D&O Insurance Guide

D&O insurance - Summary

D&O insurance covers the directors and officers of the company against lawsuits that claim financial injury as a result of mismanagement. A company pays for this coverage, so competent professionals can serve confidently as leaders of their organization without fear of personal financial loss.

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What you’re buying

In the event of a claim against the directors and officers, the insurance carrier will help navigate the lawsuit, negotiate settlements, and cover expenses. Ultimately, this means significant savings of time and money.

What it looks like in real life 

What D&O insurance doesn’t cover

Lawsuits between directors and officers within the company are typically not covered; this prevents collusion against the insurance company. Likewise, if a director or officer is found guilty of fraudulent acts, defense costs are provided until final judgment proving guilt. However, if the executive IS found guilty of fraud, they would be required to repay all defense costs.

What happens with a D&O claim: the details matter

Let’s assume you’re the CEO of a SaaS company. A few years into starting your business, an early investor sends you a letter in the mail demanding you return their $800K investment in your company, citing that you (1) misrepresented the existence of potential key partnerships and, (2) breached your contract of employment by not securing key partnerships.

The lawsuit rests on the investor’s claim that the failed partnerships would have helped net a large ROI after the sale of intellectual property and was the main driver for their investment in the company, and selection of that particular CEO. While the lawsuit may be groundless, the time and expenses required to fight the allegations are likely a substantial distraction for the company. 

Call your broker, not your lawyer

Your gut reaction may be to call your personal attorney and start drafting a response and legal plan of action. The right thing to do is call your broker and submit a claim because legal costs are only covered after you submit a claim to the insurance carrier and get their pre-approval for those expenses. This is where the policy detail notification impacts the claim process.

Notification defines the process of notifying the insurance company about a claim, specifically who has knowledge of the claim, and the timeline for notifying the carrier. A good policy limits knowledge of claims to the C-Suite and provides reasonable timelines for reporting so payments aren’t denied for “late” notice. 

Submit your Claim

You call your broker and start putting together a claim submission. A good broker will support you through the claims process. You package the plaintiff's demand letter and any other relevant materials to present a high-quality claim submission. 

Your carrier assigns an adjuster to review the details of the claim and policy, and the assigned adjuster meets with you and your broker to discuss the full story. While discussing the claim, you begin learning the policy details defining what’s really covered throughout the legal process. This is where the policy detail duty to defend impacts the claim process.

Duty to Defend defines the insurance carrier’s responsibility to defend the company’s directors and officers from lawsuits, even if they are groundless. For smaller and mid-size enterprises, this is almost always preferable to non-duty to defend, because defense costs are covered, settlements are efficient, and offloading this to the carrier saves a great deal of time.

You also discover that while the first allegation — (1) misrepresentation of key partnerships — is covered by your policy, the other allegation — (2) breach of contract, which claims the CEO was in breach of an implied contract because he was hired for key partnerships he did not end up delivering — is NOT covered by D&O insurance! It's quite common that there are multiple allegations in a single lawsuit, and this is where the policy detail allocation impacts the claim process.

Allocation defines the percentage of settlement and defense costs the carrier will cover in the event that a claim has some allegations that are not covered by the policy. A good policy will provide 100% defense costs allocation. In this case, the insurance company would pay all defense costs even though only one of the two allegations are covered by the policy. Without 100% defense cost allocation, the carrier may only pay a portion of the defense cost, leaving you to pay the remainder of the legal costs and settlements.

Start your Legal Plan

Now that you know your carrier is defending you and covering all the legal expenses, it’s time to select your legal team and start taking action. This is where the policy detail selection of counsel impacts the claim process.

Selection of Counsel defines who — you, the carrier, or both — gets to pick the law firm to represent you against the early investor. A good policy will allow you to select the counsel. This helps avoid potentially frustrating situations where the carrier chooses a legal counsel that you and your company feel is under qualified to represent the company.

Based on the wording of your policy, your insurance covers the full cost of using a law firm on your carrier’s Panel Counsel. These law firms bill on a pre-negotiated discount rate of $350/hour because the carrier sends them a large volume of work.

You, however, want to use the law firm that has previously represented your company. Unfortunately, their rate is not discounted — it’s $800/hour. This leaves you in a tough spot, because if you choose to use the law firm you worked with previously, your insurance carrier is entitled to foot your company with the delta in legal fees, roughly $450/hour. Disgruntled, you decide you’ll go with the carrier’s law firm to save the extra expense.

Over the next three months, multiple responses go back and forth between your counsel and the plaintiff’s counsel. At this point, you've racked up almost $100,000 in defense costs, all of which are covered by your insurance carrier.

In the interest of recouping some of their investment, the plaintiff presents you with multiple settlement offers. You don't want to settle because you don't believe you've done anything wrong. With the carrier covering your legal fees, you're prepared to go to court. The carrier, however, is pushing you to settle because litigation defense costs are expected to be more than proposed settlement offers. This is where the policy detail hammer clause impacts the claim process.

Hammer Clause defines the carrier’s and insured’s rights in settlement decisions. If you receive a settlement offer that an insurance carrier deems fair, but you prefer not to settle, the hammer clause defines the insurance carrier’s right to limit its exposure to the amount that the claim could settle for, plus defense costs incurred to the date of the fair settlement. A good policy will provide you with more influence on the settlement decision and define the carrier’s portion of incremental settlement and defense costs above the fair settlement amount.

Settlement & Payment

It's now seven months in and you’re approaching your court date. You are tired and no longer have the energy to fight this in court. So, you agree to a $200K settlement with the investor so you can get back to running your business. Your insurance carrier ends up paying roughly $200K in settlement and $200K defense costs.

The Bottom Line

While we all hope these claim events don’t occur, they do, and that’s why you purchase insurance. Your broker should explain these policy terms and conditions when you are purchasing D&O insurance to help you buy the right coverage for your business. Having a quality D&O insurance policy in place and a broker who can help you navigate the claim process can save you money and more importantly time — empowering you to mitigate risks of lawsuits and lost time so you can move your business forward and continue to grow.

Read more: The cost of D&O insurance: Are you afraid of paying too much?

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