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D&O Insurance 101: Policy Terms
Priya Cherian Huskins, Esq.
Apr 21, 2021
If you’re on the board of a private or public company, you could be personally liable for defense and settlement costs as a result of lawsuits for claims made against you. That is, unless you have the proper coverage in place through your insurance risk management program.
All too often, however, the only thing standing between directors and officers and a massive personal financial hit is a directors and officers (D&O) insurance policy. Getting the right D&O insurance can be challenging. D&O insurance policies are highly negotiated instruments. There isn’t a one-size-fits all form, and it takes expertise to negotiate these highly specialized policies.
What’s more, companies are facing climbing D&O insurance premiums and need the best advice on how to get the coverage they need in this tough market.
In this post, I’ll talk about some of the general terms and conditions to be aware of in D&O insurance policies, starting with the structure of a D&O policy.
D&O Insurance Policy Structure: Side A, Side B and Side C
A typical D&O insurance policy is divided into three insuring agreements: Side A, Side B, and Side C—all of which share the same single policy limit.
Side A
Side A is the part of a D&O policy that responds when a company is unable to indemnify its directors and officers; this is referred to as the “personal protection” part of a D&O insurance contract. A common example of when this insuring agreement would respond is when a company goes bankrupt. This part of the insurance policy should pay on a first-dollar basis, that is, there should be no self-insured retention (similar to a deductible).
Side B
Side B is the part of the D&O policy that reimburses a company for its indemnification obligation to its directors and officers. This part of the insurance policy is generally subject to a self-insured retention or deductible. Side B responds most commonly in the majority of claims brought against directors and officers.
Side C
Side C of the D&O policy, also known as “entity coverage,” ensures there is corporate coverage whenever the corporation is sued along with the directors and officers. For public companies, it only responds to securities claims; private companies enjoy a broader coverage grant.
Like Side B, Side C is typically subject to a self-insured retention or deductible. Side B and Side C coverage together are often referred to as “balance sheet protection” for a company.
Standalone Side A
Standalone Side A is the type of D&O policy that only provides Side A coverage. When well brokered, it provides broader coverage than the Side A typically found in a combination ABC policy, meaning that the policy will have fewer exclusions compared to a typical ABC policy.
For this reason, this type of Side A policy is also referred to as a “Difference-in-Condition” (DIC) policy. Many companies will structure their insurance program to include a combination of regular ABC insurance policies and Side A-only policies.
Why have both? The traditional reason concerns bankruptcy. The concern is that directors and officers with only an ABC policy may find themselves without insurance coverage if their company ends up in bankruptcy.
If a company goes bankrupt with a D&O policy that includes Side C coverage (and perhaps Side B), a bankruptcy trustee might attempt to seize the insurance policy proceeds for the bankruptcy estate, leaving the directors and officers without coverage. The argument for seizure by a trustee of a standalone Side A policy is much weaker since this policy provides no corporate balance sheet protection.
When companies are doing well, bankruptcy feels like a remote concern; however, an increasing number of well-capitalized companies are purchasing at least a small amount of standalone Side A coverage in addition to regular ABC D&O policies because:
- They regard it as a risk management best practice.
- They value the broader coverage that standalone Side A policies can offer compared to the Side A portion of a regular D&O policy.
- The standalone Side A policy can respond with first-dollar coverage in some cases, including if a company refuses to indemnify a director or officer. Without standalone Side A protection, if a company were to refuse to indemnify a director or officer for an indemnifiable claim, the individual may have to pay the Side B self-insured retention before the insurance policy would respond. This is potentially a big exposure; the retention could be hundreds of thousands or even millions of dollars.
For more on how the different parts of a D&O insurance policy may respond to various common types of litigation, it may be useful to refer to this article that lays out a variety of typical litigation scenarios.
Key D&O Insurance Exclusions
A policy exclusion removes a claim from the scope of the policy’s coverage. Many of these exclusions are negotiable. Here are a few key exclusions to consider:
Intentional fraud: While insurance carriers typically cannot insure for these types of claims (for more on this see a 2021 Delaware Supreme Court decision), the negotiable aspect is the point at which such conduct becomes excluded.
If the conduct can only be excluded after a final adjudication of fraudulent conduct, then an insurance carrier will advance all defense costs until the final settlement is made. This is clearly better for an insured director or officer than if the exclusion could be triggered earlier in time.
Insured versus Insured: This is a common exclusion in private company policies. If the biggest threat of litigation for your private company is that of directors and officers bringing claims against one another, take note that a private company D&O insurance policy is probably not going to respond. This is the “insured vs. insured” exclusion.
However, you can negotiate the exceptions—that is, the “carve backs”—to the exclusions. An important carve back here is the number of years a director or officer is separated from the company before the exclusion no longer applies.
For example, the policy could say that the exclusion no longer applies if the if the director or officer in question sues other directors and officers more than two years after separating from the company.
Public policies typically do not have this exclusion for natural persons suing one other, but are likely to have an “entity versus insured” exclusion, meaning there is no coverage if the corporate entity sues an individual director or officer.
Additional Protections Through Insurance
D&O insurance is just one of a number of insurance policies that corporations should consider a part of their insurance risk management program. For example, when it comes to mitigating risk for directors and officers, employment practices liability insurance and fiduciary insurance are key (the latter responds when individuals are accused of wrongdoing in their capacities as fiduciaries for ERISA and other similar plans).
Other policies may be just as important, for example, cyber liability coverage, business interruption coverage, property insurance, and so on. Part of creating an overall insurance risk management program for a company is balancing where you will spend your insurance dollars.
For more on the topic of D&O insurance, check out our D&O insurance guides for both private and public companies:
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