Understanding Directors and Officers Liability Insurance
Employees accepting to serve as corporate officers or directors assume personal liability risks both under hundreds of Australian statutes and common law. That’s why most of them expect some form of officers and directors liability insurance when they accept those positions. Despite what many people think, D&O insurance policies aren’t considered standard insurance products. They can vary greatly, which is why it’s important to understand and ensure you get the right type of coverage that will have the officer or director covered when they need it most. But before you decide on the best policy, you should first get a thorough understanding of the common risk scenarios, the typical layers of indemnity protection, and the board’s role in finding the best policy.
Common Risk Scenarios
There are a few common risk scenarios that can lead to claims or allegations against directors and officers, such as:
- Failing to comply with laws and regulations, which can lead to penalties and fines
- Wrongful employment practices such as sexual harassment, discrimination or wrongful termination
- Making decisions that exceed the authority granted
- Misrepresentation in a prospectus, wrongful shareholder actions or inaccurate disclosure of information
Layers of Indemnity Protection
Most Australian private and public sector corporate statutes allow corporations to indemnify their D&Os from potential personal liability in the performance of their roles. This protection is confirmed by corporate bylaws or articles of incorporation, and they can be reinforced by indemnity agreements between the corporation and every officer and director. However, these indemnities are only effective if they’re legally enforceable and if the corporation has enough funds to cover the liabilities. If the corporation isn’t permitted to indemnify or doesn’t have the funds to pay for liability costs, directors and officers will look to officers and directors liability insurance policy for coverage. And if both the corporation and the policy aren’t sufficient to respond to the claims or allegations, then the directors and officers face the worst-case scenario where they have to personally defend themselves and pay for all associated costs.
Board’s Role in Finding the Ideal Policy
The biggest mistake board members make when purchasing D&O insurance is allowing the CFO to choose and purchase a policy for them. The problem with this is the fact that most CFOs will look to get the most affordable policy. The cost of the insurance policy is just one of the many factors to consider. Every D&O has the obligation to care for the corporation, which means they also need to understand the associated risks and how the insurance policies respond to those risks. That being said, the board should be directly involved in the procurement process of selecting a D&O policy and they should address key decisions. Some of the key decisions include:
Choosing the Right Broker – As aforementioned, D&O insurance policies aren’t off-the-shelf products, meaning no two policies are the same. For that reason, it’s best to work with a broker who can guide the members of the board through the decision making process by answering questions and giving suggestions.
Make Sure the Broker Works With Reputable Carriers – You should make sure the insurance broker you choose works with a number of reputable carriers in order to give you more freedom of choice and get the best possible policy for your corporation, industry and risk profile. The broker should provide assurances regarding the experience, financial capacity and reputability of the carriers they propose.
Asking the Right Questions and Reviewing the Policy Yearly – Directors and officers should demonstrate their due diligence in ensuring the best policy terms were considered and that they also have an appropriate policy limit in mind. Further, since industry standards for directors and officer’s insurance policies are constantly evolving, the board and the broker should work together to benefit from the changes by reviewing the adequacy of the policies on a yearly basis.
Types of Coverage
The board should inquire about the types of recommended coverage by the broker, which can include:
- Side A Coverage provides personal coverage for non-indemnified claims. This is also known as catastrophe protection for individual directors and officers, and it provides protection from litigation even if the corporation can’t provide indemnity protection
- Side B Coverage provides the corporation with reimbursement for indemnified claims paid out to directors and officers. This is also known as balance sheet protection
- Side C Coverage provides protection for corporate liability when the entity is a defendant in covered claims. This is also known as balance sheet protection
Keep in mind, there are even more complex types of coverage that provide protection before the aforementioned types of protection. This is exactly why working with a broker with experience in the field is highly recommended. Brokers will do all the legwork, give you personal advice and service that will help you navigate through these muddy waters.