How does Directors and Officers (D&O) insurance work?
Directors and Officers insurance is becoming more and more prevalent these days as a necessary protection for companies and their management. Quite often, I am asked how the coverage works. Since a full explanation is pretty detailed, this post will give a broad, detailed response.
Directors and Officers insurance protects the management of a company against a broad array of potential claims. If an act should occur that triggers one of these claims, what happens next? How does the coverage kick in? To answer this we need to look into the different parts that make up a D&O policy. Most every policy begins with three main parts known as Side A, Side B and Side C. These components determine which part of the coverage would be responsible to pay for defense and damages when a claim comes to bear.
Side A D&O Coverage
Side A coverage of a directors and officers insurance policy is the component of the policy that will indemnify a director or officer when the company cannot cover such an officer for defense and damages. This is especially important to directors and officers because a situation such as this puts their personal assets at risk.
Nine times out of ten, a company will cover costs to defend company officers if a claim is levied and needs to be defended. If the suit is lost, the company will cover the damages….nine times out of ten. But what if there is a situation where the company can’t indemnify an officer in this situation? A common cause of this is bankruptcy. If a company goes belly up and there is a claim against an officer of that company, how would that officer be indemnified? The answer is he or she wouldn’t.
This is where Side A coverage would kick in. Since the director or officer would not be indemnified in certain scenarios, the Side A coverage steps into the gap in order to cover defense costs and potential damages for which a director and officer would be liable. In absence of such coverage, if the company is not in a position to indemnify, the officer is on the hook for defense and damages costs.
Side B D&O Coverage
Side B coverage of a directors and officers insurance policy is the component of the policy that will indemnify a company when such a claim arises. As mentioned, nine times out of ten a company will defend and indemnify a director or officer if a claim is filed. If a company indemnifies a director or officer once a claim is defended and damages paid, there are substantial costs associated with defense and damages that the company has to cover. So where does that leave the company? This is where Side B of the Directors and Officers policy comes into play.
Side B does not cover directors and officers personally. Side B covers the company in the event that the company is picking up the tab for defense and damage costs associated with a suit brought against that company’s directors and officers. This is how a company gets made whole.
Side C D&O Coverage
Side C of a directors and officers insurance policy is the part of the coverage known as ‘Entity Coverage’. Entity Coverage covers a company should a company been involved in a claim along with its directors and officers. Often if a claim is made against a director of officer of a company, that company will be named in the suit as well.
Side C covers the firm’s liabilities in such a scenario. This is opposed to Side A or B where the liabilities of the director or officer is taken into account.
Retention is just another word for deductible. A retention amount will typically be assigned to Sides B & C ranging from $5k to $25k. The choice of retention is up to the company and will affect the premium amount for the company. The higher the retention, the lower the cost. In the event of a claim, the retention becomes the company’s responsibility after which the insurance kicks in.
In most cases, Side A coverage will have a $0 retention. The rationale behind this is that Side A is the part of the coverage that covers directors and officers personally when a company does not provide cover. Because of the personal cost nature of Side A, a large retention such as $25k becomes unaffordable. Hence, Side A coverage is typically first dollar coverage (or $0 deductible).
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