How does D&O Liability Insurance work?

D&O insurance for company directors and officers

A D&O liability insurance policy includes multiple insuring agreements, the most common of which are known as Side A, Side B, and Side C. Each agreement fits a different need and situation. In this article we show the value of D&O liability insurance by providing a description and claims example for these three main insuring agreements. Continue reading to learn how these different agreements work.

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    Different situations require different D&O solutions

    In D&O Insurance Explained, we established that a directors and officers liability insurance policy is designed to protect corporate directors and senior management from financial loss in the event of lawsuits. A claim on a D&O insurance policy would pay the losses associated with monetary demands, for example, defence costs, settlements, or even fines for wrongful acts committed by directors and officers.

    In some situations, the corporation may pay to defend its directors and officers. However in other cases, the corporation may be unable to afford it or legally not allowed to do so. Either way, the D&O policy protects the directors and officers, or the corporation, when lawsuits against the directors and officers arise.

    The structure of a D&O insurance policy hinges on the concept of indemnification. Remember, a D&O insurance policy is only one of the components of a corporation’s indemnity and insurance program.

    To understand how a D&O policy responds, we have to look at the structure of a D&O policy. D&O policies, at their core, protect directors and officers, and this is the purpose of Side A and B of the policy. Side C is a relatively newer coverage offering, and it’s for the entity.

    Side A – Non-Indemnifiable Loss

    This insuring agreement responds in situations where the corporation is bankrupt or legally not allowed to indemnify the directors and officers. When this clause responds to a claim, the insurance policy indemnifies the directors and officers directly for the defence and settlement costs or judgments against them.

    This may happen when there are allegations, for example, for breach of duties, negligent acts, or business-related suits.

    Here’s an example: 

     A company falls under bankruptcy protection. The CEO sells all the assets to avoid bankruptcy. Later, the creditors file a claim against the directors and officers, alleging they breached their fiduciary duty. The creditors argue the directors failed to oversee the sale of assets and secure a deal necessary to avoid bankruptcy. In this example, considering the corporation was under bankruptcy protection, it would not be able to indemnify the directors. Therefore the insurance policy would indemnify the directors directly.

    Key notions about this coverage:

    • Side A is insurance for the directors and officers only – not the corporation
    • Side A does not have a policy deductible
    • Additional Side A insurance is commonly available and worth considering

    Side B – Indemnifiable Loss

    Corporate Reimbursement

    Side B Coverage, or Insuring Agreement B, is the most commonly accessed D&O insurance coverage. Wth Side B, the insurance policy responds to reimburse the corporation for indemnifying its directors and officers for defence costs, settlements, or judgments. Note that this coverage reimburses the corporation only to the extent it has indemnified the directors or officers (as opposed to covering the liabilities of the corporation). This is why D&O insurance is often explained as balance sheet protection for the corporation.

    This coverage is subject to a deductible.

    This is how Side B coverage responds: 

    Side C – Entity Coverage

    Security claims coverage for publicly traded companies

    Entity coverage protects the balance sheet of the corporation and is subject to a deductible. Side C coverage for private entities is different than that for publicly traded companies.

    Security claims coverage for publicly traded companies

    For publicly traded companies, the Side C insuring agreement provides coverage for the corporation’s own liability arising from “securities claims.”

    Security claims coverage for private companies

    Side C coverage for private entities is different. For private companies, not-for-profit organizations, and even home owner associations, entity coverage covers lawsuits against the corporation itself. 

    Entity Coverage for private companies can be extensive.  A “claim” under a D&O policy is typically defined as “a written demand for monetary relief, non-monetary or injunctive relief”, which opens the door to claims beyond lawsuits. This means that corporations might find coverage in a D&O policy for things like a government subpoena or an investigation demand. 

    What is excluded on a D&O policy?

    •  A D&O policy will not cover business risks that cannot be insured or risks covered under other policies (such as professional liability or bodily injury property damage)
    •  A D&O policy will exclude claims for fraudulent or dishonest acts by directors or companies or intentional violations of the law. Even so, this exclusion is typically doesn’t apply until the unlawful misconduct has been finally adjudicated as such by law. In other words, the insured will be defended until proven guilty.
    • A D&O policy will not cover prior known claims or circumstances relating to wrongful acts that took place before the policy went into effect.

    It is essential to read the policy declaration to understand the limit of insurance and deductible structure.  Look to the policy wordings to determine the details on what the policy will cover and what it will exclude. The wordings also state the obligations of the insured and insurance company for claims reporting and claims handling.

    For more on claims, check out our lesson on D&O Claims. 

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