D&O insurance is purchased by organisations of all shapes and sizes. While the primary purpose of coverage is to protect individuals, depending on the organisation’s size a policy may also provide some benefit to the entity itself.
The coverage afforded by D&O insurance has evolved over time, with many improvements occurring in recent years. As more insurers have entered the market, increased competition has lead to broader coverage and reduced premiums, making D&O a valuable risk management solution for many organisations.
As the exposures faced by directors and officers are continually changing, insurers’ policies are regularly updated to address their needs. As new features are added, they become a point of difference for a while, before eventually being adopted by the market as a whole.
D&O provides an organisation and its management with coverage on many fronts. While no two policies are the same, a typical policy provides three forms of protection as standard, as outlined in its insuring agreements; Side-A, Side-B and Side-C.
Side-A: Directors and officers liability
Side-A, also known as directors and officers liability, is the first insuring agreement of a D&O policy. Side-A protects executives from claims when corporate indemnification is not available from their organisation.
As non-indemnification can occur for many reasons, Side-A coverage plays an important role in protecting individuals when this financial support is not available. It provides an essential last line of defence, ensuring that their assets remain safeguarded from the consequences of personal liability.
For example, consider a board of directors implicated in a claim following an organisation’s bankruptcy. As the organisation effectively has no money, it cannot fulfil its corporate indemnification obligations.
As a result, the directors immediately notify their D&O insurer and seek protection under the Side-A insuring agreement. The insurer is now responsible for financing the costs of their defence and any subsequent claims settlement.
Side-B: Corporate reimbursement
Side-B, also known as corporate reimbursement, is the second insuring agreement of a D&O policy. Side-B reimburses an organisation for the expenses it occurs when defending its management in accordance with its corporate indemnification obligations.
By indemnifying its executives, an organisation is responsible for paying all legal expenses and claim settlements on their behalf. The costs of doing this can be impairing for even the largest of organisations and can potentially affect its financial stability. Side-B coverage, therefore, supports an organisation financially when it is, in turn, supporting its management.
Take, for example, an executive who is named in a formal investigation by regulatory authorities following allegations of wrongful behaviour. The organisation, as per its indemnification obligations, begins to incur defence costs on behalf of the executive and therefore, lodges a claim with its insurer under the Side-B insuring agreement, requesting reimbursement for these costs.
Important! Side-B is only intended to cover the costs incurred on behalf of directors and officers, and will not protect an organisation from claims made directly against it.
Side-C: Entity securities coverage
Some D&O policies also include a third insuring agreement, Side-C, also known as entity securities coverage. Side-C coverage is typically reserved for publicly listed companies and protects the corporate entity from its own liability exposures.
The coverage provided by Side-C is limited to claims made against a company as a result of the offer, sale or purchase of its securities; in other words, the shares listed on the stockmarket available for purchase by investors.
Side-C has been developed in response to the increased frequency in which companies become involved in shareholder related disputes. By electing Side-C coverage, a company can be protected for the legal and claim settlement costs it incurs whilst defending its own corporate actions.
Side-C is typically offered by insurers as an optional insuring agreement, allowing policyholders to elect this protection for the payment of extra premium. The extra premium is charged to compensate the insurer for the additional claims exposure that Side-C brings.
Let’s consider that a company and its management are named in a securities-related lawsuit. The company indemnifies its managers according to its corporate indemnification obligations. In turn, the company makes a claim under Side-B for reimbursement of the costs incurred in defending management.
In addition to the claim against management, the company is also required to defend its own interests, and therefore, makes a claim under Side-C for the costs specifically related to the defence and settlement of the claim against the entity.
Other forms of entity coverage
As well as the benefits it provides to public companies, D&O has become an increasingly popular risk management solution for private companies and non-profits. As a result, many insurers have developed policies specifically to meet the needs of these privately owned, unlisted organisations.
The differences between the D&O coverage available to private organisations, and that of their public counterparts, generally relates to the breadth of coverage available for the entity.
While it is certainly possible for the managers of private organisations to be implicated in a claim, more often than not, it is the entity that is targeted. To account for this and to ensure that an organisation’s assets are adequately protected, many private D&O policies include broader entity coverage than traditionally offered.
The theory behind this expanded coverage is that the personal wealth of private company managers is often closely tied to the organisation’s financial health. Many executives have a significant shareholding in the organisations they operate, so therefore, any loss incurred by the entity is likely to affect their personal net worth as well.
In addition to Side-C, the two most common forms of entity coverage available include employment practices liability and management liability.
Employment practices liability
Employment practices liability insurance (EPL) protects an organisation from employment-related claims. EPL ensures that the entity is covered for its own defence and settlement expenses if an employee (or similar party) makes a claim against it.
While EPL is often available to large organisations on a stand-alone basis, it may also be attached to a D&O policy as an optional insuring agreement, for the payment of extra premium.
Management liability insurance (ML) is a type of D&O policy specifically tailored to meet the needs of small and medium enterprises. It is structured as a package-policy and contains a range of broad entity style coverages to protect an organisation and its managers from a variety of claims.
These entity coverages, typically only available to larger organisations on a stand-alone basis, make ML a very cost effective insurance solution. In addition to traditional directors and officers liability and corporate reimbursement insuring agreements, it often includes the following:
- Corporate liability: broad civil liability coverage for claims made against the entity
- Employment practices liability: entity coverage for employment-related claims
- Superannuation trustee liability: entity coverage for claims arising from the management of retirement, superannuation or 401k schemes
- Crime: coverage for crime committed against the entity, such as fraud and misappropriation
- Statutory liability: entity coverage for pecuniary penalties and possibly fines, resulting from breaches in legislation
- Taxation investigation: coverage for investigations undertaken by taxation authorities
The benefits of entity coverage
Entity coverage provides an organisation with peace of mind during difficult times. Without this protection, an organisation is potentially exposed to hardship whilst honouring its indemnification obligations and whilst defending claims made directly against it.
By transferring these liabilities to an insurer, an organisation can shield itself from claims. This proactive approach to risk management is not only wise from the entity’s point of view but also from the perspective of shareholders, who appreciate the preservation the company’s capital.
As we’ve shown, large organisations will acquire D&O coverage to protect their executives and the organisation’s interest in defending them. Depending on the size and corporate structure of their particular organisation a D&O policy may be able to expand to provide some level of protection for the entity itself. While this is not the primary reason for acquiring D&O, it is certainly beneficial.