Directors and officers liability (D&O) insurance is a fundamental component of any company’s risk management program. A lack of D&O insurance may dissuade talented individuals from seeking an executive position at your company, as they don’t want to put their personal assets at risk in the event of a lawsuit.

As a savvy business owner looking to protect your bottom line, how do you weigh the cost of insurance to protect your senior leadership with the potential risk of a lawsuit? As regulatory investigations and defense expenses increase, prices for D&O insurance have gone up as well. Corporate indemnification provides the first line of liability protection; but certain circumstances—most notably, if the company goes bankrupt—necessitates that additional protection is offered to directors and officers.

A variety of factors determine the price of a company’s D&O insurance. Some low-risk companies pay pennies on the dollar; others pay a lot more, but they understand it’s a lot less than the expenses they’d incur in a lawsuit. Recognizing the cost drivers of D&O insurance—a company’s exposures, legislation and trends in D&O lawsuits—can help you decide what coverage your company needs to mitigate its unique exposures.

Current and New Legislation

Securities Exchange Commission (SEC) regulations continue to impact the cost of D&O insurance. Publicly held companies especially must be cognizant and keep current on SEC disclosure obligations and provisions in the Sarbanes-Oxley (SOX) Act of 2002, which was enacted in response to the corporate scandals of Enron, Tyco, WorldCom and others.

Also recent changes to the Dodd-Frank Wall Street Reform and Consumer Protection Act have caused a spike in whistleblower reporting, bringing to light many D&O claims and increasing the need for D&O insurance. The new whistleblower provision in the Act now gives whistleblowers a “bounty,” or monetary compensation, if the lawsuit results in more than $1 million in monetary sanctions. Given this new incentive, there has already been an increase in the number of whistleblowers that have emerged since the Act added the provisions in early 2011.

 Trends in D&O Lawsuits

Even after a thorough assessment of a company’s risks, D&O insurance continues to be a high-severity product, as carriers are often hit unexpectedly with catastrophic claims. It’s no surprise that as litigation increases, the price of D&O insurance increases as well. In addition, as the litigation process grows lengthier and if multiple lawsuits erupt from a single transaction, a company can quickly exhaust its primary layer of D&O coverage.

Some types of lawsuits occur less often, but result in catastrophic losses. Other types result in smaller payouts, but occur more frequently. Nonetheless, defense expenses can cost millions of dollars, even if the director or officer is not found liable. Some of the types of lawsuits that affect directors and officers include the following:

• Breach of fiduciary duty lawsuits
• Employee Retirement Income Security Act (ERISA) lawsuits
• Employment-related lawsuits
• Mergers and acquisitions (M&A) and “merger objection” lawsuits
• Securities class-action lawsuits
• Shareholder derivative suits

Within the last few years, there has been an increase in M&A lawsuits. In 2014, there were more than 600 lawsuits regarding M&A. Some M&A cases involve multiple lawsuits and a lengthy litigation process, which can deeply cut into a company’s primary D&O policy.

Know What Your Policy Covers

While many companies usually focus on the cost of their D&O policy, understanding the scope of the policy is even more critical. Most D&O policies are renewed yearly, and the terms and conditions can change. Read through your policy carefully. Be aware of the following:

• Look at the limits of your liability. Are they enough to cover your exposures? Companies with a lot of risk exposures usually find that they need more than just the primary coverage, and purchase excess insurance as well.

• Be aware of exclusions; most D&O policies do not cover claims that arise from fraudulent or criminal acts.
• For some insurance carriers, Employment Practices Liability (EPL) insurance and Fiduciary Liability insurance are policies that are purchased separately from primary D&O insurance. Don’t assume they are automatically included in your D&O policy.

For more information on D&O coverage options for your company, contact Clarke & Sampson, Inc. today at 703.683.6601