provide that coverage may be rescinded if the application contains inaccurate statements. To ensure that you aren’t deprived of coverage because of an inaccuracy in an application form that you didn’t have input to, confirm that your D&O policy contains a severability clause. It limits the insurer’s ability to rescind the policy to those directors who had actual knowledge of any materially false statements in the application. 

Getting Advice

Hopefully this brief foray into the intricacies of D&O insurance has convinced you that it’s best to work with an insurance professional who specializes in D&O and other business insurance products. With the help of an insurance professional, you’ll want to ensure you’re adequately covered for a wide range of claims, from regulatory actions to criminal investigations and employee lawsuits and everything in between.

It’s good practice for the board to invite an insurance professional to attend the occasional board or committee meeting to discuss the ins-and-outs of D&O coverage, trends in litigation risk, and coverage for changes in laws and regulations.

Questions for the Savvy Director

Given the importance of D&O insurance to protect directors and the company, it’s worthwhile to have some questions at the ready the next time the topic comes up.

• What is the total amount of coverage? How much is Side A only?
• What are the exclusions or limitations? How do these affect coverage for directors?
• What are the conduct exclusions for the Side A coverage?
• What is the “prior acts” date?
• How does the company select its D&O insurer?
• What are the policy’s key terms and conditions?
• How does the company ensure that we have adequate coverage?
• What is the scope of coverage provided by the policy?
• What are the consequences of not being covered or having inadequate coverage?
• How does the company determine whether to make a claim?
• How does the company ensure that its D&O coverage remains up-to-date and relevant to our current needs?
• What role do external insurance advisors play in advising the company about D&O insurance?

Your takeaways:

• D&O insurance policies offer liability coverage for a company’s directors and officers to protect them from claims arising from decisions and actions taken as part of their duties.
• Careful vetting of D&O coverage should be a priority. Asking the right questions helps ensure adequate coverage when it’s most needed.
• Any business with a corporate board should invest in D&O insurance, including private companies and non-profits.
• From your perspective as a director, Side A coverage is what matters most. It extends your protection beyond indemnification by the company.
• Get to know the exclusions in your D&O policy.
• Work with an insurance professional to get a complete picture of your risk and how well you’re covered.

Resources:

• New To the Board? What D&O Insurance Can Do for You. Courtney Wilson. Stikeman Elliott LLP. December 2018.
• Types and Costs of D&O Coverage. Business Owner’s Playbook. © 2024 The Hartford.
• D&O Coverage: Mind the Gap. Dan Fisher. Corporate Board Member.
• Sides A, B & C of a D&O Insurance Policy: What You Need to Know. © Axxima.
• Five Essential D&O Insurance Questions. John N. Skakun III. Directors & Boards. September 2023.
• 20 Questions Directors Should Ask About Directors’ and Officers’ Indemnification and Insurance. Richard A. Shaw, QC, ICD.D. © 2014 CPA Canada.

Thank you.

Scott

Scott Baldwin is a certified corporate director (ICD.D) and co-founder of DirectorPrep.com – an online membership with practical tools for board directors who choose a growth mindset.

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