Many small business owners believe that their general liability insurance or umbrella business insurance policies will cover claims involving directors and officers of the company. However, general liability policies do not respond to management liability lawsuits.
Some also believe that D&O insurance is only for large or publicly traded companies. This is also not true. A business of any size will usually have officers and possibly directors who can be targeted by litigants over their management of company affairs. Although privately help business don’t risk exposure to securities class action suits, a business does have to have shareholders in order for it’s directors and officers to be personally sued.
Directors and officers liability Insurance (often called D&O) is liability insurance payable to the directors and officers of a company, or to the organization(s) itself, as indemnification (reimbursement) for losses or advancement of defense costs in the event an insured suffers such a loss as a result of a legal action brought for alleged wrongful acts in their capacity as directors and officers. Such coverage can extend to defense costs arising out of criminal and regulatory investigations/trials as well; in fact, often civil and criminal actions are brought against directors/officers simultaneously.
D&O liability insurance protects corporate directors and officers in the event they are personally sued. The board of directors, the president, treasurer, and other officers of your organization are the brains of the company. Increasingly, directors face personal financial liability in an increasingly complex and litigious world. That is the purpose of D&O coverage: to lower that risk in order to attract the best brains for your company. The insurance protects directors and officers by covering legal fees, settlements, and other costs.
In some cases when a company hires a new officer they will demand D&O coverage as a condition of their employment because they do not want to put their personal assets at stake. Sometimes outside investors, such as venture capitalist or other financiers will require D&O policies before providing funding to the business. They often see the coverage as a way to protect their investment.
Directors and officers are sued for a variety of reasons connected with their company positions, including misuse of company funds, misrepresentation of company assets, fraud, failure to comply with workplace laws, and lack of corporate governance among other issues. Simply hiring employees potentially exposes directors or officers to employment practices litigation (EPL), which may be covered by some D&O policies. Claims over employment are now the most common lawsuits brought against a company’s management.
D&O insurance had been criticized for undermining corporate governance by eliminating a strong disincentive for illegal or unethical behavior. Insurance companies understand that by writing D&O insurance policies they facilitate the source of wrongful acts that they are insuring against. In the 1930’s Insured’s had to pay premiums out of their own pockets, so volume grew slowly. But legal changes on the United States during the late 1980’s allowed corporations to pay premiums.
One in six company executives — or 17 percent — believe their business will experience a D&O related loss in the next years, according to a survey of decision-makers at 451 U.S. companies, more than 90 percent of which had annual revenues of less than $25 million. The survey, sponsored by Chubb, found that one in eight survey respondents — or 12 percent — had experienced a D&O lawsuit within the past five years. The costs to settle and/or litigate those cases averaged $225,682, with some losses approaching $5 million, the survey found.
The cost of D&O insurance is based on a variety of different factors. Small private companies are considered low risk and could pay as little as $500 per year per million in premiums. Large publicly traded companies are usually considered high risk and could pay from $10,000 to $30,000 per million in annual premium. That’s a small charge to protect against a potential settlement that could be a seven figure settlement.