See Client Communications article Directors and Officers Liability.
Corporations and other organizations often buy liability policies that leave directors and officers without sufficient protection. Consequently, these leaders, either individually or collectively, are exposed to claims that they harmed the organization or an individual in the course of managing financial affairs and establishing policies.
For example, a stockholder of a corporation or a member of an organization may allege financial loss as a result of a director's or officer's breach of the duty of care or loyalty to the organization. Or employees, governmental entities, competitors, or creditors may allege negligence or another breach of duty. The organization's liability policies, such as business auto and commercial general liability, cover directors and officers, but generally are limited to claims based on bodily injury and property damage.
Organizations that depend on directors and officers for leadership would have a difficult time convincing individuals to serve in those positions without some method of protecting their personal assets from claims arising out of decisions made in good faith.
One method used by organizations to protect directors and officers is corporate indemnification of the individual director or officer by the organization. Such indemnification must be permitted by the organization's charter or bylaws and usually is subject to limitations on the types of claims for which the individual is entitled to indemnification.
The problems with this method are that the organization itself remains subject to the financial consequences of indemnification, and individual directors and officers still may be required to pay claims that exceed the limits in the charter or bylaws. Directors and officers liability insurance (D&O) has been developed to protect organizations and their directors and officers against these potential losses.
History of Directors and Officers Liability
Underwriters at Lloyd's of London wrote the first D&O policies shortly after the 1929 stock market crash, when stockholders sued the individual directors of several failed corporations. Interest in the coverage was revived in the 1960s, following several significant events. First, stockholders were winning high-profile, high-dollar lawsuits against boards of directors accused of insider stock transactions and faulty financial reporting.
At the same time, Delaware passed a law permitting corporations to indemnify directors and officers for individual liability arising out of the good-faith performance of their duties and to purchase insurance to cover the corporation's indemnification and the individuals' liability. Finally, the Internal Revenue Service ruled in 1969 that the premiums paid by corporations and individuals for D&O liability insurance were tax-deductible.
The litigation explosion in the 1980s created even greater interest in D&O liability insurance, as stockholders affected by the consequences of mergers and acquisitions looked for ways to recover their financial losses. During this time, directors and officers of nonprofit organizations also were the targets of claims alleging wrongful acts, and insurers developed new types of D&O policies for those organizations.
D&O Liability Policy Features
The liability exposure of directors and officers is similar to the errors and omissions liability exposure of professionals, and the D&O liability policies developed to cover the exposure are similar to E&O liability policies.
There is no standard policy form. Although similar in structure, D&O policies differ significantly from one insurer to another.
D&O policies are written on a claims-made basis, which means that, to be covered, the incident giving rise to the claim must occur during the policy period or after an earlier "retroactive date," and the actual claim for damages must be made within the policy period or before the expiration of an "extended reporting" period. See technical reportClaims-Made Management Liability Policy Forms for more information.
Typical D&O policies include a declarations page, an insuring agreement, definitions, exclusions, special provisions, and conditions.
The declarations page of a D&O policy contains the usual information: the insurer and named insured, address, policy period, limit of liability, deductible or retention amount, and the premium. The limit of liability usually is expressed as an aggregate for all claims during the policy period including defense costs. The deductible or retention may be either an aggregate for all claims alleging a single cause or a deductible for each director or officer involved in a single cause subject to an aggregate if more than one director or officer are involved in the claim.
The insuring agreement in D&O policies designed for a for-profit organization includes two distinct but inseparable coverages: (1) direct liability coverage for the directors' and officers' wrongful acts, covering claims for which the organization does not indemnify the individuals in accordance with its charter or bylaws; and (2) reimbursement coverage for the organization for payments it is obligated to make to indemnify directors and officers. The D&O policy written for a for-profit organization, therefore, does not directly cover the organization; it responds to claims brought against the organization's directors and officers (either individually or collectively).
The insuring agreement in D&O policies designed for a non-profit organization, on the other hand, typically indemnifies the organization for some direct claims brought against the organization itself. Coverage for such claims may be limited by the insuring agreement, definitions and exclusions.
The two coverages may not be written separately and payments under one or both coverages are generally subject to the single limit of liability. Unlike other liability policies, the limit of liability in both coverages in the D&O policy usually includes the cost of defense as a part of the covered claim.
The two most important definitions in the D&O policy are those defining "wrongful acts" and "covered persons."
The typical D&O policy defines "wrongful act" as "any actual or alleged error, misstatement, misleading statement, act or omission, or neglect or breach of duty by the directors or officers in the discharge of their duties solely by reason of their being directors or officers of the organization shown in the Declarations." This is a broad statement of the types of acts that trigger coverage, subject to the exclusions stated in the policy.
The persons covered under the typical D&O policy include persons who were, are, or may be duly elected or appointed directors and officers of the organization and also the estates, heirs, or legal representatives of deceased directors and officers. This definition makes it clear that past, present, and future directors and officers are covered, providing important protection for anyone who considers accepting such a position. Other terms defined in the policy may include "loss" or "damages" (many policies exclude punitive damages here) and "subsidiary" (to include the directors and officers of other organizations owned or acquired by the organization named in the declarations).
In policies designed for non-profit organizations, covered persons generally include employees and volunteers.
Exclusions in a D&O policy can have a profound effect on the scope of coverage the policy provides. The exclusions section may differ significantly from one insurer to another and the producer should take special care when studying it and explaining it to a prospective client. The typical policy includes the following exclusions:
- Acts involving any personal profit or advantage to the director or officer
- Criminal, dishonest, or fraudulent acts
- Failure to maintain insurance
- Acts committed before the policy period
- Pollution incidents
- Responsibilities under the Employee Retirement Income Security Act (ERISA)
- Bodily injury, sickness, disease, death, emotional distress, personal injury, or property damage
- Actions of one director or officer against another or of the organization against a director or officer
- An insurer may remove or modify some of these exclusions, such as failure to maintain insurance and the actions of one insured against another, for an additional premium.
Other types of policies are available to cover wrongful acts involving ERISA (see technical report Fiduciary Liability, Employee Benefits Liability and ERISA Bonds and to cover bodily injury and property damage (CGL and BAP).
Most D&O policies have two deductibles. One deductible applies to each director and officer and the other applies as an aggregate if more than one director or officer is involved in a claim.
The aggregate deductible, or perhaps a third (higher) deductible, may apply to the reimbursement coverage provided to the organization.
In addition to the deductibles, some policies include a retention, expressed as a percentage (typically 95 percent), which obligates the insurer to pay only a specified portion of each loss in excess of the deductible amount. For example, a policy with a $5,000 deductible for the reimbursement coverage and a 95 percent retention factor would pay only $470,250 for a $500,000 loss, including damages and defense costs ($500,000 less $5,000 = $495,000 times 95 percent = $470,250).
Directors and officers liability insurance is a specialized form of coverage underwritten by only a few insurers. Surplus lines insurers provide the coverage through surplus lines agents or managing general agents. Admitted companies offer programs targeted to specific industries or types of organizations, either directly to agents or through managing general agencies.
Underwriters providing D&O liability insurance want to cover claims that are fortuitous, not those that are sure to occur or those inherent in the type of organization seeking coverage. Accordingly, they seek organizations with long and successful histories. The organization's financial information is of utmost importance, and underwriters usually require financial statements for the most recent three years, along with a detailed application.
Since the insurance coverage is on the individual directors and officers, the underwriter is interested in their names, length of service, and outside affiliations. Other considerations include the type of industry in which the organization is involved, the organization's competitive position within the industry, and public image. Previous claims or suits against the organization or its directors and officers must be disclosed. The policy excludes any claim arising out of circumstances of which a covered person is aware at the time of the application for coverage; so the producer should be sure each covered person is polled before indicating there are no such circumstances.
An understanding of the kinds of loss exposures directors and officers face when performing their duties for the organization is key to selling D&O coverage. What types of claims are made against directors and officers for the consequences of their decisions on behalf of the organization? The answer lies in the legally defined duties that they owe the organization, its shareholders or members, and third parties.
A director or officer owes duties of (1) loyalty to the organization and avoiding personal activities that would harm the organization, (2) reasonable care in managing the organization's finances and activities, and (3) obedience to the organization's charter and bylaws, as well as state and federal laws and regulations. Insurers that sell D&O liability insurance usually can provide the producer a list of specific types of claims that the policy has covered or would cover. Displaying or discussing such a list would be an excellent way to attract a prospect's attention to the need for a D&O policy.
For-profit corporations of all sizes and descriptions are prospects for D&O liability, although policies are more likely to be sold to publicly traded corporations than closely held corporations.
The best prospects for the average producer are the non-profit organizations that are so prevalent in communities of all sizes: churches, social clubs, business clubs, charitable organizations, sports organizations, condominium associations, community service organizations, trade associations, and chambers of commerce.
Reference Sources: International Risk Management Institute