Directors & Officers Insurance (D&O)

Also known as Management Liability, or simply D&O insurance, a Directors & Officers insurance policy one of the most essential insurance policies for start ups, venture-back businesses, and operations that have investors, executives, and/or a Board of Directors.

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It's an insurance policy designed to cover executives, c-suite officers, board members and other individuals so they can confidently focus on the organization without fear of personal financial loss. If they make a bad decision and it affects the business, a D&O insurance policy will protect the personal assets such as their home, finances, and more.

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D&O insurance is for early stage businesses, medium sized operations, and large publicly traded companies. It can be viewed as a policy whose impact goes beyond those of general liability and umbrella insurance for company board members and executives. It is open to profit-making organizations as well as to non profit organizations.

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Picture this - you sit on the board of a growing technology company providing microchips to a large cell phone company. You learn of a new supplier and advise the business to make the change. A year later, the business goes bankrupt due to the supplier you recommended. The board puts the blame on you and go after you personally for compensation.

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The D&O insurance policy indemnifies either a company or its officials from the financial implications of a decision error, behavioral misdeed, or bad investment. Although certain companies have laws that protect the rights and assets of directors and officers while they are acting in their capacity as a Director or Officer, certain companies do not. Meanwhile, sometimes, even these rights do not fully cover the officers in the event of cases with large financial implications.

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ADVISOR TIP: If you're a start-up looking to raise capital or a recently funded business looking to build your board, a D&O policy is a great tool to attract reputable investors and advisors as it shows you are proactively thinking about protecting their personal assets.

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What happens if a bad decision is made and millions of dollars are lost?

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Let's say you're a leader at a company with numerous high-level management employees. You empower your CFO to make choices that could benefit the business. Unfortunately, the CFO overlooks some important data and allocates the budget into the wrong departments causing a fast burn-rate. The investors become vile and decide to sue.

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The difference between a D&O-insured company and an uninsured company then comes to play. The former can bounce back, with the intervention of the insurance company. While the latter may take a while to get off its loss and stagger back to shape; if it ever does.

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ADVISOR TIP: A D&O policy is part of Management Liability, a package of insurance designed to protect the company and people leading it. This includes Employment Practices Liability Insurance, Fiduciary Liability, Commercial Crime, and Kidnap and Ransom Insurance.

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So, in summary, it is safe to say that the D&O insurance policy is the extra lifeline that a company enjoys if a decision, action, or investment does not pay off. By the principles of realism, no company can exist devoid of operational risks. Some risks turn out good while others, despite proper projections and predictions, turn out as errors. So on such rainy days when hopes get bleak, the Directors and officers insurance is the net that saves the officers and the company.  

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Director and Officers policies are very complex, so make sure you speak with a Fullsteam Advisor to learn more and understand the value of a D&O policy.

If you are an executive or sit on the board of a private or public company, then you may be personally liable for wrongful acts. If you are personally sued by a shareholder or investor, for example, then your personal assets could be on the line. Directors and Officers Insurance can protect the company and individuals from certain claims made against them.

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D&O insurance can be a lot to wrap your head around, so it's best to work with an experienced advisor if you are considering the coverage. Below we map out the "3 sides" of coverage and explain what each of them do.

• SIDE A: When a company is unable to or refuses to indemnify its directors and officers, Side A will respond to a claim providing personal protection to those individuals. This coverage is most common when a company goes bankrupt and typically has no self insured retention (similar to a deductible). It's also known as "personal protection."
• SIDE B: When a company decides to indemnify their directors and officers, Side B will respond to a claim and reimburse the company for legal defense and other costs.
• SIDE C: If the company is being sued for mismanagement, Side C will cover the company itself (vs individual executives). This is also known as entity coverage, and like Side B, it typically has a self-insured retention. Side B and Side C coverage together is also known as "balance sheet protection."

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ADVISOR TIP: You have the option to combine Side A, B, and C onto one single policy. This can reduce the total premium, however, there's broader coverage and fewer exclusions when Side A is on a standalone policy. You also have the option to purchase a combined Side A, B, and C policy and a standalone Side A policy.

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Directors & Officers policies will have exclusions, many of which are negotiable, so it's important your advisor reviews these exclusions and works with the insurance company to revise the terms. Common exclusions found on a D&O policy are the following:

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• Claims that should be covered elsewhere: D&O is covering the executives and board members from financial mismanagement. It does not cover things like third-party bodily injury and property damage, worker injuries, cyber crime, and discrimination (to name a few).
• Criminal, Dishonest, and Fraudulent Acts: If any acts are deemed deliberate by the carrier and courts, then coverage will not apply, including illegal profits. Like all insurance policies, criminal acts made by the business are not covered.
• Major Shareholder Exclusions (can potentially be added by endorsement): If a claim is brought by a majority owned shareholder, a lot of D&O policies will not cover it. This may be added by endorsement so it's important you discuss this with your advisor. If an executive is found guilty of fraud after a claim is paid, then they would be required to pay back all defense costs.

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ADVISOR TIP: The coverage afforded by a Directors and Officers policy is not black and white, as all D&O policies are underwritten specifically based on the operations, ownership, financials, and other factors. Many are negotiable, so align with your broker on your specific needs.

Any business should consider a Directors & Officers policy as there are various ways it can come into play. It's often the most overlooked insurance policy as it's assumed to only be for large businesses or publicly traded corporations. The fact of the matter, any size business may find value in a D&O policy.

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Below are the most common scenarios that prompt the D&O discussion:

• Small, private companies looking to raise funds and attract investors: High quality investors understand that value of a D&O policy as it will protect their personal assets if things go south. If you're looking to raise funds and attract board members, a D&O policy is a great tool to get their attention.
• Venture-backed business:  If you raise money or start to build your board, chances are a D&O policy will be required on your term sheet by investors and board members. It's becoming best-practice in the VC + Private Equity world to require this as it's value has proven to be effective.
• Operations with large liabilities: If your business owes creditors any significant amount of money and you default on payments, creditors could go after executives and board members individually to collect. A D&O policy will protect the personal assets of these individuals.
• Highly regulated industries: Companies that operate in regulated industries such a financial institutions including hedge funds, investment advisors, venture capital and private equity firms, will need to consider D&O insurance. Other industries includes, manufacturers, technology companies, healthcare, and life-science companies.
• Companies at the brink of insolvency: At the point of dissolution, investors and stakeholders may go to the length of making claims on the assets of the company and even those of the directors and officers for investment settlement. Protect the personal assets of officers from the prying eyes of investors through the insurance plan.‍
• Publicly traded corporations: Perhaps the most well-known reason for a D&O policy due to compliance requirements and regulatory enforcement. If your business is considering going public or is currently publicly traded, it will protect officers, executives, and other board members.

ADVISOR TIP: Schedule a free consultation with our D&O advisor, Tyler Crawford, to learn more about how this coverage can be valuable to your risk management portfolio.

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In today's business environment and changing litigation, claim scenarios can arise in numerous ways. You would assume that selecting directors and officers based on great character would eliminate the possibility for losses to occur, but the reality is, not everything can be anticipated. It's difficult to identify any one factor that contributes to there being many more insurance claims than average, but possible causes include: the structure of the business, the type of industry it is in, or even how long it has existed. Further, any person associated with the business such as employees, regulations, competitors, creditors, and shareholders all have reason to create claim scenarios.

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Below are some of the most common claims filed with D&O insurance:

• Employee wrongdoings: Surprisingly, employees are the most common sources of a D&O claim against their organization. For example, if an employee feels they were mistreated, perhaps sexually harrassed, they may go to the management team. If their issues are not addressed, they may seek legal action.
• By-law failure: Your board has contractual obligations to follow and a responsibility to follow certain codes and rules. If these are violated, it leaves the board open to lawsuits. For example, if a board member is improperly removed, and the member decides it was not following the laws of their agreement, they may sue.
• Theft: Often, companies with boards are working on innovative ideas that require top talent from other organizations. For example, you decide to hire a Chief Technology Officer and they implement proprietary software from their previous employer.

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The list of D&O claims is extensive, and increasing year after year as new industries emerge and laws change. Your business is unique and will come with claim scenarios that differ from other industries. Speak with an advisor today about your business and common D&O claims that you should consider.

Unlike most insurance policies, a D&O policy requires more than just a questionnaire or phone call with your agent. Underwriters at the top insurance companies will have their own set of questions, and will want to review recent financial statements, cap table, and contracts to consider releasing quotes.

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Below are the most common requirements:

• Basic Company Details: The first set of details any underwriter will need to review are the basic company details. They will want to review the type of operation, industry, and size of your business.
• Company Financials: The company’s financial circumstances is the basic component of a D&O policy. Specifically, its most recent income statement (revenue, expenses, etc.) and balance sheet (cash and liquid assets, debt, and reserves).
• Prior Events: Like all insurance and underwriting processes, prior and losses or litigations will have weight on carrier interest and pricing. You must disclose any events that happened in the past or are currently in litigation.
• Management and Executive Compensation: Since the D&O policy is protecting the assets of executives, directors, or board members, underwriting will review the cap table structure, compensation, and individuals on the board. The background and experience of these individuals is a key component of the underwriting process.
• Contracts: Depending on your industry, underwriters will request to review contracts such as moratoriums and partnerships agreements.

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NOTE: Publicly traded companies will have additional details to provide such as disclosure practices, stock price volatility, and corporate governance.

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The cost for D&O insurance is similar to other insurance policies as the pricing will depend on multiple key factors such as:

• The type of operation
• The company size
• Safeguards in place to reduce losses
• Company financials
• Annual revenue
• Board/Executive experience
• Claims history

In addition, companies that have been in business for multiple years without losses, will likely pay less than younger organizations. Companies with a strong financial position (lower bankruptcy risk) will also pay a lower annual premium.

The average annual cost of D&O insurance is usually in the range of $5,000 and $10,000 a year for $1,000,000 in limits. Businesses in highly regulated industries (Fintech, for example), should expect to pay more.

Our experienced D&O advisors can provide accurate ballpark pricing within minutes for those looking for budgeting support. Schedule a call today.

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