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how does d&o insurance work?

How Does D&O Insurance Work?

Directors & Officers (D&O) Insurance policies are complex and can be confusing for any executive — but it’s well worth taking the time to understand your policy In order to protect the directors and officers of private or public companies for alleged wrongful acts, D&O insurance policies consist of multiple insuring agreements. These are known as Side A, Side B and Side C.

We break down a typical Directors and Officers insurance policy structure to step you through the three insuring agreements so you can proceed with confidence knowing how the policy should be structured to protect the Board of Directors or the company.

What does Directors and Officers Insurance Cover?

Claims of mismanagement or breaches of a company’s fiduciary duties are covered by D&O insurance. These legal actions or investigations of wrongdoings are typically brought by shareholders, employees, regulators, creditors, competitors, liquidators. D&O Insurance can also be extended to provide entity coverage against employment practices liability and statutory liability.

A D&O insurance policy is a second line of defence to indemnification and typically forms part of a corporation’s full indemnity program. Regardless of whether the corporation defends the directors and officers or not, D&O insurance is there to protect the directors if they face any lawsuits. Common payouts from D&O insurance cover the losses associated with monetary demands such as defence and settlement costs.

D&O Insurance Policy Structure

D&O policies are typically structured with three available insuring clauses:

Here’s what a typical D&O policy structure looks like:

D&O policy structure

Side A Coverage – Directors & Officers / Insured Persons

Side A coverage exists to protect the directors and officers of a company if they face personal liability risk when company indemnification is not available to them. The sole purpose of Side A policy is to protect the personal assets of directors and officers and not the corporation. This insuring agreement is the final protection should the company be unable to indemnify its director or officer itself. It’s worthwhile noting that there is no deductible with Side A coverage.

Claims example

The CEO of a company that is at risk of insolvency has to sell the company’s assets to avoid insolvency.

Shareholders allege a breach in fiduciary duty and lodge a claim against the board of directors arguing there was insufficient supervision of the asset sale. Therefore, the director's actions were inadequate in avoiding insolvency.

The corporation is unable to indemnify the board of directors as it is insolvent. Side A coverage would directly indemnify the directors.

Side B Coverage – Company Reimbursement

If the corporation is able to indemnify its directors or officers, then Side B coverage provides the company reimbursement for its expenses in doing so. Side B coverage acts as a form of balance sheet protection to the company. It enables companies to transfer their responsibility for certain liabilities and costs to the insurer under a deed of indemnity between the company, and its directors or officers.

It’s important to note that Side B coverage comes with a ‘deductible’, also referred to as an excess.

Claims example

A disgruntled employee makes a claim against a company officer and effectively sues for alleged misconduct.

The company covers the costs of court proceedings for its company officer throughout the proceeding.

The company then approaches its D&O insurer to reimburse the costs it’s incurred to indemnify its officer. In doing, the company helps protect its balance sheet and is required to pay a deductible as set out in the policy terms and conditions.

Side C Coverage – Entity Coverage

Side C coverage offers insurance protection for the entity’s own liability. Many insurance providers do not offer this cover due to high claims history over recent years.

Australia’s ever-increasing regulatory system, and most recently the unpredictable impacts of COVID-19, have seen corporations operating in an environment with frequent regulatory change and increased regulatory oversight. The rise in Royal Commissions and public awareness has also brought about heightened community scrutiny, which opens more windows of opportunity for claims and investigations brought against not only directors and officers but claims specific to securities law against the company, too.

It’s important to note that the scope of protection that Side C offers is different between policies that are for private companies and those for publicly traded companies.

For private companies, Side C coverage provides entity coverage for lawsuits against the corporation itself. This also includes not-for-profit organisations or strata corporations such as homeowner associations. Publicly traded companies however benefit from Side C coverage’s protections for its own liability arising from securities claims.

Claims example

Consider an organisation that became a publicly listed company and had recently undergone a significant merger by acquiring a smaller competitor.

It becomes apparent to shareholders that there was insufficient communication regarding the merger and investors were not provided timely access to information about the company; information which could have affected its market price or share value.

A class action is raised that alleges the company breached its continuous disclosure obligations and results in a securities claim.

The company would then make a claim under its D&O policy, where Side C would cover the expenses associated with defending itself throughout the class action. This helps protect the entity’s balance sheet.

Directors and Officers Insurance Exclusions

Directors and Officers exclusions can be categorised into two types — Standard Exclusions that are built into the policy wording and Customised Exclusions that are endorsed onto the policy by insurers.

It is crucial to understand your Directors and Officers policy and its specific exclusions. Insurers underwrite all public company Directors and Officers policies, and they will add customised exclusions as they deem fit. It is important to understand what these exclusions mean and if there are any reporting requirements.

There is a list of standard exclusions that you can expect to see on your D&O insurance policy, which may include:

Personal Conduct Exclusion

This exclusion is part of every Directors and Officers policy and excludes dishonest or fraudulent acts committed by an insured. It can extend to exclude intentional violation or breach of law/regulation and unfair profit or gain to which an insured has no legal entitlement. It is worth noting that most policies defend the Directors & Officers until final adjudication.. Policies typically include severability clauses that isolate the Wrongful Act or conduct by one insured so that it is not imputed to other insureds.

Bodily Injury/Property Damage

The policy will not respond to a claim for Bodily Injury & Property Damage claim as this exposure is typically covered by a Public Liability policy.  This exclusion may have a write back (gives coverage back) for Defence Costs, Employment-Related Wrongful Acts and Security Claims.

Prior & Pending Exclusion

Prior & Pending Exclusion excludes cover for any pending or prior litigation involving the Company that has begun before the Prior & Pending date of the policy.

Insured Versus Insured for USA Claims

There are many variations to this exclusion, but the main purpose is to exclude cover for dispute between insureds / the company and an insured in the USA.

Customised exclusions within your D&O policy structure may include:

Future Offering Exclusion

This exclusion states that any future offering of securities is excluded.  There can be amendments to this exclusion to include a threshold and jurisdiction limitation. This is important for the managers of the D&O insurance, as they must notify the broker/insurer to ensure future capital raisings are underwritten and can be covered.

Major Shareholder Exclusion

This exclusion has a threshold for major shareholders (i.e. 10/15/20%) and the policy will not cover a claim brought by a major shareholder against the Directors & Officers. This exclusion may havea requirement that the major shareholder has a holding above a threshold together with a board position to trigger the exclusion.

Retroactive Date Exclusion

This excludes any wrongful act committed or alleged to have been committed prior to the inception of the policy. This is a way for insurers to exclude past acts and make the policy only forward-looking.

Insolvency Exclusion

This exclusion removes any coverage for claims arising out of insolvency. This exclusion can typically be removed if the company shows they are in a good financial position and can internally fund the company’s operations for 12-18+ months.

Political Risks Exclusion

This excludes claims connected with nationalisation of a Company or any part of a Company’s business. It will also exclude the seizure, reversion, appropriation of a company’s assets by a governing body.

Failure to Maintain Insurance

This excludes any claim which alleges the mismanagement of the company’s insurance program.

Professional Services Exclusion

This exclusion removes coverage in connection to the performance of or failure to perform professional services.

Pollution/Environmental Exclusion

This excludes any claim or allegation due to pollution or environmental event.

The complexity, intricacy, breadth and scope of D&O insurance policy structures call for specialist guidance regarding your risk management. At KBI, we have placed Directors and Officers Liability Insurance for over 300 public companies throughout Australia, Asia and North America. Our experience with not-for-profit organisations and private companies is also reputable. We offer tailored D&O insurance policy structures to suit your individual needs.

Allow us to provide some tailored information – obligation-free!

Have any questions?

Talk to one of our D&O Experts today!

*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.

About KBI

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.

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