If all D&O policies were the same, choosing the cheapest D&O option would make sense. But all D&O policies aren’t the same. Differences in policy terms can have a huge impact on the amount of coverage you have in the event of a loss, and saving a little money on a cheaper policy now could result in significant uncovered costs down the road.
Not All D&O Policies Are Created Equal
D&O insurance typically follows the same basic structure. You have your three “sides” of coverage.
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Side A covers the directors and officers when the organization cannot provide indemnification.
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Side B provides coverage for when the organization does indemnify the directors and officers.
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Side C provides coverage for the organization when it’s named in securities claims.
But beyond this basic structure, coverage can vary significantly from one carrier and policy to the next. D&O insurance is not standardized. One policy may offer comprehensive coverage that will provide robust protection if you’re sued. Another policy may have so many exclusions and restrictions that you end up with little or no coverage for a lawsuit.
Policy Language Can Make or Break Coverage
For public companies, D&O insurance is more than a regulatory or governance requirement. It is a critical risk management tool that protects directors, officers and the organization from potentially significant financial and reputational harm. Small differences in policy language can have major consequences when a claim is filed.
Some coverage elements to review include:
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Definitions. How the policy defines key terms can determine whether or not you have coverage for a claim. Example: Even the definition of the word “claim” varies from policy to policy. If there is no claim, there is no coverage, so this definition is critical.
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Endorsements. Clauses called endorsements can provide additional coverage, but it all comes down to the wording. Example: A D&O tail or run-off endorsement provides an extended reporting period. This is important because D&O insurance operates on a claims-made basis, and claims that are reported after the policy has terminated do not have coverage. However, tail endorsements can vary in detail and length.
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Exclusions. Certain exclusions are common in D&O policies, but the exact wording can determine whether the exclusion strips away coverage that you need, and some policies may include exclusions that other policies leave out. Example: Some D&O policies have a prior acts exclusion that bars coverage for acts that occurred before an established date.
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Carve-backs. Clauses that restore coverage that would otherwise be excluded can provide important protection, but these carve-backs vary. Example: D&O policies typically exclude insured vs. insured claims, so you won’t have coverage if one director sues another. However, carve-backs can establish coverage for certain scenarios, such as shareholder derivative lawsuits.
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Coverage amount. The amount of coverage available will depend on the policy’s limits, and there may be sublimits for certain types of claims. It’s also important to consider the retention, which is the amount that the insured must pay before coverage begins. Example: D&O policies often have sublimits for claims involving regulatory action.
Finding D&O Coverage That Fits Your Risk Profile
Buying a D&O policy that doesn’t provide coverage when you need it is like buying a car that doesn’t actually run. It may seem like you’ve saved money on the purchase, but you’ve actually wasted money on a piece of junk, and you’ll end up paying more in the long run.
The goal is not to purchase the cheapest D&O policy, nor is the goal to spend money on policy bells and whistles that you don’t need. Insurance can be expensive, and even with recent D&O rate decreases, it’s not financially prudent to spend money on an overpriced policy.
The goal is to secure coverage that aligns with your organization’s risk profile and protects leadership in the event of a claim. Otherwise, it won’t do much good if you ever face a claim, and you may end up facing a lawsuit without coverage.
The key is to find coverage that matches your risk exposures.
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Is the amount of coverage sufficient for your organization? The amount of coverage you need will depend on your revenue, as well as other factors like your industry, financial profile and board composition.
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Do you have sufficient coverage for prior acts? If your organization has gone through a merger or acquisition, or if you’ve switched D&O insurers for other reasons, you could end up with coverage gaps due to the claims-made nature of D&O insurance. Pre-IPO activity could also come under scrutiny, so companies should consider whether they have coverage for actions leading up to going public.
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Could any terms be negotiated in your favor? If your policy’s terms are more restrictive than some, you may be able to negotiate more favorable terms. It may also be possible to clarify certain terms so you can be confident about your coverage.
D&O insurance is highly customizable, which means policy differences can have a significant impact on claims. An experienced broker can help identify potential gaps, clarify policy language and negotiate stronger protection where appropriate.
Contact the Capital Market Group at NSI for D&O coverage guidance.
