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7 steps how to get the most out of your D&O policy

Topic Featured News

directors & officers policy

In order to be successful, organizations must navigate the evolving risks and opportunities in today’s world. Business and economic transformation, digital revolution, rising geopolitical tensions, climate and environmental disruption, and changing social attitudes are producing a world in constant flux.

As organizations face increasingly turbulent times, scrutiny of the decisions made by directors and officers is intensifying. Directors and officers need to guide their businesses through this ever-changing landscape and any false move can lead to accusations of mismanagement. Even if the board has done nothing wrong, refuting accusations or responding to regulatory inquiries can take up management time and result in unexpected legal bills.

Although risk and insurance professionals should consider how they can contribute to and lead efforts internally to mitigate these risks, understanding and purchasing appropriate D&O insurance and making use of it effectively can be an invaluable tool to protect the directors and officers of the company.

*Some of the information presented below is based on a survey AIG conducted in cooperation with the British insurance and risk management association Airmic and the thought leadership agency Longitude. The survey results are based on answers provided by 157 respondents who primarily work within risk and insurance management and enterprise risk management functions at large multinational businesses. Read the full report here.

Step 1: Understand the coverage and processes

Only 18% of the survey respondents believe their directors are aware of their personal liabilities, and only 14% are confident that their directors have read and understood their D&O policy. This suggests a perception of complacency within the boardroom that an investigation or action will not happen to them.

If directors and officers do not fully understand the liabilities they face and the events that can lead to claims, then it is unlikely they will be prepared to respond appropriately when an action actually develops. It is essential that directors and officers are fully aware of the notification process to follow with any type of claim or circumstance that might give rise to a claim. As such, all named directors and officers in a policy should be fully aware of the coverage they have and the process to follow in the event of an action.

Step 2: Ensure sufficient limits for all defense costs

The costs associated with an investigation and prosecution can be hard to predict but will quickly escalate as lawyers are retained. The individuals concerned will want to retain the best defense lawyers possible in the event of a prosecution. Depending on the subject matter of the prosecution, a specialist lawyer may be required. In fact, defense costs can rise up to hundreds of thousands of euros per director or officer, and in some instances the costs are even higher.

The D&O risks facing small-to-medium enterprises (SMEs) may sometimes be overlooked, but they are no less important for the survival of the business. SMEs should not underestimate the cost of defending a claim or responding to an investigation. When purchasing D&O insurance, 1 million euros in costs may sound like a lot of money, but if several directors and/or officers are subject to a criminal investigation, then it is unlikely to be enough to cover all the defense costs.

Today, defense costs are particularly expensive in territories one might expect, such as the US and the UK. However, costs can also be eye-wateringly high in territories that boards may not be as focused on, such as South Korea and India. Accordingly, these trends should be monitored across the organization’s footprint.

Step 3: Determine your strategy when buying a D&O policy

A traditional D&O policy will provide cover for non-indemnifiable loss for directors and officers (Side A), indemnifiable loss (Side B) and sometimes loss to the company itself for securities claims (Side C). If an action takes place that results in Side B and Side C losses, it is possible that the limits will be exhausted before covering any potential Side A losses. As a result, Side A difference-in-conditions (DIC) can be bought to provide additional limits to named individuals and sit on top of the traditional D&O policy.

Noona Barlow, Head of International Financial Lines Claims at AIG, says: “Buyers need to determine their strategy and priorities when buying a D&O policy. Some buyers will prioritize balance sheet protection in the event the company is sued. Some companies will only buy Side A or treat it as only Side A for the main board in a catastrophic event. Identifying and communicating the strategy from the beginning will avoid confusion when a claim arises.”

Step 4: Keep the insurer in the loop

In most D&O policies, the insurer’s consent is required before lawyers are retained by the company or an individual director or officer. If the insured does not follow this process, then it risks the insurer declining to cover these defense costs, when coverage may have been available if the correct protocols had been followed.

Moreover, most companies will not have experience in handling a D&O claim. A knowledgeable D&O insurer will have extensive experience with D&O claims, including which legal advisors can assist the best with specialist claims. Hiring the wrong advisor early in a case can increase the overall cost and prejudice possible defenses.

Step 5: Understand what a D&O policy pays for

In the UK and Europe, D&O insurers typically pay out more in defense costs for directors and officers than they do for settlements or indemnity payments, but our survey shows more than half of respondents did not know this.

In the US, the majority of large claims payments result from securities actions which will often lead to a settlement. D&O policies generally provide broad coverage that ensures defense costs are paid in full until the limit is exhausted, or the director or officer admits fraud or is found guilty. At that point, coverage will end. 

Step 6: Collaborate to understand the risk profile                                           

While risk professionals need to consider and assess the exposures facing their organization’s directors and officers, it is only through collaboration with the board and C-suite that they will fully understand the risk profile.

When buying coverage, those directors and officers likely to be the subject of claims under the policy should be involved in the risk strategy and risk mapping process. This will ensure that all stakeholders relevant to the policy will have an early insight into the types of coverage available, and what may be excluded.

Step 7: Review policies and anticipate new threats

The organization’s D&O risks and the policies bought to protect directors and officers should be reviewed each year. As a part of this process, the legal environment, regulatory change and claims activity in the countries in which they operate should also be assessed to gauge trends and the priorities of national governments and law enforcement agencies. It is not uncommon for the regulatory environment to change and a country that was previously passive on D&O scrutiny to become more aggressive.

It is more important than ever that risk professionals fully understand the relevant risks to their directors and officers, and ensure the right protocols are in place for good corporate governance that can prevent a claim. Providing ample and accurate information on the evolving exposures, as well as compliance procedures, to directors and officers would help elevate understanding. Issues to be covered could include anti-money laundering protocols, insider trading policy, and bribery and corruption training.

Key takeaways

  • Identify and review regularly the personal liability faced by the organization’s directors and officers
  • Engage the C-suite and the board from the beginning on D&O risk assessment and insurance design and purchases
  • Design and communicate a clear notification and claims management process in the event of a claim
  • Review the risk profile, notification process and coverage as directors and officers change