19 May 2014
Directors' and officers' insurance – a vital part of your risk management strategy
Risk management email newsletter
Directors' and officers' insurance is an essential element in a company's armoury for protection against key risks facing the company and its senior executives. The risks have been heightened of late given the wave of financial and corporate scandals, and of course the changes in the regulatory and law enforcement landscape. This note highlights the key elements of D&O insurance which every board should be aware of.
What is D&O insurance and why do you need it?
D&O cover is designed to protect directors and officers of a company for claims that they acted in breach of their duties (whether contractual, tortious or regulatory) including negligent breaches and breach of duty or trust. The cover typically includes liability for damages and also for the cost of appropriate separate legal representation for the individual.
In an increasingly litigious environment and one in which regulators are ever keener to want to be seen to be taking action, a company may find that it is unable to attract and retain the highest calibre of people without appropriate D&O cover.
Employers will often directly provide indemnification to key employees in the event of a claim being brought against those individuals. D&O insurance offers protection to directors' and officers' personal assets in the event the indemnification provided by the company fails or is not forthcoming e.g. in the event of insolvency. Further, it provides balance sheet protection for the company; the policy will typically reimburse the company for such indemnification costs.
What are the key provisions included in most policies?
A D&O policy will typically cover the "loss" incurred by the "insured" arising as a result of a "claim" made for a "wrongful act". The definitions of the italicised words will depend on the definitions applied in each policy, but will typically be:
* Loss - includes defence costs and damages that an individual is held liable to pay. Loss will exclude criminal fines and penalties. Any defence costs may become repayable to insurers if there is a final decision of fraud or other criminal conduct by the director or officer.
* Insured - includes directors and officers and can be extended to other senior employees of the company, for example compliance officers and in-house counsel. Typically it will include shadow, de facto, non-executive and prospective directors.
* Claim - includes any civil, criminal, regulatory proceeding.
* Wrongful act - means any actual or alleged act, error, or omission or a claim made against a director or officer as a result of that capacity.
Careful consideration should also be given to the extent of the cover required. Inevitably this will impact the cost of the premium but, in the event of a substantive dispute or regulatory investigation, that premium will be very significantly lower than the loss likely to be incurred even if the director or officer is not found liable. Defence costs over a prolonged period of investigation and legal proceedings in themselves can be significant. The correct limit for cover will depend on the company's circumstances, its understanding of the particular risks its senior executives face, and the applicable market advice from its brokers.
The exclusions in the policy should be considered carefully at the time of taking cover. The company may also wish to consider purchasing an extension to the standard cover provided.
What are typical policy exclusions?
If fraud or dishonesty is found on the part of the director or officer, cover will not be provided. To the extent cover has been advanced before such a finding is made (e.g. defence costs), insurers will be entitled to recover those advanced funds.
The following exclusions may, to some extent, be negotiable depending on the circumstances.
* Prior notice. Cover will not be provided for claims notified under a previous policy.
* Prior and pending litigation or retroactive date exclusions. Litigation commenced or wrongful acts committed before a certain date may be excluded.
* Property damage or bodily injury.
* Offering exclusion. Private or public offerings of the company's securities may be excluded. This clause can often be amended to include cover for offerings made outside the US or private placements of securities for example where the risks are perceived as lower.
* Pollution. Liabilities arising directly as a result of pollution by the company are usually excluded. However, cover for loss to the company's share value as a result of pollution may be obtained for example.
* Insured vs insured claims. This will exclude cover for a claim brought against a director or officer by the company or other directors. This is intended to protect the insurer from abuse of process e.g. collusive claims.
What are the typical policy extensions?
Each standard policy will differ depending on the company and the insurer. However, the following extensions to standard policies are typically available to companies.
* Investigation costs. Defence costs are part of the cover provided by D&O policies. The cost of preparing for an official investigation can also be included.
* Discovery period. Policies are typically "claims made" policies whereby the policy applicable at the time the claim is made is invoked (rather than the policy existing when the relevant event occurred). If the policy is not renewed, an extension covering claims notified outside the covered period but occurring before the expiry of the original policy may be advisable.
* New subsidiaries. A policy extension of this kind will automatically cover subsidiaries to the insured.
* Outside directorship positions. Joint ventures may be considered outside companies therefore an extension for directors taking directorships outside the company may be appropriate.
* Manslaughter and health and safety.
* Extradition costs.
Claims against individuals threaten both the personal assets of directors & officers and the financial viability of the company concerned. D&O insurance allows the board to mitigate against such risks to retain the best individuals and secure the financial health of the organisation.
Our risk management team has specialists in issues relating to D&O insurance cover. Whether you are at the stage of obtaining insurance or needing to make a claim, we can provide advice specifically tailored to you. We act for companies, individuals and underwriters in respect of D&O insurance issues and the substantive disputes regarding invoking the insurance. Please don't hesitate to get in touch if you require any further information.