Should my business buy directors and officers insurance, what does it cover and what does it cost?
Some business executives believe that this type of policy, called D&O for short, is only for publicly traded companies. Not true. Although privately held businesses don't risk exposure to securities class action suits, a business doesn't have to have shareholders in order for its directors and/or officers to be personally sued. It really depends on if you have relationships with vendors or customers, or if you intend to seek venture capital funding or other financial investors. These are all external exposures for which business executives can be held accountable. Second, some smaller business executives believe that their general liability or umbrella business insurance policies will cover claims involving directors and officers. The general liability or umbrella policies don't respond to management liability lawsuits.
Third, some business executives believe that D&O policies are only for large companies. Not true, again! A business of any size will usually have officers and possibly directors who can be targeted by litigants over their management of company affairs. Many insurance companies now offer small business executive liability coverage starting at $1,500 per year to protect directors and officers. That's small change to protect against a potential six- or seven-figure settlement.
D&O liability insurance protects corporate directors and officers in the event they are personally sued -- often in addition to the company being sued -- by investors, employees, vendors, competitors, and customers, among other parties. The insurance protects directors and officers by covering legal fees, settlements, and other costs; in addition, the coverage sometimes can extend to protect the company if it is named in a suit, as well.
In many cases, when you appoint directors or hire new officers they will demand D&O coverage as a condition of serving or employment because they don't want to put their personal assets at stake. Sometimes outside investors, such as venture capitalists or other financiers, will require D&O policies before providing funding to your business -- they often see the coverage as a way to protect their investment.
Directors and officers are sued for a variety of reasons connected with their company positions, including misuse of company funds, misrepresentation of company assets, fraud, failure to comply with workplace laws, and lack of corporate governance among other issues.
One in six company executives -- or 17 percent -- believe their business will experience a D&O related loss in the next year, according to a survey of decision-makers at 451 U.S. companies, more than 90 percent of which had annual revenues of less than $25 million. The survey, sponsored by Chubb, found that one in eight survey respondents -- or 12 percent -- had experienced a D&O lawsuit within the past five years. The costs to settle and/or litigate those cases averaged $225,682, with some losses approaching $5 million, the survey found.
Bankruptcy is one of the leading causes of loss for a business -- and one of the leading causes of D&O lawsuits. A bankruptcy can spark litigation against directors and officers from creditors, lenders, customers, as well as investors. Even if a company doesn't go bankrupt and just needs to downsize, employee layoffs may still prompt claims personally targeting directors and officers, in addition to the business.
The cost of D&O insurance is based on a variety of different factors, but smaller private companies are considered low-risk by underwriters and could pay as little as $500 per year per million in premiums. On the other hand, large publicly traded companies are usually considered high-risk and can pay from $10,000 to $30,000 per million in annual premiums.