What Should a D&O Policy Cover?

Grey Swan,

A 2012 PriceWaterhouseCoopers whitepaper on risk practices talks about the increasing frequency of black swan events, those catastrophic events that catch us by surprise. “By their nature, black swan events should only occur at unprecedented intervals. Yet recent experiences suggest that events that fit the definition of black swans are happening more and more frequently. So, are black swans actually turning grey?” Is the unthinkable now not only thinkable, but part of the landscape? It is these types of events for which Directors and Officers (D&O) insurance is designed. Will they happen? Hopefully not. But luckily, D&O insurance covers more than hope does.

What You May Not Be Getting with Your Current Policy

For the past five or six years, we’ve been in a soft market. Usually, these ebb and flow, but we’re still in the thick of it. What this means for policy purchasers, though, is that prices are very low. How could this be anything but good? The issue is that the policies tend to be very broad. Coverage has expanded so much that you cover a number of interests under one policy. For instance, you’ll have directors, officers, independent directors, internal management, and the company at-large all sharing one limit.

This is one of those things that’s not a problem until it is. If there are multiple actions, investigations, and perhaps criminal charges, potentially in multiple jurisdictions at the same time, coverage can be pulled too thin. Sino Forest, for instance, is facing an OSC investigation, criminal charges, and class actions in several different jurisdictions. The company is named, as are independent directors, management, and other parties, but from public reports it appears that there is only $60 million in policy proceeds. How is that policy going to respond? How will it handle multiple demands from multiple interests? Are the “black hats” going to eat up all the proceeds, leaving the “white hats” with nothing? These are questions you don’t want to find answers to as you’re going through investigations and litigation.

What You Should Be Getting from Your D&O Insurance

Before you select a policy, consider the following:

  • Why are you are buying this insurance?
  • Who do you want to protect?
  • How do you best structure that program to fill your needs?
  • What is excluded?

Here are the quick broad strokes: D&O covers criminal, civil, regulatory, and administrative proceedings that occur as a result of:

  • Misstatements
  • Neglect
  • Breach of duty
  • Errors
  • Omissions

The first layer of protection for directors and officers is indemnification from the company through a written agreement, bylaws, or the articles of incorporation. The company indemnifies them in instances when they are forced to incur expenses because of their capacity as director or officer.

So, what if there is no indemnification available from the company? For example, what if the company is in bankruptcy or CCAA? In those cases, it cannot indemnify its directors and officers. In this case, the D&O policy can be the first to respond and it may well be the only protection available before the individuals’ personal assets are exposed. But even then, there may not be enough coverage available to meet all the insureds’ exposures. To meet this risk, individuals can purchase a Side A Differences in Conditions policy (a “DIC”). This can be bought for just a small group of interests or stakeholders. For instance, you might cover only independent directors.

If there is no indemnification available from the company, and the underlying insurance is exhausted, the DIC would come into play. But Differences in Conditions means that it could also drop down and provide protection even if the underlying policy isn’t exhausted. So in some cases the DIC can provide broader coverage than the primary policy.

Everyone fears the black swan event; that single cataclysmic event. But what about the flock of grey swans that are gliding in the background? It is against these that D&O insurance guards. It is essential to know what your policy covers – and what it does not.


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Grey Swan

Grey Swan provides specialized independent insurance advice delivering a focused perspective to clients that is based on the over 25 years of insurance industry, legal, and claims experience that our founder brings to the table.

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