The Purpose of Directors and Officers Liability Insurance – FAQ

Many consider directors and officers to be untouchable entities that have complete power over the operations of a company. You’d think that whatever happens in the company, the upper management will never be held responsible. However, in reality, directors and officers are the part of the company that’s most likely to be targeted by costly lawsuits arising from a decision or action they have made, regardless of how innocuous it may have seemed at the time.

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Considering this, companies should protect their management with the right type of insurance. The main purpose of directors and officers liability insurance is to provide protection to corporate directors and officers if they’re personally sued for actual or alleged wrongdoing when managing a company. This type of insurance will cover defence costs and damages that occurred as a result of wrongful act allegations and lawsuits.

Directors liability insurance offers financial support for a standard indemnification provision (the hold harmless provision). It moves potential costs from directors and officers for losses linked to an action they took on behalf of the company. The coverage pays the organisation when it indemnifies the individuals and also provides ‘entity coverage’, which reduces disputes of coverage allocation in case the directors and officers and the insured organisation are named in the same lawsuit.

Here’s a quick look at why having a comprehensive officers and directors liability insurance is important and some of the most frequently asked questions regarding the policy.

Understanding D&O

Directors and officers liability insurance applies to any person who is a director or an officer of a business for-profit or nonprofit organization. A directors and officers liability policy provides coverage for personal losses, and can also help compensate a business or nonprofit organization for the legal expenses or other expenses incurred in defending these people against lawsuits.

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Directors and officers liability insurance claims are paid to directors and officers of a company or organization for losses or payment of defence costs if they’re facing legal action. This coverage can increase to criminal and regulatory investigations or trial defence costs. Civil and criminal actions are often taken against directors and officers together. Most policies have “insured vs. insured” clauses, in which the insurance company won’t pay any claim when current or former directors and officers sue the company. This prevents the company from profiting from fraud or conspiracy.

D&O policies come in different forms. This mainly depends on the nature of the organisation and the risks it faces. It’s best to seek out an insurance company with rich experience in this field. You can also consult with an insurance broker who can evaluate your options and help you get the best insurance deal.

If a company doesn’t reveal material information or willfully gives inaccurate information, the insurer may decide to deny the payment because of misunderstanding. The policy has a “severability clause” that can prevent the wrongdoing of one insured from affecting the insurance for other insureds.

What Risks Does a Directors and Officers Policy Cover?

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If you’re a business leader, you can be held responsible for various corporate issues. These are the most common claims that directors and officers can face against which a D&O policy can offer protection:

  • Poor corporate governance;
  • Stock underperformance;
  • Failure to comply with laws and regulations;
  • Making a decision without the required authority;
  • Employment practices and HR issues;
  • Cyber liability.

Which Businesses Require This Type of Insurance?

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It’s a mistake to believe that D&O claims are only impacting public and big-scale companies. In fact, all organisations, no matter if they’re private, non-profit, or public and the people who lead them are exposed to D&O claims. The costs linked with lawsuits from these exposures are so big, that D&O insurance is a must-have requirement for many businesses. Organisations that aren’t getting this coverage risk bankruptcy or losses from which they will not recover easily.

A company doesn’t have to have a large amount of revenue for the directors and officers to be personally sued because of their management of company operations. Even smaller businesses with fewer assets may need protection just as much as any large corporation.

What Happens If a Claim Is Made After a Director Stops Holding Office?

According to the Australian Institute of Company Directors, the director or officer may be held at fault even after they stop holding office. It’s essential for companies to keep D&O insurance for previous directors. If the D&O cover is not maintained, a former director may be left without any support against a policy for claims occurring after they cease to hold office. In best cases, the D&O insurance policy should include ‘run-off cover’. This cover is used after a director ceases to hold office. In Australia, the duration of run-off cover should last at least for seven years.

Why Is D&O Insurance in High Demand?

Today, employees know their rights more than ever before. A director or an officer should keep in mind that these people are no longer afraid to use them even if that means seeking legal help for a class action lawsuit. Active investors can also hold business leaders accountable for their actions to improve practices and have strong, profitable businesses.

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The awareness of international laws and regulations like the strict data protection laws slowly grows around the world. This makes it even more important for businesses to purchase D&O insurance. The management can be held accountable for a company’s failure to comply with laws and regulations.