From our friends over at Investopedia, by Julia Kagan 03/04/2022
What Is Directors and Officers (D&O) Liability Insurance?
Directors and officers (D&O) liability insurance is insurance coverage intended to protect individuals from personal losses if they are sued as a result of serving as a director or an officer of a business or other type of organization. It can also cover the legal fees and other costs the organization may incur as a result of such a suit.
KEY TAKEAWAYS
Directors and officers (D&O) liability insurance covers directors and officers or their company or organization if sued (most policies exclude fraud and criminal offenses).
D&O insurance claims are paid to cover losses associated with the lawsuit, including legal defense fees.
Side A coverage covers directors and officers for claims where the company refuses to or is financially unable to pay for indemnification.
Side B coverage covers the losses of directors and officers when the company does grant indemnification.
Side C coverage, also called "entity coverage," extends coverage for the corporate entity itself.
Understanding Directors and Officers (D&O) Liability Insurance
D&O insurance applies to anyone who serves as a director or an officer of a for-profit business or nonprofit organization. A D&O insurance policy insures against personal losses, and it can also help reimburse a business or nonprofit for the legal fees or other costs incurred in defending such individuals against lawsuits.
D&O insurance claims are paid to directors and officers of a company or organization for losses or reimbursement of defense costs if legal action is brought against them. Such coverage can also extend to criminal and regulatory investigations or trial defense costs. Civil and criminal actions are often brought against directors and officers simultaneously.
D&O insurance is akin to corporate governance, corporate law, and the fiduciary duty owed to stakeholders, such as shareholders and beneficiaries. US federal law grants directors and officers broad discretion in their business activities. Corporate law is typically handled at the state level. Publicly traded companies are subject to more federal regulation than privately held companies, particularly due to the Securities Act of 1933 and the Securities Exchange Act of 1934.
Types of Directors and Officers Liability Insurance
The typical D&O insurance policy contains three types of insuring agreements. They're commonly referred to as Side A, Side B, and Side C.
Side A coverage covers directors and officers for claims where the company refuses to or is financially unable to pay for indemnification. This can occur, for example, if the company has declared bankruptcy. Under Side A coverage, the individual officer is the one who's insured and it's their personal assets that are at risk.
Side B coverage covers the losses of directors and officers when the company does grant indemnification. In this case, the policy will reimburse the company for legal costs. Under Side B coverage, it is the company that is insured while its corporate assets are at risk.
Side C coverage, also called "entity coverage," extends coverage for the corporate entity itself. Under Side C coverage, the company is insured and its corporate assets are at risk.
The exact coverage that a company goes with ultimately depends on its unique business model characteristics, needs, history, and financial picture.
Directors and Officers Liability Insurance Process
The process of D&O insurance in real life is straightforward. It all starts when a manager allegedly fails to perform his or her role. Some common risk scenarios include employment malpractice, reporting errors, inaccurate disclosures, insolvencies, and regulation violations. As a result, several claimants decide to sue the manager.
Once the manager and the legal/risk management departments are informed of the claim, they then provide a description of the claim to their broker/insurer. If the claim is covered, the insurer covers the defense costs. If the claim is covered and the case is lost, the insurer pays for the defense costs and the financial losses.
Of course, that example heavily depends on the terms and conditions of the specific policy.
Do I Need D&O Insurance?
It depends on the size and nature of your business. But generally speaking, D&O insurance should seriously be considered. A Chubb study showed that more than 25% of private companies reported a D&O loss over the span of three years, with 96% being negatively impacted financially.1 So while D&O insurance isn't necessary for every single business, in every situation, it's fair to say that any company with a board of directors would be wise to consider D&O insurance.
Do Small Businesses Need D&O Insurance?
Small businesses aren't immune to costly lawsuits. It might be easy to assume that lawsuits and fines are only triggered by disgruntled shareholders. That's definitely the case with high-profile suits against large public companies. However, for private companies, the most damaging suits are brought by customers, vendors, and other third parties.1 Small companies might be uniquely vulnerable to a potentially damaging lawsuit because they don't have the financial muscle that larger companies may have.