If you have raised a business from scratch, we can safely assume that you must have made some tough decisions while managing the business. You may or may not have ‘experienced’ this, but, with these tough (and sometimes, unpopular) decisions, comes the risk of legal liabilities. You (or any of your directors or officers, for that matter) may get indicted, charged or sued by any of the stakeholders over such decisions, taken during the normal course of the business. The chain of events may lead to ugly legal battles, huge expenses or even attachments of personal assets of your directors and officers.
This is where a protection mechanism (a ‘Kavach’, so to say!) becomes extremely necessary for your directors or officers. Yes, we are going to talk about Director's & Officer's Liability Insurance (or simply D&O Insurance). This is one ‘safety net’ coming from the insurance industry to help businesses threatened by the extremely volatile and dynamic liability environment prevailing these days. In this article, we will discuss what D&O insurance is, why your business needs one and other related topics.
Let’s start with the very basics first.
Table of Content
• What is D&O Insurance?
• Types of D&O Insurance?
• What does D&O Insurance cover?
• What does D&O Insurance not cover?
• Why does your business need D&O cover?
• What is a reasonable level of D&O coverage?
What is D&O Insurance?
The D&O Insurance is a policy designed to cover the potential legal liabilities of directors, board members and other employees in a management/supervisory capacity-in case they get indicted over the decisions taken by them to manage the business. This insurance cover protects the personal assets of the directors and officers and compensates them for settlements and legal expenses resulting from such suits and litigations.
Types of D&O Insurance
There are 3 types of D&O insurance. An organization can opt for any one, depending on its needs, business model and financial position.
• Side A Coverage- Protects the directors and officers against financial liabilities in case the organisation refuses to or is unable to come to their rescue. Here, the individual director or officer is insured and his personal assets are considered as risk.
• Side B Coverage- Covers directors and officers against liabilities where the organisation grants the indemnification. Here, the organisation is insured and its corporate assets are considered as risk.
• Side C Coverage- It is basically an extension of the Side B Coverage. It protects the corporate assets of the organization as well. Side C coverage is also called ‘entity coverage’. Under this coverage, the organisation is insured and its corporate assets are considered as risk.
What does D&O Insurance cover?
The coverage of a D&O Insurance policy includes (but is not limited to)-
- The costs associated with the defence, investigation, negotiation and settlement of a covered claim ( including court attendance costs, attorneys’ fees, bail and bond costs and so on)
- Pecuniary Penalties
- Subsidiary coverage
- Coverage for outside directors
- Employer - Employee Disputes
- Crisis Communication Costs
- Kidnap & Response Costs
- Cover for failure/negligence to monitor any claims related to professional indemnity
- Public Relations Expenses
- Cover for damage to reputation
- Coverage for Retired Directors and Non-Executive Directors
- Emergency Costs
- Severability coverage
What does D&O Insurance not cover?
Please note that D&O Insurance does not cover the following–
- Dishonest & fraudulent Acts-Fines and penalties resulting from intentionally fraudulent and malicious acts committed by executives. However, well-crafted exclusions are in place in the coverage for those who were unaware of such fraud.
- Cyber Threats-Data breaches and cyber attacks
- Professional Services Claims-Claims related to omissions, errors and negligence while providing professional services.
- Third-Party Injury-If a visitor gets hurt on your business premises
- Deliberate acts of violating a law, contract or regulation
- Misappropriation or infringement of patents or trade secrets
- Exposures related to mergers & acquisition
Now that you have gathered enough information about D&O Insurance, it's time to know why you need one..
Why does your business need D&O Insurance?
Today's businesses mostly operate in a dynamic environment and are subject to cut-throat competition. Some of these decisions may aggrieve one or more of their stakeholders at any time. Thus, such decisions make the directors and officers (or any other employee in a ‘decision-making position’) extremely vulnerable to possible lawsuits from regulators, customers, competitors, shareholders, employees and Government bodies.
Please keep in mind that being a small or medium business does not make you immune to potential lawsuits. A costly lawsuit can have a severe impact on the personal fortunes of the aforementioned employees in your business. In the case of a small business, protection from D&O insurance is even more essential as the personal net worth of the owner or any of the key employees may be attached to the financial health of the business. When a potentially damaging lawsuit comes in the way, a small or medium business may not quite have the financial ‘muscle power’ enjoyed by the larger companies to deal with it.
D&O Insurance becomes necessary for a small or medium business because it is designed to protect the personal fortunes of the employees in a management/supervisory capacity- from potential legal liabilities. As we have seen above, this insurance cover can also compensate your business against settlements and legal expenses resulting from such suits and litigations. In addition to this, one or more directors may be looking for D&O insurance before joining the Board of your business. This is to make sure that enough protection is offered by your business to cover any legal liability arising out of a management decision made by them later on. Therefore, if you want to attract some directors of high pedigree to your organization, it’s time you opt for D&O insurance, in case you are not having one already.
What is a reasonable level of D&O coverage?
Selecting a reasonable limit or level of any liability insurance is a challenge for any organization and the same applies to D&O coverage as well. An organization can opt for any limit of the D&O coverage, depending on its needs, business model and financial position. Here are some of the factors that can influence the reasonable level of D&O coverage:
• Financial background- If your business is having sound financial health and steady growth and your debt management is effective enough, you may opt for a D&O coverage with a lower premium. The converse is true as well.
• Company Size- This is the most common factor. The size of a company is not only determined by its employee strength. You can also take into account the annual revenue, the total amount of funding, the number of paying customers and other factors to figure out your company size.
• Time spent in the business- If you are a young company, you will have a relatively shorter history of effective management and a less predictable revenue stream. Thus, you will create more liabilities for insurance providers. The provider will also consider mergers or acquisitions, recent significant changes that have affected the business, changes to the company’s financial strength and shareholding agreements etc to figure out the limit of the coverage
• Risk appetite- Your willingness to tolerate risk can determine the level of your D&O coverage. If you are a risk-averse business, you can opt for a lower retention amount before the insurance policy starts. However, this will increase the cost of the policy. On the other hand, if you are more inclined to handle risk, you can opt for a higher retention amount, thereby, decreasing the premium to pay.
We hope from the above discussion, you have got a fair idea of what D&O Insurance is and why your business needs this ‘Kavach’. If you are not sure about your D&O risk level, you may get in touch with our seasoned experts. We would help you assess your D&O risk level within minutes! If you want to shield your assets against the potential risks attached to your business decisions, our advisors would be happy to help you with a coverage recommendation.
1. What are the factors that impact the cost/premium of aD&O Insurance policy?
Here are some of the important factors that impact the payable premium of a D&O Insurance policy-
• The type and nature of the business and the industry
• Total number of employees
• Size and age of the company
• Number of shareholders
• Number of directors, managers and officers in the company
• Financial stability
• Estimated revenue and/or profit
• Liability limit opted for
• Trading patterns
• Past claims made
2. Is the process to claim D&O insurance coverage a complex one?
No. The process of the D&O Insurance claim is a fairly simple one. Once the organization or its legal/risk management department becomes aware of such a suit, they need to describe the claim to the insurer. The insurer will then assess if the claim is covered under their D&O Insurance policy. If it is covered, the insurer will bear the defence costs. If the case is lost eventually, the insurer would pay for the financial losses as well. On the other hand, the insurer may avoid payment if the organization deliberately submits incorrect information or fails to disclose material information.
3. Who are covered under D&O insurance?
The following groups of people are covered under a typical D&O insurance-
• Directors & Officers
• Legal heirs
• Company secretaries
• Estate representatives
• Employed lawyers
4. Is the D&O insurance coverage a costly one?
When you consider the liability it covers, you will find D&O insurance not quite expensive. A costly lawsuit can have a severe impact on the personal fortunes of the directors. When you have the option to transfer the risk to an insurance company, we think it does not make sense to expose yourself as a director or your personal assets to a lawsuit.
5. What determines the reasonable price range for a D&O insurance coverage?
The reasonable price range for a D&O liability insurance coverage depends on the needs, business model and financial position of the concerned company. If your business is having sound financial health and steady growth and you are having an effective debt management system, you may opt for a lower D&O coverage (and vice-versa). You can also take into account the total amount of funding, annual revenue, number of paying customers, and your risk appetite to figure out the reasonable price range for your D&O insurance. If you are more inclined to handle risk, you can opt for a higher retention amount, thereby, decreasing the premium to pay. The opposite is true as well.
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