Directors and Officers Liability Insurance

1. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • What is it? • Coverage developed to protect individuals who serve as directors and officers of corporations • For financial losses arising from wrongful acts • Forms differ from insurer to insurer

2. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Types of entities needing D&O coverage • Publicly traded corporations • Shares are traded publicly on a stock exchange • Privately or closely held corporations • Owned by one or a small group of individuals – or a family • Shares not offered to the general public • Not-for-profit organizations • Organized to serve a community, charitable or fraternal purpose

3. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Responsibilities of directors and officers • Directors are elected by an entity’s shareholders • Collectively known as the board of directors • May be recruited from outside the entity • Community leaders • Experts in a particular area • Director may also be a corporate officer

4. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Responsibilities of directors and officers • Sarbanes-Oxley Act of 2002 • Sets new standards for accounting and financial reporting • Mandates that chief executive officer and chief financial officer certify financial reports • Heightened scrutiny of directors who are not independent of the corporation • D&O underwriters now include review of Sarbanes-Oxley compliance when underwriting the coverage

5. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • General categories of exposures • Fiduciary duty • Directors owe the organization a high degree of good faith, candor and loyalty • Directors may face personal liability if they have breached this fiduciary duty • Negligence • Liable for losses that arise from negligence in their actions as board members • Business judgment rule • Provides a shield against liability for those who act in good faith in making business decisions • It would not shield a director who was grossly negligent or acted outside the his/her duty as a director

6. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • General categories of exposures (cont’d) • Bad faith (unauthorized conduct) • Not shielded by the business judgment rule when they engage in bad faith actions or fraud

7. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Other categories of claims • Employee claims • Employment discrimination • Basis is discrimination that arises from an employee’s membership in a protected group • State and federal laws prohibit employers from making employment decisions on the basis on an individuals • Race  National origin • Gender  Age • Religion or creed  Disability • These are the protected groups • D&O policy may include coverage for employment related practices liability (ERPL)

8. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Other categories of claims (cont’d) • Claims from outside the organization • Customers, vendors and competitors • Financial damages • Personal liability • Various governmental agencies • For violation of certain laws • ERISA • Environmental laws • Theory of Deepening Insolvency • Keeping the business going and masking financial problems • Financial mismanagement / misstatements about the business is finances

9. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Business uses • Corporate indemnification • Mandatory indemnification • An absolute statutory requirement that directors and officers • Be indemnified for their expenses to defend proceedings brought against them • As well as settlements and judgments arising from such actions • Permissive indemnification • Corporation is permitted but not required to indemnify a director or officer • Where indemnification is not mandatory

10. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Business uses (cont’d) • Why buy D&O insurance • D&O polices fund the personal liability exposures of individuals as well as paying the corporation’s expenses to indemnify those individuals • Organization may not have sufficient funds to pay for defense and settlement • It responds to claims for pure financial loss • D&O excludes coverage for damages arising from • Bodily injury • Property damage • Personal liability

11. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Business uses (cont’d) • Terminology refresher • Bodily injury – direct injury, sickness, disease or death • Financial loss – financial damages, settlements, judgments, and defense costs • Property damage – physical injury to tangible property along with the loss of use of the property

12. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Advantages • Facilitates the recruitment of outside directors • May be the only protection directors and officers have in the event of an organization’s insolvency • No corporate indemnification if funds are not available • Protects the assets of the corporation that might otherwise be needed to indemnify officers and directors for judgments and settlements costs • Not-for-profits simply do not have enough funds available to indemnify

13. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Advantages (cont’d) • Premium cost could be miniscule when compared to costs of defense or settlement • D&O insurers could recommend risk management consultants or legal firms that specialize in director or officer claims • D&O policies provide that insured organization will control the defense of claims • Insureds will want to play a prominent role in their defense • Lengthy process of application may lead to risk management initiatives that otherwise might be overlooked

14. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Disadvantages • Investment in a policy that may be rarely used • Lengthy time to complete application • No standard D&O policies • Risk manager must carefully review the coverage • D&O insurance is a specialized practice area • Requires agents, brokers and underwriters who are experienced in the area • Cost of defense included within limits of liability • Policy may have to be stretched to cover defense costs and settlements

15. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Disadvantages (cont’d) • D&O policies will not respond to all claims • Organization will control defense of claims • Must engage legal counsel • Resources are tied up in their defense • They cannot simply just turn a claim over to the insurer and let them handle everything

16. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • General attributes of most D&O policies • Coverage grants • Coverage A (Side A Coverage) • Coverage for losses not subject to corporate indemnification • No (or small) retention or deductible • Coverage B (Side B Coverage) • Funds claims that are subject to corporate indemnification • Deductibles ranging from a thousand to hundreds of thousand of dollars • Aggregate limit of liability • The most that will be paid in any policy period • Defense cost included in the limit of liability • Careful analysis needed in choosing proper limit of liability

17. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • General attributes of most D&O policies • Claims-made coverage • Policy applies to claims made and reported during the policy period or discovery period • Discovery period – Time after policy is canceled or non-renewed that insured is given to discover claims that arise from wrongful acts during the policy period • Claims made and reported coverage • Policy applies to claims made and reported during the policy period • Occurrence based coverage • Policy that applied to the occurrence that caused the damage will respond regardless of when the claim is filed

18. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Claims reporting requirements • Require organization to notify insurer in writing of any claim within a certain timeframe of when the claim was received • Circumstances that may result in a claim • Insureds must also notify insurer of any occurrence or circumstance that may reasonably be expected to result in a claim • Including reasons for expecting the claim • Designed to make underwriters more aware of potential claims so subsequent policies can be priced more effectively • Serves to allocate claims to the most appropriate policy period

19. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Definitions • Claim • Written demands for monetary relief or non-monetary relief for civil, criminal or arbitration proceedings • Also for injunctive relief, regulatory proceedings or regulatory investigations • Director or officer • Insured person, executive, individual insured • Past, present and future directors, officers, trustees and governors of the organization

20. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Definitions (cont’d) • Insured • Individual insureds and the organization (or entity) • Loss • Damages, settlements, judgments, interest on judgments and defense costs • Excludes fines, penalties, taxes, punitive damages • Wrongful act • Breach of duty, neglect, errors, mistakes, misstatements, misleading statements and acts or omissions

21. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Definitions (cont’d) • Exclusions • Those that deal with corporate governance • Gaining in fact of any profit or advantage to which the insured was not legally entitled • Payments to directors or officers without the previous approval of the shareholders • Deliberate criminal or fraudulent acts of the insured • Those that are uninsurable or better insured elsewhere • Bodily injury  Pollution liability • Property damage  Violations of ERISA • Personal injury

22. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Definitions (cont’d) • Limit of liability • Coverage limit • Includes defense costs • Aggregate Limit • Caps the amount the insurer will pay for all claims within a policy period • Control of defense • Insured and not the insurer controls the defense of claims • Insured may not admit to or assume liability without consent of insurer • Insurer may want to monitor the defense and participate in it and the settlement negotiations

23. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Definitions (cont’d) • Panel counsel • Pre-approved list of defense attorneys attached to and part of policy • List of specialists in particular areas of law • Fee levels that are reasonable and set in advance

24. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Discovery provisions • Unilateral discovery • Extended discovery period is guaranteed to be available only if policy is non-renewed by the insurance company • Bilateral discovery • Extended discovery period is available if either the insured or insurer non-renew the policy • Changing carriers • New carrier should be asked to provide “prior acts coverage” • New policy will cover claims for wrongful acts committed before the new policy began • New carrier may attach a retroactive date • Limits the coverage date to wrongful acts that occurred between the retroactive date and the policy’s expiration date

25. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Changes in the organization • Mergers and acquisitions should be reported to the D&O carrier • Policy may be invalidated upon completion of the deal

26. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Other insuring agreements • Coverage C (Side C) – Organization entity coverage • Coverage for the entity itself • Not-for-profit entity coverage • Entity coverage • Not-for-profits may lack financial assets to successfully defend a suit • Insuring agreements may also offer to advance defense costs

27. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Other insuring agreements (cont’d) • Publicly traded entity coverage • Restricted to entity coverage for securities violations or statutes regulating securities, including their purchase and sale • Securities claims often involve a drop in price or allegations of misleading information that encouraged the purchase of that stock

28. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • The allocation issue • Part of a claim is covered and part is not • Defense and settlement cost must be allocated • Claims that involve covered and uncovered parties • Covered parties – Directors and officers • Uncovered parties – Corporation or organization and its employees • Claims that involve covered and uncovered allegations

29. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Coverage for claims arising from Initial Public Offerings (IPO’s) • Private companies IPOs – First offering of stock when going public • Existing public companies – additional shares of stock or secondary offering • Private company D&O – may exclude coverage for IPOs • Underwriters need to review and analyze information that is developed to sell these shares • Prospectus

30. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • Coverage for claims arising from Initial Public Offerings (IPO’s) (cont’d) • Some private company’s D&O policies may offer securities coverage • Limited coverage for claims from certain types of securities • Underwriter must offer a coverage proposal as long as: • Company notifies underwriter of the IPO in advance • Provides additional details • Pays the premium in advance

31. Directors and Officers Liability Insurance Chapter 18 Risk Management For Financial Planners • The application • Attached to and part of the policy • Representations made in the application form the basis for the coverage • Material misrepresentations may void the policy • Duly authorized officer of the organization signs the application • Warrants that the information is true and correct