Directors and Officers Insurance: What It Is and Which Businesses Need It

Directors and officers insurance, also called D&O liability insurance, protects a company’s leadership from financial losses resulting from business-related lawsuits. They are protected from claims against them if they serve on the board or as officers.

Leadership can be held responsible for business failures and potentially implicated in claims against the company. This type of insurance is not necessary for every business. However, it allows officers to lead confidently without worrying about monetary loss.

Which businesses need directors and officers insurance?

Directors and officers insurance is generally worth purchasing if your company:

  • Is publicly traded. Shareholders have the right to sue directors or officers for poor stock performance. Public businesses are more likely to buy directors and officers insurance than private companies.

  • Has a board of directors. Individuals can’t serve on the board if they aren’t protected from lawsuits.

  • Has private equity. Coverage may be required for venture capital firms and other private equity companies.

  • Is recruiting top talent for executive-level positions. This protection may make it more competitive to offer executive positions.

  • Includes indemnity provisions in employment contracts for executives. Indemnity clauses ensure that an entire company, not an individual executive, is responsible for any legal expenses incurred by an executive if sued in connection with business matters. Directors and officers insurance protects the business against major financial losses in the event of a suit if indemnity clauses are included in employment contracts.

What does it cover?

Directors and officers insurance pays for claims filed against company leadership. The coverage has three parts, referred to as sides:

  • Side A: Covers company directors and officers when the company can’t reimburse them.

  • Side B: Reimburses the company after it compensates a director/officer for loss.

  • Side C: Provides direct coverage of the business when both the business and its directors and officers are named in a securities lawsuit.

There are different types of policies; select coverage based on how your business is organized and what risks you’re exposed to.

Some risks you may want to cover include:

  • Employment lawsuits. An employee could feel that they have been treated unfairly, and this could lead to an investigation by the company’s officers.

  • Creditor, investor or shareholder lawsuits. A creditor can sue a company’s directors if it fails to repay a loan. Investors or shareholders could also bring a lawsuit against the directors of a company for poor performance.

  • Legal mistakes and failures. Failure to comply with pollution regulations could lead to a lawsuit.

  • Client data breaches. A client could sue a business or its officers after a cyberattack.

What’s commonly excluded from coverage?

Here are some standard exclusions you can expect to see in directors and officers insurance policies:

  • Fraud and criminal offenses. An executive won’t be covered if they take money from the company, or are arrested for driving while impaired.

  • Pending and prior litigation. Coverage does not apply to cases that are ongoing or occur before the policy starts.

  • Bodily injury/property damage. Customer injury or property damage would usually fall under a general insurance policy.

  • Insured-versus-insured claims. A director or officer who sues another person is not covered.

  • Employee Retirement Income Security Act claims. Claims of mismanagement of employee benefit plans would typically be covered by fiduciary liability insurance.

How much does it cost?

Premium amounts vary. However, a survey by the insurance marketplace Insureon found that 54% of its small-business customers paid less than $1,500 per year for directors and officers insurance. The coverage you choose and other factors will affect the amount you pay. A higher risk factor generally means a higher premium. The following are some common factors an insurer would use to assess risk:

  • Company size and number of employees. Larger companies with many employees are more likely to be at risk than smaller ones.

  • Industry and operating costs. The securities and investment banking industry is more risky than other industries.

  • Years in business and management experience. It can be more difficult to underwrite a new business with inexperienced management.

  • Business ownership structure. Companies that are publicly owned are more at risk than those that are privately owned.

  • Company’s financial security. Unstable finances can lead to a company’s insolvency and increase the risk of a lawsuit.

  • Claims history. Insurance companies review the company’s past history to find any lawsuits.

It’s important to shop around before you purchase a policy. If you receive at least three price quotes, you will be able to gauge what the premium is for your business.

What’s self-insured retention?

Self-insured retention is the dollar amount you’ll be required to pay on each claim before the insurer will start covering costs. This rate may be listed on your policy’s declaration page. It can be thought of as a type deductible. A low-risk company might have a retention of $1,000 while a high-risk company might have a retention of $250,000.

A retention can also be used as a cost-control tool. As a retention goes up, your premium goes down. This is because you’re taking on more risk than the insurance company would otherwise. Insurance companies also have to pay for every claim. Small claims can be handled by a business, which lowers the cost for an insurance company.

Where can I purchase a policy?

Many insurers offer directors and officers policies. These policies can be bought separately or combined with other types business insurance.

According to S&P Global Market Intelligence, the largest insurance providers by direct premiums for this type of policy in 2020 were:

  • Axa S.A.

  • Chubb Ltd.

  • American International Group Inc.

Other popular carriers include:

  • Travelers.

  • The Hartford.

  • Nationwide (policies for public companies not offered).

If you currently have business insurance, your first step may be to contact your agent to see if they offer directors and officers policies. Online quotes can be requested directly from the insurance company or arranged through an insurance broker.

It’s best to work with a knowledgeable insurance professional who can explain the finer details of the policy. Before you purchase the policy, it is a good idea to have an attorney or other insurance professional review it.

Lisa Anthony, https://www.nerdwallet.com/article/small-business/directors-and-officers-insurance
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