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.

These D&O claim scenarios, from a sample American International Group Inc. D&O policy, show situations where D&O coverage proved worthwhile:

• An employee accused of embezzlement was arrested at work and later sued the employer and its directors and officers, alleging wrongful termination and violation of his rights. The accusations were proven false, and the employee was awarded $10 million in damages, $4 million of which was paid by the company's D&O insurer.

• Company executives were the subjects of an IRS investigation after the company did not pay some federal taxes. They were acquitted of wrongdoing, and the D&O plan paid $275,000 of legal defense costs.

Reasons to buy

Who should buy D&O insurance? The Independent Insurance Agents of America 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, vice president and D&O underwriting manager at The Chubb Corp., D&O is rarely purchased by companies with less than $1 million in assets because of its cost — between $8,000 and $15,000 per year in premiums. 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.

Employment practices claims are now the most common lawsuits brought against a company's management. According to a 1999 Tillinghast/Towers Perrin survey, 27 percent of all reported D&O claims resulted from alleged employment discrimination. Other common employment-related claims include sexual harassment and wrongful termination lawsuits, both of which are covered under employment practices in D&O policies. And the average D&O employee claim, according to Tillinghast/Towers Perrin, is $306,000.

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." Start-up companies and those with nebulous business plans are likely to find themselves under closer scrutiny from D&O underwriters. On the flip side, companies with uneventful litigation histories, both as defendant and plaintiff, are considered lower claim risks.