As a business owner or decisionmaker, should you invest in directors and officers (D&O) insurance? The short answer is, if your company maintains a board of directors or officers committee, it can be a good idea. The longer (and more accurate) answer is that it depends. Although having a commercial general liability (CGL) policy will go a long way toward protecting the business from financial loss, it can leave the company’s assets — and personal assets of the directors and officers — at risk. And in such instances, specialized coverage can help.
Of course, a number of factors come into play anytime a company is considering its insurance options. As it relates to D&O insurance, you’ll want to take into account everything from your industry, to company size, environmental risk factors and budgetary considerations. D&O insurance policies can be expensive, especially with reports predicting continued rate increases through the remainder of the year. At BCH, we find a back-to-basics approach can often help when it comes to determining which types of insurance are right for a company. Read on to learn the ins and outs of D&O coverage, and factors you should consider when determining whether to sign on.
Understanding D&O Coverage
First, it’s important to understand what D&O coverage is, and the options available to you. D&O insurance protects the personal assets of directors, officers and their spouses in the event they are personally sued for wrongful acts — whether alleged or proven — in managing a company. These individuals are typically covered by legal action from:
- Third Parties
D&O coverage usually includes the cost of legal fees, settlements and financial losses associated with allegations regarding breaches of fiduciary duty, failure to comply with regulations, lack of corporate governance, creditor claims and reporting errors. Claims concerning outright fraud, criminal activity or lawsuits between managers within the same company, however, are a few examples of allegations that are not covered by D&O insurance.
There are five types of D&O insurance policies:
- Side A Insurance — This coverage protects the directors’ and officers’ assets.
- Side B Insurance — This coverage reimburses a company’s indemnification obligations.
- Side C Insurance — This coverage protects the company in the event of a lawsuit.
- Employment Practices Liability — This coverage protects directors and officers against wrongful termination, discrimination or sexual harassment suits.
- Fiduciary Liability Insurance — This coverage protects fiduciaries from Employee Retirement Income Security Act (ERISA) lawsuits.
Reasons to Consider D&O Insurance
If the policy expense outweighs the needs of the company, D&O insurance might not be the option for you. Many private companies opt out of D&O because they have less risk involved compared to public companies. D&O lawsuits are notoriously expensive and have bankrupted companies in the past, so companies with valuable assets and higher risks involved with losing them should certainly consider their options. Here are a few factors business owners should take into consideration when it comes to D&O insurance:
- If a company is looking for top talent to promote growth or compete with high-grossing industries, it should consider insuring future directors and officers. Many talented executives won’t leave their current company for one that won’t protect their assets, or which leaves them vulnerable to financial loss.
- Businesses that focus on personal accountability or have active investors that influence corporate behavior should strongly consider a D&O policy to protect their executives. Public companies are often held responsible for shortcomings inside and outside the business. These conditions contribute to the company’s risk of litigation or lawsuit.
- Another consideration is the company’s financial stability, especially in relation to debt. In 2021, 5.4 million new business applications were filed largely as a result of the pandemic. The U.S. Small Business Administration (SBA) reported $44.8 billion in funding to small businesses last year to support job and entrepreneurial growth. While these loans allow companies to grow, recover or establish themselves, any debt to be paid back to the government or other entities might put the company in a bind. This is especially true if that growth opened the company up to new risks.
- If a company has been through litigation in the past, insurance underwriters will often categorize it as a higher-risk policyholder. While that doesn’t necessarily mean the company needs to consider D&O insurance, it will factor into the cost of insurance. For smaller, private businesses, past litigation might be a one-off occurrence. It’s best to speak with an expert risk advisor to understand the likelihood of lawsuits or potential risk areas.
Current Events and Trends in D&O Insurance
Trends in D&O lawsuits have a major impact on insurance carriers and their risk assessments. Between the growing number of annual D&O policy renewals and unfavorable losses for commercial insurance policies, the number of lawsuits and, subsequently, the cost of premiums, have experienced double-digit rate increases in the last few years. Current and new legislation has a major influence on lawsuit trends because it can introduce new areas of vulnerability and require businesses to take proactive steps toward changing existing policies.
Current events such as environmental, social and governance (ESG) topics, global health reports and economic developments are trends to watch for in 2022. The pandemic changed the way many businesses respond to health concerns. With more employees working from home and increased flexibility in hybrid schedules, senior leadership is subject to more scrutiny based on how they handle and accommodate those affected by environmental issues. Claims related to mismanagement have contributed to the rising number of premiums, but these numbers are projected to continue increasing through 2022.
BCH Tip: For insights on corporate social responsibility and well-being in the workplace, check out our Second Quarterly HR Edge newsletter.
The increased frequency and cost associated with cyberattacks have put most, if not all, industries at an increased risk when it comes to D&O claims. Investing in cybersecurity software, implementing controls to detect data breaches, ransomware or phishing scams, and failing to report incidents to the appropriate parties, are common allegations filed against corporate leaders. In these situations, investors and shareholders believe their personal and financial information was mismanaged or neglected, and that responsibility often falls back on the directors and officers.
Consulting with a benefits advisor, implementing strategic risk management programs and investing in business insurance can help business owners avoid costly litigation fees. If you’re considering D&O insurance, BCH has expert risk advisors who can help you find the right policy for your industry, risk level and budget. Feel free to contact us at any time so we can put our expertise to work and allow you to return focus to the growth and success of your business when it matters.