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Directors and officers liability Insurance (also written "directors’ and officers’ liability insurance"; often called "D&O") is
liability insurance Liability insurance (also called third-party insurance) is a part of the general insurance Insurance is a means of protection from financial loss. It is a form of risk management Risk management is the identification, evaluation, and ...
payable to the directors and officers of a company, or to the organization(s) itself, as indemnification (reimbursement) for losses or advancement of defense costs in the event an insured suffers such a loss as a result of a legal action brought for alleged wrongful acts in their capacity as directors and officers. Such coverage can extend to defense costs arising out of criminal and regulatory investigations/trials as well; in fact, often civil and criminal actions are brought against directors/officers simultaneously. Intentional illegal acts, however, are typically not covered under D&O policies. It has become closely associated with broader management liability insurance, which covers
liabilities Liability may refer to: Law * Legal liability, in both civil and criminal law ** Public liability, part of the law of tort which focuses on civil wrongs ** Product liability, the area of law in which manufacturers, distributors, suppliers, reta ...
of the corporation itself as well as the personal liabilities for the directors and officers of the corporation.


Background

The insurance is closely related to
corporate governance Corporate governance is the collection of mechanisms, processes and relations used by various parties to control and to operate a corporation A corporation is an organization—usually a group of people or a company—authorized by the St ...
,
corporations law Corporate law (also known as business law or enterprise law or sometimes company law) is the body of law Law is a system A system is a group of Interaction, interacting or interrelated elements that act according to a set of rules to f ...
, and the
fiduciary A fiduciary is a person who holds a legal Law is a system A system is a group of Interaction, interacting or interrelated elements that act according to a set of rules to form a unified whole. A system, surrounded and influenced by ...
duty owed to shareholders or other beneficiaries. Under the United States
business judgment rule The business judgment rule is a case law-derived doctrine in corporations law that courts defer to the business judgment of corporate executives. It is rooted in the principle that the "directors of a corporation... are clothed with presumptio ...
, the directors and officers are granted broad discretion in their business activities. In the United States, corporate law is typically at the state level; corporations are often domiciled in
Delaware Delaware ( ) is a state in the Mid-Atlantic (United States), Mid-Atlantic region of the United States, bordering Maryland to its south and west; Pennsylvania to its north; and New Jersey and the Atlantic Ocean to its east. The state takes i ...
(with one estimate at 97% of American corporations domiciled in either their home state or Delaware), due to its developed corporate law and tax benefits. Publicly traded companies are subject to more federal claims, particularly due to the
Securities Act of 1933 The Securities Act of 1933, also known as the 1933 Act, the Securities Act, the Truth in Securities Act, the Federal Securities Act, and the '33 Act, was enacted by the United States Congress The United States Congress is the legislature ...
and the
Securities Exchange Act of 1934 The Securities Exchange Act of 1934 (also called the Exchange Act, '34 Act, or 1934 Act) (, codified at et seq.) is a law governing the secondary trading of securities (stock In finance, stock (also capital stock) consists of all of th ...
.


Corporate indemnification

In the United States, the
articles of association In corporate governance Corporate governance is the collection of mechanisms, processes and relations used by various parties to control and to operate a corporation A corporation is an organization—usually a group of people or a c ...
often includes an
indemnification Indemnity is a contractual obligation of one party (indemnifier) to compensate the loss incurred to the other party (indemnity holder) due to the acts of the indemnitor or any other party. The duty to indemnify is usually, but not always, coextensi ...
provision holding the officers harmless for losses occurring due to their role in the company. The purchased insurance is typically in addition to this corporate indemnification, or reimburses the corporation. In some states corporations may be mandated to indemnify directors and officers in order to encourage people to take the positions and in most cases the corporations have the option to indemnify their officers. However, in certain cases the corporation may be explicitly forbidden from indemnifying such director or officer. Liabilities which aren't indemnified by the corporation are potentially covered by certain types of D&O insurance (particularly Side-A Broad Form DIC policies).


Brief history

The insurance was first marketed in the 1930s by
Lloyd's Lloyd's of London, generally known simply as Lloyd's, is an insurance Insurance is a means of protection from financial loss. It is a form of risk management, primarily used to hedge against the risk of a contingent or uncertain loss ...
but into the 1960s the volume sold was "negligible".Gische DM, Werner ME. (2003)
Directors and Officers Liability Insurance: An Overview
Citing: Joseph P. Monteleone & Nicholas J. Conca, Directors and Officers Indemnification and Liability Insurance: An Overview of Legal and Practical Issues, 51 Bus. Law 573, 574 (1996). and Roberta Romano, What Went Wrong with Directors’ and Officers’ Liability Insurance, 14 Del. J. Corp. L. 1, 21 & nn. 74-77 (1989).
Corporations began to allow for corporate indemnification in the 1940s and 1950s, and the 1960s " merger mania" was followed by costly litigation.Taffae P. (2009)
The ABCs of D&O Insurance Clauses
PropertyCasualty360.com
In the 1980s, the United States experienced a "D&O crisis" along with the overall liability crisis, with increased premiums, reduced availability, and numerous additional exclusionary clauses in the
insurance policy In insurance Insurance is a means of protection from financial loss. It is a form of risk management Risk management is the identification, evaluation, and prioritization of risk In simple terms, risk is the possibility of something ...
. Due to changes in securities laws in the 1960s, the insurance was sold primarily based on the concerns of directors & officers of "personal financial protection" (protecting personal rather than corporate assets), but the coverages have evolved so that personal and corporate indemnification are both considered. The 1995 decision of the 9th Circuit in ''Nordstrom, Inc. v. Chubb & Son, Inc.'' resulted in the emphasis in "Side C" (corporate entity) coverage. The decision resolved an "allocation problem" of how to allocate costs between individual insureds, as the corporation was typically not insured while individuals were. There is no standard D&O form, but each has shared a similar outline. In 2007 Romania changed its corporate law making D&O insurance compulsory. Romania is the only country in EU to make D&O insurance compulsory.


Coverages

Under the "traditional" D&O policy applied to "public companies" (those having securities trading under national securities exchanges etc.), there are three insuring clauses. These insuring clauses are termed: Side-A or "non-indemnified"; Side-B; or "indemnified"; and Side-C; "entity securities coverage". D&O policies may also provide an additional Side-D clause, which provides for a sublimit for investigative costs coverage related to a shareholder derivative demand. In detail, the coverage clauses provide the following: *Side-A provides coverage to individual directors and officers when not indemnified by the corporation as a result of state law or financial incapability of the corporation; however, exclusions may apply if a corporation simply refuses to pay the legal defense/loss of a director or officer, or if a bankruptcy court issues an order preventing such indemnification *Side-B provides coverage for the corporation (organizations) when it indemnifies the directors and officers (corporate reimbursement) *Side-C provides coverage to the corporation (organizations) itself for securities claims brought against it (NOTE: securities claims only coverage applies to publicly traded companies and large private companies; small private companies may be able to obtain broader "entity" coverage) More extensive coverage can be obtained for individual directors and officers under a Broad Form Side-A DIC ("Difference in Conditions") policy purchased to not only provide excess Side-A coverage but also to fill the gaps in coverage under the traditional policy, respond when the traditional policy does not, protect the individual directors and officers in the face of U.S. bankruptcy courts deeming the D&O policy part of the bankruptcy estate and otherwise more fully protect the personal assets of individual directors and officers.


Claims

The types of claims are dependent upon the nature of the company. Directors and officers of a corporation may be liable if they damage the corporation in breach of their
legal duty A duty (from "due" meaning "that which is owing"; fro, deu, did, past participle of ''devoir''; la, debere, debitum, whence "debt") is a commitment or expectation to perform some action in general or if certain circumstances arise. A duty may ...
, mix personal and business assets, or fail to disclose conflicts of interest. State law may protect the directors and officers from liability (particularly exculpatory provisions under state law relating to directors). Even innocent errors in judgment by executives may precipitate claims. The types of claims are dependent upon the nature of the corporation. For public companies, claims are primarily due to lawsuits by shareholders after financial difficulties, with a 2011
Towers Watson Towers Watson & Co. was a global professional services firm. Its principal lines of business were risk management and human resource consulting. It also had Actuary, actuarial and investment consulting practices. In January 2016, Towers Watson me ...
survey finding that 69% of publicly traded company respondents had a claim for a
shareholder A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a Trust law, trust or partnership) that is registered by the corporation as the ...
lawsuit in the past 10 years as opposed to 21% of private companies respondents.Directors and Officers Liability: 2011 Survey of Insurance Purchasing Trends
Towers Watson.
Other claims arise from shareholder-derivative actions, creditors (particularly after entering the zone of insolvency), customers, regulators (including those that would bring civil and criminal charges), and competitors (for anti-trust or unfair trade practice allegations). For nonprofits, claims are typically related to employment practice and less commonly regulatory or other fiduciary claims. For private companies, claims are often from competitors or customers for antitrust or deceptive business practicesD&O Insurance Overview
Boundas, Skarzynski, Walsh & Black LLC.
and one survey of 451 executives found that lawsuits cost an average of $308,475. One relatively neglected area is the personal liability to non-shareholders that directors may face due to
tort A tort, in common law In law, common law (also known as judicial precedent or judge-made law, or ) is the body of law created by judges and similar quasi-judicial by virtue of being stated in written opinions. ' is the most-used legal dict ...

tort
s committed as a result of negligent supervision.


Purchase and application

D&O insurance is usually purchased by the company itself, even when it is for the sole benefit of directors and officers. Reasons for doing so are many, but commonly would assist a company in attracting and retaining directors. Where a country's legislation prevents the company from purchasing the insurance, a premium split between the directors and the company is often done, so as to demonstrate that the directors have paid a portion of the
premium Premium may refer to: Marketing * Premium (marketing), a promotional item that can be received for a small fee when redeeming proofs of purchase that come with or on retail products * Premium segment, high-price brands or services in marketing, ...
. Problems related to income tax liability may come into play when a corporation avoids country specific liability law in order to protect its individual directors and officers through insurance. If the company fails to disclose material information or willfully provides inaccurate information, the insurer may avoid payment due to
misrepresentation In common law In law, common law (also known as judicial precedent or judge-made law, or case law) is the body of law created by judges and similar quasi-judicial tribunals by virtue of being stated in written opinions. ''Black's Law Dictionary' ...
. The "severability clause" in the policy conditions may be intended to protect against this by preventing misconduct by one insured from affecting insurance for other insureds; however, in certain jurisdictions it may be ineffective.


Criminal acts exclusion

Intentional illegal acts or illegal profits are typically not covered under D&O insurance policies; coverage would only extend to "wrongful acts" as defined under the policy, which may include certain acts, omissions, misstatements while acting for the organization. Due to exclusions and as a matter of public policy, coverage is not provided for criminal fraud.


Other exclusions

Directors and former directors may sue the company, particularly given their inside knowledge and potentially large stake in the organization. However, most D&O policies contain an "insured versus insured" exclusion which may prevent any payment in these circumstances. It is intended to prevent collusion, where an insured company could sue a director and collect the insurance money. However, it is possible to "carve out" this exclusion so that it does not apply to certain cases, such derivative actions, receivership trustees, and whistleblower actions. Coverage may be "rescinded" (voided, essentially excluded) in some cases, especially if there is some mistake in the application as to the financial details. Non-rescindable coverage may be purchased in some cases which can prevent this lack of coverage. Also, claims that come about from an issue that was known before the insurance was bought are rejected. If you hide this information, it can make the policy void for non-disclosure.


Motivation and controversy

Directors and officers insurance is provided so that competent professionals can serve as supervisors of organizations without fear of personal financial loss. Directors are typically not managing the day-to-day operations of the organization and therefore cannot ensure that the organization will be successful; further, business is inherently risky. Thus the
business judgment rule The business judgment rule is a case law-derived doctrine in corporations law that courts defer to the business judgment of corporate executives. It is rooted in the principle that the "directors of a corporation... are clothed with presumptio ...
has developed to shield directors in most instances. However, insuring negligence in supervising organizations, or wrongful acts and misrepresentation in financial statements is controversial due to its effect on
accountability Accountability, in terms of ethics and governance, is equated with answerability, blameworthiness, legal liability, liability, and the expectation of account-giving. As in an aspect of governance, it has been central to discussions related to probl ...

accountability
, otherwise known as the
moral hazard #REDIRECT Moral hazard#REDIRECT Moral hazard In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, a ...
problem. In the United States, corporate boards have a "
duty of care In tort law A tort, in common law In law, common law (also known as judicial precedent or judge-made law, or case law) is the body of law created by judges and similar quasi-judicial tribunals by virtue of being stated in written opinions ...
", but if personal financial consequences for violating that duty of care are lacking, the boards may not perform proper due diligence. In the famous case of '' Smith v. Van Gorkom'' (1985), the
Delaware Supreme Court The Supreme Court of Delaware is the sole appellate court in the United States state of Delaware. Because Delaware is a popular haven for Delaware corporation, corporations, the Court has developed a worldwide reputation as a respected source of ...
found a board grossly negligent and therefore liable. The decision created a backlash and a statute change in Delaware which allowed a corporation to amend its charter to eliminate directors' personal liability for violation of the duty of care; a version of this statute has been passed in all states, and most large corporations have such an " exculpatory clause". In some cases scholars propose that the risk of personal liability for corporate officers be increased.Drury LL. (2007)
What's the Cost of a Free Pass? A Call for the Re-Assessment of Statutes that Allow for the Elimination of Personal Liability for Directors
''Tennessee Journal Business Law''.


Empirical research

One empirical study found that increased D&O insurance is associated with reduced shareholder benefits from mergers & acquisitions.


Monitoring role

Since insurance companies ultimately bear costs for negligent management, theoretically insurance companies may enforce better management practices and reduce moral hazard. Empirical research, however, has not found that insurance companies perform effective monitoring of management.


Berkshire Hathaway

Berkshire Hathaway Berkshire Hathaway () is an American multinational Multinational may refer to: * Multinational corporation, a corporate organization operating in multiple countries * Multinational force, a military body from multiple countries * Multinational ...

Berkshire Hathaway
, the holding company managed by
Warren Buffett Warren Edward Buffett ( ; born August 30, 1930) is an American business magnate, investor, and philanthropist. He is currently the chairman and CEO of Berkshire Hathaway Berkshire Hathaway () is an American multinational Multinational may ...
, does not purchase D&O insurance for its directors, unlike most similar companies. Warren Buffett believes that the directors should face consequences of their mistakes the way that other shareholders do. Notably, however, this statement overlooks the holding-company structure of Berkshire Hathaway, auxiliary indemnification agreements with Buffett, and the individual operating companies may still purchase such insurance.


Market size and vendors

In the United States, total direct premiums written amounted to about $2.9b from 2013 to 2014, with
Axa XL Axa XL is an American subsidiary of global insurance and reinsurance company Axa. It is headquartered in Stamford, Connecticut, domiciled in Hamilton, Bermuda, and has more than 100 offices on 6 continents. In 2016, the company wrote $13.890 bil ...
as the market leader with 15% market share according to analysts at Fitch Ratings. The leaders in the provision of Directors & Officers Liability Insurance include:
Axa XL Axa XL is an American subsidiary of global insurance and reinsurance company Axa. It is headquartered in Stamford, Connecticut, domiciled in Hamilton, Bermuda, and has more than 100 offices on 6 continents. In 2016, the company wrote $13.890 bil ...
,
AIG American International Group, Inc., also known as AIG, is an American multinational finance and insurance corporation with operations in more than 80 countries and jurisdictions. , AIG companies employed 49,600 people.Chubb Limited Chubb Limited, incorporated in Zürich, Zürich, Switzerland, is the parent company of Chubb, a global provider of insurance products covering property and casualty, accident and health, reinsurance, and life insurance and the largest publicly trad ...
, Tokio Marine HCC,
The Travelers Companies The Travelers Companies, Inc., commonly known as Travelers, is an American insurance company. It is the second-largest writer of U.S. commercial property casualty insurance, and the sixth-largest writer of U.S. personal insurance through independ ...
,
CNA Financial CNA Financial Corporation is a financial corporation based in Chicago, Illinois, United States. Its principal subsidiary, Continental Casualty Company (CCC), was founded in 1897. CNA, the current parent company, was incorporated in 1967. CNA is t ...
,
Berkshire Hathaway Berkshire Hathaway () is an American multinational Multinational may refer to: * Multinational corporation, a corporate organization operating in multiple countries * Multinational force, a military body from multiple countries * Multinational ...

Berkshire Hathaway
, Sompo Group via
Sompo Japan Nipponkoa Insurance , formerly NKSJ Holdings and , is a Japanese insurance Insurance is a means of protection from financial loss. It is a form of risk management Risk management is the identification, evaluation, and prioritization of risk In simple t ...
, among many others. In the United Kingdom, the majority of contracts are facilitated on behalf of policyholders by intermediary brokers.


External links


The ABCs of D&O Insurance Clauses


References

* Bandle, L'assurance D&O (with English and German abstract), Lausanne, 1999 * Mannsdorfer, Die sonstigen, uebrigen oder allgemeinen Bestimmungen in der D&O-Versicherung (with German and French abstract), HAVE 3/2010, 222-247 {{DEFAULTSORT:Directors And Officers Liability Insurance Corporate directors Liability insurance Types of insurance