Executive Liability Insurance – Why Private Companies Need It
Since its inception about fifty years ago, D&O insurance has evolved into a family of products responding differently to the needs of publicly traded companies, privately held businesses and not-for-profit entities and their respective board members, officers and trustees.
Directors’ & Officers’ Liability, Executive Liability or Management Liability insurance are essentially interchangeable terms. However, insuring agreements, definitions, exclusions and coverage options vary materially depending upon the type of policyholder being insured and the insurer underwriting the risk. Executive Liability insurance, once considered a necessity solely for publicly traded companies, particularly due to their exposure to shareholder litigation, has become recognized as an essential part of a risk transfer program for privately held companies and not-for-profit organizations.
Optimization of protection is a common goal shared by all types of organizations. In our opinion, the best way to achieve that objective is through engagement of highly experienced insurance, legal and financial advisors who work collaboratively with management to continually assess and treat these specialized enterprise risk exposures.
Private Company D&O Exposures
In 2005, Chubb Insurance Group, one of the largest underwriters of D&O insurance, conducted a survey of the D&O insurance purchasing trends of 450 private companies. A significant percentage of respondents gave the following reasons for not purchasing D&O insurance:
• did not see the need for D&O insurance,
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• their D&O liability risk was low,
• thought D&O risk is covered under other liability policies
The companies responding as non-purchasers of D&O insurance experienced at least one D&O claim in the five years preceding the survey. Results showed that private companies with 250 or more employees, were the subject of D&O litigation during the preceding five years and 20% of companies with 25 to 49 employees, experienced a D&O claim.
The survey revealed 43% of D&O litigation was brought by customers, 29% from regulatory agencies, and 11% from non-publicly traded equity securities holders. The average loss reported by the private companies was $380,000. Companies with D&O insurance experienced an average loss of $129,000. Companies without D&O insurance experienced an average loss of $480,000.
Some Common Examples of Private Company D&O Claims
• Major shareholder led buy-outs of minority shareholders alleging misrepresentations of the company’s fair market value
• purchaser of a company or its assets alleging misrepresentation
• sale of company assets to entities controlled by the majority shareholder
• creditors’ committee or bankruptcy trustee claims
• private equity investors and lenders’ claims
• vendors alleging misrepresentation in connection with an extension of credit
• consumer protection and privacy claims
Private Company D&O Policy Considerations
Executive Liability insurance policies for privately held companies typically provide a combination or package of coverage that includes, but may not be limited to: Directors’ & Officers’ Liability, Employment Practices Liability, ERISA Fiduciary Liability and Commercial Crime/ Fidelity insurance.
D&O policies, whether underwritten on a stand-alone basis or in the form of a combination-type policy form, are underwritten on a “claims-made” basis. This means the claim must be made against the Insured and reported to the insurer during the same effective policy period, or under a specified Extended (claims) Reporting Period following the policy’s expiration. This is a completely different coverage trigger from other liability policies such as Commercial General Liability that are traditionally underwritten with an “occurrence” trigger, which implicates the insurance policy that was in effect at the time of the accident, even if the claim is not reported until years later.
“Side A” coverage, which protects individual Insureds in the event the Insured entity is unable to indemnify individuals, is a standard agreement contained within many private company policy forms. These policies are generally structured with a shared policy limit among the various insuring agreements resulting in a more affordable insurance product tailored to small and mid-sized enterprises. For an additional premium, separate policy limits may be purchased for one or more of each distinct insuring agreement affording a more customized insurance package.
Also, policies should be evaluated to determine whether they extend coverage for covered “wrongful acts” committed by non-officers or directors, such as employees, independent contractors, leased, and part-time employees.
Imputation of Knowledge & Severability
Coverage can be materially affected if an Insured individual has knowledge of facts or circumstances or was involved in wrongful conduct that gave rise to the claim, prior to the effective date of policy under which the claim was reported. Policies differ as to whether and to what extent, the knowledge or conduct of one “bad actor” may be imputed to “innocent “individual Insureds and / or to the Insured entity.
“Severability”, is an important provision in D&O policies that is often overlooked by policyholders until it threatens to void coverage during a serious pending claim. The severability clause can be drafted with varying degrees of flexibility– from “partial” to “full severability.” A “full severability” provision is always most preferable from an Insured’s standpoint. Many D&O policies, impute the knowledge of certain policy-specified senior level officer positions to the Insured entity. That imputation of knowledge can operate to void coverage that might have otherwise been available to the Insured entity.
M&A and “Tail Coverage” Considerations
The “claims-made” coverage trigger is critically important in an M&A context where contingent liability risks are inherent. In these contexts, it’s important to evaluate the seller’s policies’ options to purchase a “tail” or “extended reporting period” for each of the target company’s policies containing a “claims-made” trigger.
A “tail” coverage option allows for the reporting of claims alleging “wrongful acts” that occurred during the expired policy period, yet were not actually asserted against the Insured until after the policy’s expiration, but instead were asserted during the “extended reporting” or “tail” period. An acquiring company’s insurance professional should work closely with legal counsel’s due diligence team to identify and present alternatives to manage contingent exposures.
What a Director or Officer Doesn’t Know Will Hurt Them
Directors’ & Officers’ Liability insurance policies were originally created solely to protect the personal assets of the individuals serving on public company boards and executive officers. In 1992, one of the most prominent D&O insurers led a major transformational change in D&O underwriting by expanding coverage to include certain claims against the insured entity. Entity coverage for publicly traded companies is typically restricted to securities claims, while privately held companies and not-for-profit organizations benefit from more comprehensive entity coverage because they lack the public securities risk exposure of publicly traded companies.