D&O insurance explained
- Increased corporate governance means more D&O exposures
- D&O insurance covers claims resulting from managerial decisions that have adverse consequences
- D&O insurance is a complex cover requiring attention to what is and isn’t covered
- Common risk scenarios include failure to comply with regulation or laws, reporting errors or misrepresentation. Common exclusions include fraud, intentional non-compliant acts and property damage
- International insurance programs necessary for companies with global subsidiaries and office
What is D&O insurance?
D&O insurance policies offer liability cover for company managers to protect them from claims which may arise from the decisions and actions taken within the scope of their regular duties. As such, D&O insurance has become a regular part of companies risk management.
Companies purchase D&O cover because managers can make mistakes. D&O coverage includes financial protection for managers against the consequences of actual or alleged “wrongful acts”. Policies cover the personal liability of company directors but also the reimbursement of the insured company in case it has paid the claim of a third party on behalf of its managers in order to protect them.
Coverage is usually for current, future and past directors and officers of a company and its subsidiaries. D&O insurance grants cover on a claims-made basis. This means that claims are only covered if they are made while the policy is in effect or within a contractually agreed extended reporting period, which can extend up to another 72 months or even longer in some countries.
Coverage does not include fraudulent, criminal or intentional non-compliant acts or cases where directors obtained illegal remuneration, or acted for personal profit.
Therefore, D&O insurance raises many important questions which companies must face: How much is enough? What and who is covered – and not covered? Should small-to-medium sized enterprises (SME) purchase D&O? What does the typical program look like? How can risk management protect officers from the many perils they face in today’s business environment?
D&O insurance structure
The structure of a D&O insurance policy depends on which of three insuring agreements are purchased (ABC policies are generally chosen, as these are standard form policies for publicly listed companies; for private or non-profit companies, only AB policies would be used) [see table].
Directors and officers are confronted with an increasing peril that their company may not be able to reimburse them for loss. An extra layer of defence to personal funds can be secured by purchasing Side A cover, which insures directors and officers only (not the company) when indemnification is unavailable.
Often not enough coverage is bought for the risk, so a major trend is for more Side A cover to be purchased in order for an individual officer to protect personal assets. D&O cover has become a regular cover for large multinational companies, but all sizes of organizations – public, private or non-profit – have potential exposures.
There is increasing demand for SME D&O cover, though penetration is still low due to lack of awareness and education. D&O products are perceived to be expensive, but actually are quite affordable. For example, a small firm with a $100m turnover can obtain no-frills D&O cover with very low limits for less than $1,000 per year.
How D&O works: Excess layer structures
Larger sized programs with limits over $30m are usually too large for one insurer and require a group of insurers to share the risks. In this setup, the lead insurer is usually more experienced and able to handle wordings, advise on international insurance program (see below) setup and settle claims.
The lead carries the “primary layer” up to, for example, $30m, and would pay claims up to that amount. When that limit is reached, it “erodes” and the next layer kicks in, up to a certain amount, and so on. The lead insurer carries most of the claims and generally pays defence costs and creates policy wording, so is most at risk. Hence, premiums are much higher.
Another way of risk sharing is through proportional coinsurance, where insurers split the premium proportionally depending on their risk share. Claims would be settled likewise. More difficult scenarios with mixtures of proportional and non-proportional elements also exist.
Larger clients with subsidiaries in other countries need an international insurance solution to protect directors and officers in all markets. Some markets require the company to take out insurance from a locally admitted insurer.
Other more progressive markets allow a master policy to be issued in another country that covers local exposures. Cover is typically provided by a combination of locally admitted policies and a global master policy, which provides additional cover to harmonize the protection globally (unless standalone local policies are required).
Who is covered?
- Past, present and future directors
- Non-executive directors
- Employees in a managerial or supervisory capacity
Who is covered?
- Stockholders, investors, creditors, banks
- Supervisory board
- The company itself, employees
- Regulators, state authorities, unions
- Customers, suppliers, competitors
Six steps to structuring an insurance program
Benefit from the degressive nature of insurance pricing and prefer higher limits over lower limits. Large towers offer great value for premium money, as the price per unit of capacity gets cheaper the higher the tower
Consider special and dedicated protection for the natural insured persons that cannot be eroded by entity coverage elements and still works in case the entity can no longer indemnify (dedicated Side A sitting excess of ABC)
Diversify your program. A tower consisting of many carriers with small lines is much more stable than the same tower consisting of few carriers with large lines
Make sure you have an international insurance program in place in case your subsidiaries operate in strictly non-admitted territories
Confirm the claims department of your lead carrier has already successfully settled large claims. What is their claims protocol in general? Meet with claims people as well as with underwriters
Don’t overload policies with too many (exotic) “extras”. The limit must be available for the main risks (Regulatory, SEC, M&A, etc) and should not be eroded by details that can be easily self-insured, especially if they concern the entity.
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