We are often asked what the difference is between Directors and Officers (D&O) and Errors and Omissions (E&O) insurance for family offices and family business. It can be very confusing as there appear to be subtle differences. The differences lie in management decisions and the impact on stakeholders, as opposed to services that are provided to clients and beneficiaries.
In a family business when multiple generations are involved, it becomes critical to understand the succession plan, who is responsible for the plan’s execution, and what roles and responsibilities exist. In this scenario, it is not uncommon to see an overlap of company executives and family members involved in creating a long-term plan.
The first step is usually hiring tax and estate professionals. However, choosing trustees and service providers to carry out your goals is no easy task. If your choice is an individual rather than an institutional provider, the next step is to find the best person for the job. Sometimes, the best person for the job does not want to take on the enormity of the responsibilities and the personal liability. So, families sometimes must reach out to their second, third, or even fourth choices.
As families evaluate this option, they may look to executives of the family business or consider forming a family office. In this article, we will discuss family offices and the two insurance programs—Errors and Omissions and Directors and Officers—that protect them.
What is a Family Office and What are Their Exposures?
A family office is a private financial services practice that serves a high-net-worth family. Family offices generally focus on tax structures, investment management, and concierge services. They also oversee and execute family wealth management and philanthropic endeavors.
Since family needs and dynamics change over time, an effective family office requires a continuous evaluation of liability exposures. Typically, families that incorporate a family office will hire a CEO and a senior management team to handle these changes. However, just like other directors and officers, people working for family offices can be sued for everything from mismanagement of funds to employment discrimination.
Sometimes family goals and business can become too demanding for management to provide ongoing administration of the family’s affairs, especially if the family business is also the business owner and family’s investment vehicle. Conflicts of interest may arise when employees and the family become investment partners through co-investment opportunities and when choices need to be made between what is best to grow the business versus investment opportunities for the family.
Additionally, this interrelationship can become time-consuming for busy employees who are performing non-employee tasks such as serving as trustees or undefined distribution agents or managing the family’s homes and travel. Some risk is involved for the employee as well. For example, personal liability can ensue if an employee errs in executing a task on behalf of the family, not the business.
What are the E&O and D&O Solutions?
When it comes to protecting your family office from improperly performed services, there are two insurance policies to consider––a Directors & Officers (D&O) policy and an Errors & Omissions (E&O) policy. Both policies protect your business, but they differ in the protections they offer.
D&O and E&O are complimentary insurance policies. One is meant for carrying out management decisions, and the other for the performance of professional services.
What is Directors and Officers Insurance?
D&O insurance is the policy that responds when directors, officers, and trustees of companies are sued in their capacity as directors, officers, and trustees. You could think of it as a kind of malpractice insurance for the management of an entity. These management responsibilities include:
- setting and carrying out the organization’s mission, policies, and procedures
- handling the family wealth transfer vehicle, family business, and budgeting
- setting human resources policies
- adapting to regulatory changes and tax amendments
Claims covered by D&O insurance include:
- employment practices suits
- negligent acts
- unfair business practices
- mismanagement of funds
- release of private information
- investment decisions
- conflicts of interest
What is Errors and Omissions Insurance?
E&O insurance protects management and employees for mistakes made in carrying out their professional duties. For family offices, these professional duties can include management and protection of assets as well as regulatory requirements and service in other fiduciary roles.
Claims covered by E&O insurance include:
- financial damage to a client
- design flaws
- negligence by omissions
Read more about how The Family Office & Trustee Liability Resource Group works with individual and institutional trustees to manage the directors and officers (D&O) liability risks for fiduciaries.
Why Do You Need Both E&O and D&O Insurance?
Let’s explore real estate investing as an example of when you might need both of these protections.
It is common for the first generation of a high-net-worth family to invest directly in real property assets. As the investments grow and become more complicated, these individuals will form an investment vehicle and hire professional management. At some point, the founder may decide that senior management should also benefit from good organizational and operation management. So, the founder structures co-investment opportunities for management to participate in profits and wealth creation.
The first generation then will create wealth transfer vehicles for the next generations. The founder may have grown close to their management team and choose to ask them to serve as trustees for these vehicles. However, when the founder passes away and the trust vehicles become active, management must make some challenging decisions. The team now has a fiduciary responsibility to the beneficiaries for investments, administration, distribution, reporting, and duties to employees, business partners, and customers.
The trustees also have exposure for errors and omissions for the trustee and other potential fiduciary responsibilities such as personal representative, trust protector, and power of attorney. The management team also has personal liability for decisions they make as the investment vehicles’ directors and officers.
Also, as the family accumulates more wealth, the scope of family office services may expand to include strategic, technological, tax, and investments services as well as philanthropic and operational services. Under these circumstances, the family may choose to create a private trust company.
Effective corporate governance may also encompass recruiting outside independent directors for the family office. If the family has a family foundation to carry our philanthropic goals, there may be a board of trustees and a board of directors for the foundation. If there is a private trust company, a third independent board may be established.
Insurance Professionals Can Design Your E&O and D&O Program
Although we used a real estate example, the same issues exist with all family businesses. It is the creations of these various services and boards that highlight the differences between E&O and D&O and why you need them both.
After a complete review of your family office structure and an analysis of services provided to the family and others, your insurance professional can design a combined E&O and D&O program for your family office. It takes expertise to define the definition of professional services and recognize the need for certain endorsements, such as outside directorships, and understand how these policies interact.
The right E&O and D&O policies will protect your employees and management as well as your family assets and your legacy. At Woodruff Sawyer, we know how complicated these decisions can be. Reach out to The Family Office & Trustee Liability Resource Group if you have questions.
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