Directors and Officers insurance cleans up executive messes

If an employee is hurt on the job, your workers compensation insurance will pay. If a visitor falls on a slippery floor and sues, your general liability insurance covers the claim. But what if your company is hit by a less tangible but financially devastating event, such as an employee sexual harassment lawsuit or allegations of fraud against a key manager? Directors and Officers liability insurance (D&O) can cover your legal costs.

Traditional D&O insurance covers financial liability claims against a company's officers and directors, including the CEO, chief financial officer, vice presidents, and shareholder-elected directors. Because traditional D&O insurance is targeted to financial- and securities-related claims, it is less relevant for smaller or privately held companies. However, another breed of D&O insurance is available, combining D&O liability with "employment practices liability insurance" (EPLI) — an attractive package for mid-size and small businesses.

Reasons to buy

Who should buy D&O insurance? The Independent Insurance Agents & Brokers of America (IIABA) says that D&O coverage for small and mid-sized businesses is most useful for professional firms, such as accountants, lawyers, and consultants. Any decision involving the investment of money is fair game for a stockholder lawsuit, whether from outside stockholders or from employees; companies structured to include a board of directors should purchase D&O coverage.

According to Tony Galban, senior vice president and underwriting manager for directors' and officers' liability insurance at The Chubb Corp., D&O is rarely purchased by companies with less than $1 million in assets because of its cost.

Paul Rauner, president of Chicago Risk Services, an insurance broker in the Midwest, says that the cost of D&O insurance is based on the amount of risk a company brings to the table.

"Small, established private companies are considered low-risk by underwriters and could pay as little as $500 per year per million in premiums," Rauner says. "Large public companies are typically considered high-risk and pay from $10,000 to $30,000 per million in annual premiums."

Galban at Chubb notes that a start-up company with nebulous business plans is likely to find itself under closer scrutiny from D&O underwriters because start-ups are considered high-risk ventures. As an example, Galban says a start-up would pay $10,000 annually for $2 million in D&O coverage.

However, Galban says as employment practices lawsuits become more numerous, the target market for a package of D&O with EPLI has changed to include smaller companies. With employment liability a hot issue among corporations, it's no surprise that many companies' first purchase of D&O insurance is the two-in-one package of EPLI and D&O.

D&O coverage features

A typical D&O policy might include the following coverage for private companies: Securities liability coverage for IPOs and private placements EPLI, including the following types of claims: Wrongful termination Harassment Retaliation Discrimination Wrongful discipline

Employment practices claims are now the most common lawsuits brought against a company's management. According to a 2007 Towers Perrin survey titles "Insurance Purchasing and Claims Trends," 38 percent of all reported D&O claims from public companies resulted from alleged wrongful employee dismissal or termination, and 44 percent were against private companies.

Other common employment-related claims include discrimination and salary, and wage or compensation disputes, both of which are covered under employment practices in D&O policies. And the average D&O employee claim today, according to Towers Perrin, is $146,078. For all claim types, the average was $12 million in 2007.

But it's not just EPLI coverage that makes D&O attractive to smaller corporations. Often a company strikes out to purchase D&O insurance because a board member is reluctant to continue without the assurance of liability coverage.

In addition, according to Galban, many companies purchase D&O insurance at start-up time or shortly thereafter, in anticipation of going public. "Particularly with tech-related businesses, there's an outright purchase of D&O to attract higher-caliber people into management positions," says Galban. Post-IPO, however, D&O coverage changes significantly. A public company's greater exposure to shareholder claims can scare its D&O insurance providers into charging higher premiums. And public companies are more likely to buy EPLI and D&O coverage separately.

Says Galban, "Someone planning to take on Microsoft is not considered a good risk for us. Certain classes or types of ventures we don't tend to believe in, whether or not they're capitalized in the short run. Companies with uneventful litigation histories, both as defendant and plaintiff, are considered lower claim risks."