How does D&O Insurance work?

A D&O insurance policy consists of multiple insuring agreements, typically known as Side A, Side B, and Side C. The purpose of this article is to describe the value of D&O insurance by offering a description and claims example of each insuring agreement.

In D&O Insurance Explained, we established that Directors and Officers liability insurance is a policy 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, defense costs, settlements, or even fines for wrongful acts committed by directors and officers.

We also mentioned that in some situations, the corporation may pay to defend the directors and officers. While in other cases, the corporation may be financially unable to afford it or legally not allowed to do it. Regardless, the D&O policy protects the directors, or the corporation, when lawsuits against the directors and officers arise.

The structure of a D&O policy hinges on the concept of indemnification. Remember, a D&O insurance policy is only one of the components of a corporation’s indemnity program. And it is part of a more extensive insurance and indemnity 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 defense and settlement costs or judgments against them. These would be 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 is now tasked with selling all assets to avoid bankruptcy. After all assets are disposed of, the creditors file a claim against the directors and officers, alleging a breach in fiduciary duty. They argue the directors failed to oversee the sale of the assets and secure a deal necessary to avoid bankruptcy. In this example, considering the corporation was under bankruptcy protection, the corporation would not be able to indemnify the directors. This means 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 typically available and worth considering

Side B – Indemnifiable Loss

Corporate Reimbursement

Side B Coverage, or Insuring Agreement B, is the most commonly accessed coverage. This is when the insurance policy responds to reimburse the corporation for indemnifying its directors and officers for defense costs, settlements, or judgments. It is essential to note this coverage reimburses the corporation only to the extent of the indemnification provided to the directors (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

The breadth of coverage and scope of Side C is entirely different between policies for private companies and for publicly traded companies. For publicly traded companies, this insuring agreement provides coverage for its own liability arising from “securities claims.”

For private companies, not for profits or even homeowners associations (strata corporations), this is entity coverage and would cover lawsuits against the corporation itself. 

It should be noted the Entity Coverage for private companies can be extensive. “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 corporations might find coverage for things like a government subpoena or investigation demand in a D&O policy. 

This coverage is subject to a deductible. It is considered to be protection for the balance sheet of the corporation.

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. This exclusion typically doesn’t kick in until the unlawful misconduct has been finally adjudicated by law. This means 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.

As with all other insurance policies, it is essential to read the policy declaration to understand the limit of insurance and deductible structure. The policy wordings provide the details on what is covered and what is excluded. There is also a section stating the obligations of the insured and insurer concerning claims reporting and claims handling.

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

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