E&O Insights: Directors & Officers Liability Is Not Your Normal Insurance Product

If you asked 100 insurance professionals on the agency side what one line of business “scares” them the most, it’s likely that directors and officers (D&O) liability would be at the top of the list. The lack of standardization of policy forms contributes to this anxiety. In addition, lack of real experience or expertise, coupled with the potential for significant judgments, make this a product to be respected and not taken for granted.

Most companies’ state law governs the issue of indemnification, granting corporations the authority to indemnify while limiting the circumstances in which they can do so. Even in states where the statutes are considered broad, one thing is clear: corporate bylaws and/or indemnification agreements do not provide absolute protection. As a result, D&O insurance is an important component in any comprehensive protection plan.

In the past 10 years or so, it seems that directors and officers working in the business world have operated under heavy scrutiny. The economy, stock market and various alleged scandals, coupled with an enhanced level of governmental regulation, have put directors’ and officers’ actions under a microscope. As they look to protect their personal assets should a big claim develop, in most cases directors and officers look to their insurance program – specifically to their D&O insurance – to do the job.

While a D&O policy cannot protect against every risk, with the proper focus and attention to detail, there are several areas where a comprehensive and properly negotiated D&O policy can help to significantly reduce the chance that a director’s or officer’s personal assets could be at risk.

Not All D&O Carriers Are Equal

Virtually all D&O carriers provide this coverage on a claims-made basis. It is vital that agents understand this type of coverage and its nuances, such as “retro date” and what constitutes the “trigger of coverage.” In some respects, this is where much of the similarity ends. Within the D&O insurance marketplace, agents can expect a tremendous lack of uniformity in terms and conditions and scope of coverage. This should result in a concerted effort by the agent to note the specific details, especially when dealing with definitions, exclusions and conditions. Agents who do not take heed of these details may find some of their customers experiencing the difference between a policy providing coverage for a big loss compared to one that leaves the customer with no coverage.

While price may be an issue, it is not the most important factor. Other areas where agents may see differences include:

• Terms and conditions;
• Claims-handling expertise;
• Financial rating; and
• Longevity in the industry.

Insuring Agreement is the Heart

As with most insurance coverage, the insuring agreement is the heart of the D&O policy, as it sets forth the basic scope of the coverage provided. Typically, D&O insurance policies provide three main types of coverage in three distinct insuring agreements:

• Non-Indemnifiable Coverage – which protects directors and officers when the company may not indemnify its directors or officers by law or for public policy reasons, or cannot indemnify its directors or officers due to financial insolvency.
• Corporate Reimbursement – which protects the company by reimbursing the company for the amounts it pays to its directors and officers as indemnification.
• Entity Protection – which protects the company for its own wrongful acts.

Who is an Insured

The “who is an insured” section of the policy usually provides coverage for the company’s directors and officers, the company itself and the company’s subsidiaries. Agents may find one or more of their carriers going beyond this to include as an insured individuals serving outside entity organization, a debtor-in-possession in a bankruptcy context or other high-profile individuals such as the general counsel or risk manager.

There are advantages to this broad definition, as it increases the likelihood the D&O policy will respond in the event of a claim because more entities/individuals are covered. However, because more entities/individuals are covered, this broad definition will serve to dilute the protection afforded. This could result in less protection for certain key individuals.

What Constitutes a Claim

What constitutes a claim will be defined by the policy. Agents should expect some significant differences among different D&O policies. This is a key area to note when comparing policy forms.

Definition of Wrongful Act

This definition of a wrongful act is normally very broad and will include any breach of duty, neglect, error, misstatement, misleading statement, omission or act by an insured. While some may contend there is coverage unless there is a specific exclusion, this could be a dangerous trap as carriers may look to address this issue under areas such as the insuring agreement.

The norm is for carriers to specifically list their exclusions. While there is the potential for many of the exclusions to be similar, agents should still review the exclusions closely. Although an agent may understand the exclusion wording, it is still advisable to discuss this with the carrier to truly understand the exclusion’s meaning and intent.

As noted by the following claim, agents should make a solid effort to understand their customers and provide them the coverage they are requesting, or advise them accordingly if that coverage is unavailable.

An agency had a client who originally owned three haircut salons for which the agent procured property and general liability coverage. The client decided to sell the salons and enter into a franchise agreement with the buyers. At that time, the client asked the agent to secure coverage that would protect the client from suits filed by franchisees. The agency procured a D&O policy that had a specific exclusion for claims by franchisees. Neither the agent nor the client read the policy. The client was sued by the franchise owner claiming failure to divulge the true nature of the gross income and expenses, asking for $900,000. In the opinion of the errors and omissions (E&O) carrier, the liability rested mainly with the agent for failing to obtain the coverage specifically requested. The case was eventually settled for $650,000.

Limit/Retention

As there is really no formula to calculate the right amount of coverage, some customers rely on case studies. While this may provide some insight into the “norm,” caution should be exercised with this approach because there is still no guarantee the average limit will be sufficient for the client. Selecting the right retention is also a complicated decision.

Regarding limits and retention, it is best for agents to provide a variety of options for the customer to consider.

Unless the agent/broker deals with this line of business frequently, dealing with a D&O expert, someone who truly knows the nuances, is suggested. The last thing an agent needs is for the customer to have a D&O claim and experience the issues carriers can raise to limit or deny coverage. There are many areas within the coverage form where policy language may be negotiated, which takes tremendous attention to detail and experience.