Setting the Limit for your D&O Insurance
With Directors and Officers Insurance premiums increasing significantly and a number of insurers withdrawing from the D&O market we are regularly asked by Boards what appropriate D&O coverage ie the limit of indemnity should be?
In order to answer this question, there are some fundamentals of D&O Insurance that should be understood.
Who Shares the Policy?
The policy limit is a shared limit for Insured Persons, this covers Directors and Officers (C-Suite management) and the company (if Side C is present).
What’s Covered in the Policy?
The limit of liability includes settlements and court awarded judgements and defence costs, which would otherwise need to be paid by the company or its executives.
What does Aggregate Limit mean?
The aggregate limit is the limit of liability available to each individual claim as well as all claims in the aggregate ie one large claim could erode the entire limit for the policy period and the aggregate limit typically doesn’t have a reinstatement.
What is the Structure of the Policy?
A typical D&O policy includes the following covers:
There are a range of factors to consider when setting the limit
➤ Public / Private and Market Capitalization
Generally speaking, the larger and more sophisticated a business the higher the risk, however there are some private companies that should consider a higher limit based on the degree of exposure of a particular project or enterprise they carry out. ASX top 100/200 are obviously the main targets for class action law suits and disgruntled minority shareholders.
➤ Percentage Owned by Insiders
Where directors and significant associated shareholders hold a large percentage of the issued share capital this may affect the decision on the limit. If directors hold a large proportion of the issued capital it may be argued that this reduces the scope and potential quantum of damages by claimants. Generally D&O insurers will include an endorsement aimed at excluding internal disputes between insiders for example the major shareholder exclusion (sometimes with a board seat). This excludes cover for the major shareholder suing the board or the company as they are expected to be helping direct the company and would be typically considered insiders.
➤ Peer Group
Where possible (because generally the policy information is confidential) it is useful to refer to the limits that companies in the peer group are purchasing for a guide to what limit is appropriate. KBI has access to peer group data that can benefit boards when picking a limit.
➤ Regulatory Framework
At any particular time, certain companies are in the spotlight, whether due to Royal Commissions, ASIC investigation or Parliamentary inquiries. This may influence the board’s decision as to the size of the limit. An example of this is companies involved in the Aged Care or the Banking Industry post Royal Commissions.
➤ Company’s Capacity to Retain Risk
The company’s particular risk appetite and attitude to risk management is relevant to the choice of limit. Retained risk can be considered with reference to the level of deductible applied or to the overall limit of cover.
➤ Insolvency Risk
At certain times in the company’s development the dependency on outside equity or debt may increase the risk of insolvency. At these times the company may consider a higher limit is justified. Certainly, the Directors and Officers might consider whether the company would be able to fulfil its indemnification obligations in the foreseeable future.
➤ Merger & Acquisition Exposure
The company’s growth plans may affect the limit decision. If the company’s strategy includes growth by acquisition or places them in circumstances where they may be subject to merger or acquisition themselves, they may consider a higher limit as these are inherently riskier activities.
➤ Cost / Budget
This can be linked to the company’s capacity to retain risk and also the cost per $1mil of coverage. With insurers’ pricing fluctuating as we enter a harder insurance market, the limit chosen often becomes a commercial decision of what limit of risk transfer is viable for the board/company.
➤ High / Low Risk Industry or Jurisdiction
The industry the company is in plays an important part in the decision process. Some industries are inherently more subject to litigation or open to attack than others. Equally if the company operates in jurisdictions that are considered more risky or litigious, there may be a sound basis for a higher limit.
The Australian D&O market has hardened considerably over the last 18-24 months. A number of insurers have withdrawn from the market, restricted capacity / limits they are willing to offer and reduced their appetite for certain risk sectors. This means that even if the company has decided on the limit it wishes to purchase or the limits it has historically carried, there may be a limited number of markets available with the capacity to assist. With the hard market likely to continue well into 2021 the availability of D&O will be a key factor in obtaining the limit the Board wants.
Setting the Limit
Once the above considerations have been taken into account we believe that setting the limit is a process reached between the board and an experienced broker. The interplay of the market capitalisation of the company, the free float of shareholders and average damages settlements (including defence costs) are all taken into consideration when reaching what we consider to be a minimum limit for the Board. Once this is identified the broker needs to work to secure the best available terms for the Board’s requirements.
Given the challenging insurance market and the likelihood of significant changes to the company’s business (for example in light of COVID and the overall economic downturn), we recommend that the Board revisit the limit every year in conjunction with an experienced D&O broker.
Have any questions?
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*The Content is for informational purposes only, you should not construe any such information or other material as financial, or other advice. This information is general and does not take into account your objectives, financial situation or needs. When considering the purchase of an insurance policy, you should consider whether the advice is suitable for you and your personal circumstances. Before you make any decision about whether to acquire a certain product, you should obtain and read the relevant product disclosure statement.
KBI is a boutique insurance brokerage with a focus on Directors’ & Officers’ insurance. Our team has placed Directors’ and Officers’ Liability Insurance for over 300 public companies in Australia, Asia, North America and Europe, including the ASX, TSX/TSX-V, SGX, LSE, Nasdaq, NYSE and LSE/AIM. Our team consists of senior brokers, lawyers and past ASX listing advisors. We add value to the process by helping our clients make an informed decision during the purchasing and claims process. We also continue to provide updates to our clients, so they are properly informed on the ever-changing landscape of Directors & Officers insurance.