Intuitive Insurance Articles

Navigating D&O: How to avoid some common pitfalls when it comes to Limit Structure

Directors and Officers Liability (D&O) policies are complex and can be confusing for any executive, even for those with an understanding of how this type of cover works. Determining how to structure the policy can be a difficult process, with many factors influencing decisions. The right limit to purchase is highly subjective and varies greatly from one board of directors to another.

One of the major pitfalls often comes directly after this first step of selecting the limit, in that many overlook the need to determine the specific limit to make available for claims against the company, versus individual directors and officers.

This step is crucial as a claim against the company could erode the available limit, and depending on how the policy was structured, may leave little to no coverage for subsequent claims against individual directors or officers.

The conflict:

D&O policies include an Aggregate Limit of Liability which is shared across the following main sections of coverage:

Navigating Directors and Officers Liability InsuranceSide A – Directors and Officers Liability
Covers loss (defence costs and compensation) in respect of personal liabilities incurred by directors and officers where indemnification is not provided by the organisation.

Side B – Company Reimbursement
Covers the organisation for indemnities provided to its directors and officers.

Side C – Entity Securities
Protects the entity for claims resulting from the offer, sale or purchase of company securities.

Most policies contain a clause that prioritises payments under Side A, if more than one section is triggered by a claim/s and indemnification has not been granted.

The concern here is the clause does not prioritise Side A claims if an action is brought against an individual director or officer, subsequent to indemnity being granted to the company under Side B or C.

Side C is important coverage as it aligns shareholder interests by providing protection for an entity’s balance sheet. However, a limit that is shared equally across all sections can have significant consequences due to the fact there can be conflicting interests between directors and officers and the company itself. This is made more pertinent due to the fact securities claims (generally shareholder class actions) are costly and can potentially wipe out the limit completely, leaving executives with little or no protection.

Recommendations for resolution:

Many insurers recognise this conflict between Side A, B & C cover and have thus developed their policies to afford an additional limit, which is available for directors and/or officers should the policy limit be exhausted.

However, the limits provided by these extensions are often inadequate and therefore ineffective when trying to overcome the conflict between the three coverage sections.

There are a number of alternate approaches available to provide a reserved element of cover for directors or officers. These include:

  • Purchasing a separate, standalone A-Side policy, which would provide a separate limit available for Directors and Officers if the limit of the underlying policy had been exhausted after paying a covered claim.
  • Purchasing a separate standalone A-Side policy, which would step down if there was a difference in conditions in the underlying policy, and would also provide excess coverage should the primary limit be exhausted.
  • Capping the limit available for Side C claims.
  • Establishing an excess policy that would exclude entity securities coverage (Side A & B only).

The costs and benefits of the above vary, however it is highly worthwhile to investigate and discuss each option in depth to determine and select the right limit and structure to meet the specific needs of the organisation and its executives.

If you would like more information, please drop us a comment, email or call Intuitive on (02) 9493 6111. We’d love to hear from you.

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