In a litigious age, it's important for companies and nonprofits to protect the folks at the top. Fortunately, it's a buyer's market for D&O policies.
No one is perfect. Everyone makes a mistake once in a while, and company directors and officers are no exception. Sometimes a misstep--or perceived misstep--exposes your company to a lawsuit. Where can you turn for financial relief and strategic counsel when your organization is about to be buried in legal bills?
Often, the answer is directors and officers liability insurance. Commonly known as D&O, this coverage "steps in and stands in the shoes of the organization to cover defense costs and make payments on obligations that the organization takes on in defending them," says Andrew Gunn, vice president of specialty risk at Oswald Companies, a Cleveland-based insurance brokerage firm. "It comes into effect to protect directors and officers from their fiduciary liability."
D&O insurance covers alleged breaches of duty and wrongful acts relating to the organization's activities, says attorney Robert Katz, a member of the insurance practice group at Bricker & Eckler. Directors and officers are "supposed to be in charge of the organization and manage the managers," Katz says, "and when something goes wrong, people who think they've been damaged or hurt ... go after the directors or sometimes the officers to say they mismanaged things or they didn't exercise the right judgment."
Gunn says the first D&O policies were issued shortly after the stock market crash of 1929, when wiped-out investors sought to pin the blame on corporate bosses. Lloyd's of London issued the first policies, but they weren't very big sellers at the time. "It wasn't really until the 1950s and '60s that [D&O] came to [popularity] through securities laws that were passed," Gunn says, "and it's become more and more prevalent since then."
In the last couple of decades, the increase in both class action and individual lawsuits has made D&O coverage an inevitable cost for most businesses. "In this day and age where people sue at the drop of a hat, it's certainly an important part of a company's protection," says attorney Alan Berliner, insurance counsel and a partner at Thompson Hine.
Greg Overmyer, CEO of independent insurance agency Overmyer Associates, says every company could benefit from D&O coverage: "I can't think of an exception to the rule."
Public companies often have the greatest risk. They must adhere to complicated and ever-changing securities laws, generally have more assets, and have a larger number of shareholders, also known as potential plaintiffs.
Private companies may have employee shareholders whose interests must be protected. "The board members must work on behalf of all shareholders, and they don't always protect the interest of minority shareholders," Gunn says. "An example could be a company that decides to recapitalize their equity structure and favor the majority shareholders to the detriment of minority shareholders."
Sometimes the allegation is simply bad management. For example, two minority shareholders sued a privately held cable installer, alleging that the defendants wasted corporate assets, failed to properly evaluate costs and proactively manage the business, resulting in a decline in the value of the company. Travelers Insurance, with whom the cable installer had a D&O policy, settled the case for $150,000 after incurring $200,000 in defense expenses.
In the wake of the financial meltdown of 2008, banks, mortgage lenders and other financial institutions have needed every dollar of their D&O coverage. Aggrieved investors, borrowers and business partners have filed hundreds of suits, alleging that the money bosses knew--or should have known--that their financial palaces were really insolvent shantytowns. Other actions seek to hold directors and officers responsible for not keeping their organizations compliant with federal laws.
Former banking regulator Brian McCormally, speaking at a D&O Symposium of the Professional Liability Underwriting Society in February, said the existence of D&O insurance has been a starting point for the Federal Deposit Insurance Corp. (FDIC) in deciding whether to file damage claims against failed banks.
Even nonprofit boards and executives are at risk of being sued. "It could be alleged that they wasted the money," Katz says. "The directors could be sued because they were unqualified to handle the money. Did they fail to audit? Did they fail to have appropriate accounting procedures in place?"
Suppose you're an unpaid volunteer trustee on the YMCA board, and someone slips, falls and breaks his neck on the deck of the pool. If you voted against installing that special nonskid deck surface because it was too expensive, you'd better hope the YMCA has a good D&O policy. D&O insurance doesn't cover outright crimes committed by directors or officers, but almost anything else--a negligent business decision, for example--is covered.
A well-established part of Ohio case law is the Business Judgment Rule, which protects directors who act in good faith, with "due care" and without personal bias. "We all make judgments, but sometimes you have all the facts and sometimes you don't. You make the best judgment you can based on what you know," says Berliner.
Katz explains it this way: "You've got to show that [directors] were really negligent. They're allowed to rely on experts who [advise the] board." The Business Judgment Rule, Katz says, "protects those who approach their duties reasonably and with care."
The Business Judgment Rule does not protect officers, and it doesn't prevent anyone from filing suit against a company. Such suits are limited only by "the creativity of the plaintiff's lawyers-what they can allege and how much they can prove," Katz says. Even when a suit is ultimately found to be without merit, defense costs can quickly soar into six figures, or even millions. That's why D&O coverage is so important.
In fact, many businesspeople won't serve on a board of directors that doesn't have D&O insurance. "One of the real problems for organizations is getting people to serve as directors. D&O is often a necessary part of that," Katz says.
"People are not going to get on a board if they're not going to be covered by directors and officers insurance," says Overmyer. "I'm on six boards right now, and every one of them has D&O insurance. ... If you're getting paid to be on a board, you're really exposing yourself."
A company that doesn't have D&O coverage is leaving its directors' and officers' personal assets vulnerable to attack, as well as the organization's assets. Even if a judge eventually determines that the Business Judgment Rule protects a director from personal liability, someone must still pay the defense attorney who handled the case.
"Most [lawsuits against directors] get settled or dismissed because in the early investigation or discovery, it's decided that it's not worth the efforts to pursue it. But there's a cost in both time and money that directors want to be protected from," Katz says.
In a D&O case that goes to trial, defense costs usually account for most of the expense, according to Overmyer. Typically, D&O cases are handled by the company's lawyers, rather than the insurance company's. Defense costs are either advanced to the company or reimbursed later. It's not unusual, Overmyer says, for the total cost of a D&O case to "get up into the $500,000 to $700,000 range when you throw in defense costs."
Types of Coverage
D&O coverage can vary widely, often depending on how a company's bylaws cover indemnification for directors and officers, says Don Ortegel, a Chicago-based managing director of Aon Risk Solutions' Financial Services & Professional Group.
Traditional elements of D&O policies are known as Side A, Side B and Side C. Together they cover all the D&O insurance bases.
"Side A coverage is the portion of the policy that responds when the corporation is not able to indemnify," Ortegel says. Side A covers directors' and officers' personal liability, if any, and defense costs.
Janet Clark, a private D&O product manager with Travelers Insurance who's based in Connecticut, says Side A is the most critical piece of D&O coverage. "The CEOs probably have significant personal assets," Clark says. If an organization doesn't have Side A coverage, "They would be responsible for paying the cost out of their own pocket."
Side B coverage reimburses a company for expenses it pays in defending the actions of its directors and officers, Clark says: "It takes on the exposure to protect the corporate assets."
Side C coverage insures the company against liability. "This is much broader coverage for the company itself," Clark says. "In this day and age when litigation is so common ... they're also going to name the company, especially if the litigant is anyone other than the shareholders or owners of the company."
Most companies' D&O policies have all three sides. "For private companies and even for public ones, all three are included automatically in the policy" by Travelers, Clark says. "It's very unusual for somebody to have only a Side A coverage or a Side B coverage."
Limits & Premiums
A company with $25 million in assets will generally purchase $1 million to $2 million worth of coverage, while a company worth $250 million will generally purchase $5 million in D&O insurance, Overmyer says.
The amount of coverage can vary widely, depending on whether the organization is public or private and its total value. "It's usually dependent on the size of the company, the size of the assets, and also if they're a publicly traded company and the market cap," Gunn says.
Overmyer estimates a small, private company would pay a minimum premium of around $2,500 annually for $1 million in coverage. A publicly traded company with 35,000 to 55,000 employees may purchase $100 million in coverage and pay millions of dollars annually in D&O premiums.
There's no one-size-fits-all D&O insurance policy, says Bill Kientz, owner of consulting firm Kientz Risk Management. "There are a lot of rules of them, and there's no exact science," he says. "Different kinds of companies carry different types of risks; therefore they require higher limits versus lower limits. There's far less of an exposure for D&O if there are no outside shareholders to bring suits against the business."
To some extent, the level of coverage is dependent on what the board members want, because they're the ones left hanging out to dry if the company doesn't have Side A coverage, Ortegel says. "It really comes down to your comfort and your interest in terms of protecting your personal assets and your philosophy for transferring risk. Do they want to take that [risk] on the balance sheet or transfer that to an insurance company?"
Katz advises working with an insurance broker or risk manager to design a policy tailored to your business. "Some businesses are more prone to being attacked than others," he says. "It's a very fluid subject. The best advice I have is, work with your insurance broker to work out all the risks ... and that person can find the right policies to fit the business."
These days, companies are finding the D&O marketplace highly competitive. "The number of insurance carriers looking to write D&O coverage has never been higher," Gunn says. "In order to compete in that type of marketplace, they're offering valuable coverage enhancement and competitive pricing."
There are more than 75 U.S. carriers that now write D&O insurance, and no two contracts are exactly alike, Gunn says: "The terms and conditions vary dramatically. It's important to work with an advisor that understands these contracts."
Competition has driven the price of D&O insurance down over the last several years. It's definitely a buyer's market. "The price per million dollars is lower today than it was two to three years ago," Kientz says. "That's a good thing [for companies] because they can buy more for less."
"The key thing is to understand how your risk coverage in your price range compares to your peers in your industry," Gunn says. "If you don't know, that's something that you should probably find out."
With so much choice in the market and so much at risk, experts say it's better to be safe than sorry. If you don't have D&O coverage, now is a good time to check it out. And if you already have D&O, it might be wise to examine your current policy and see if shopping around could get you a better deal.
Lisa Aurand is a freelance writer.
Reprinted from the May 2011 issue of Columbus C.E.O. Copyright © Columbus C.E.O.