Directors and officers liability insurance

In the United States, articles of association often include an indemnification provision holding the officers harmless for losses occurring due to their role in the company. The purchased insurance is typically in addition to this corporate indemnification, or reimburses the corporation. In some states corporations may be mandated to indemnify directors and officers in order to encourage people to take the positions and in most cases the corporations have the option to indemnify their officers. However, in certain cases the corporation may be explicitly forbidden from indemnifying such director or officer. Liabilities which aren't indemnified by the corporation are potentially covered by certain types of D&O insurance (particularly Side-A Broad Form DIC policies).[5]

The insurance was first marketed in the 1930s by Lloyd's, but into the 1960s the volume sold was "negligible".[6] Corporations began to allow for corporate indemnification in the 1940s and 1950s, and the 1960s "merger mania" was followed by costly litigation.[7] In the 1980s, the United States experienced a "D&O crisis" along with the overall liability crisis, with increased premiums, reduced availability, and numerous additional exclusionary clauses in the insurance policy.[8] Due to changes in securities laws in the 1960s, the insurance was sold primarily for the concerns of directors and officers of "personal financial protection" (protecting personal rather than corporate assets), but the coverages have evolved so that personal and corporate indemnification are both considered.[6] The 1995 decision of the Ninth Circuit in Nordstrom, Inc. v. Chubb & Son, Inc. resulted in the emphasis in Side C (corporate entity) coverage.[9] The decision resolved an "allocation problem" of how to allocate costs between individual insureds, as the corporation was typically not insured while individuals were.[7] There is no standard D&O form, but each has shared a similar outline.[7] In 2007 Romania changed its corporate law making D&O insurance compulsory. Romania is the only country in EU to make D&O insurance compulsory.[10]

The types of claims are dependent on the nature of the company. Directors and officers of a corporation may be liable if they damage the corporation in breach of their legal duty, mix personal and business assets, or fail to disclose conflicts of interest. State law may protect the directors and officers from liability (particularly exculpatory provisions under state law relating to directors). Even innocent errors in judgment by executives may precipitate claims.

The types of claims are dependent on the nature of the corporation. For public companies, claims are primarily due to lawsuits by shareholders after financial difficulties, with a 2011 Towers Watson survey finding that 69% of publicly traded company respondents had a claim for a shareholder lawsuit in the past 10 years as opposed to 21% of private companies respondents.[12] Other claims arise from shareholder-derivative actions, creditors (particularly after entering the zone of insolvency), customers, regulators (including those that would bring civil and criminal charges), and competitors (for anti-trust or unfair trade practice allegations). For nonprofits, claims are typically related to employment practice and less commonly regulatory or other fiduciary claims.[12] For private companies, claims are often from competitors or customers for antitrust or deceptive business practices[13] and one survey of 451 executives found that lawsuits cost an average of $308,475.[14][15]

One relatively neglected area is the personal liability to non-shareholders that directors may face due to torts committed as a result of negligent supervision.[16]

D&O insurance is usually purchased by the company itself, even when it is for the sole benefit of directors and officers. Reasons for doing so are many, but commonly would assist a company in attracting and retaining directors.[17] Where a country's legislation prevents the company from purchasing the insurance, a premium split between the directors and the company is often done, so as to demonstrate that the directors have paid a portion of the premium. Problems related to income tax liability may come into play when a corporation avoids country specific liability law in order to protect its individual directors and officers through insurance.

If the company fails to disclose material information or willfully provides inaccurate information, the insurer may avoid payment due to misrepresentation. The "severability clause" in the policy conditions may be intended to protect against this by preventing misconduct by one insured from affecting insurance for other insureds; however, in certain jurisdictions it may be ineffective.[18]

Intentional illegal acts or illegal profits are typically not covered under D&O insurance policies; coverage would only extend to "wrongful acts" as defined under the policy, which may include certain acts, omissions, misstatements while acting for the organization. Because of exclusions and as a matter of public policy, coverage is not provided for criminal fraud.

Directors and former directors may sue the company, particularly given their inside knowledge and potentially large stake in the organization. However, most D&O policies contain an "insured versus insured" exclusion which may prevent any payment in these circumstances. It is intended to prevent collusion, where an insured company could sue a director and collect the insurance money.[19] However, it is possible to "carve out" this exclusion so that it does not apply to certain cases, such derivative actions, receivership trustees, and whistleblower actions.[19]

Coverage may be "rescinded" (voided, essentially excluded) in some cases, especially if there is some mistake in the application as to the financial details. Non-rescindable coverage may be purchased in some cases which can prevent this lack of coverage.[19] Also, claims that come about from an issue that was known before the insurance was bought are rejected. If you hide this information, it can make the policy void for non-disclosure.

One empirical study found that increased D&O insurance is associated with reduced shareholder benefits from mergers and acquisitions.[22]

Since insurance companies ultimately bear costs for negligent management, theoretically, insurance companies may enforce better management practices and reduce moral hazard. Empirical research, however, has not found that insurance companies perform effective monitoring of management.[23]

Berkshire Hathaway, the holding company managed by Warren Buffett, does not purchase D&O insurance for its directors, unlike most similar companies. Warren Buffett believes that the directors should face consequences of their mistakes the way that other shareholders do.[24] Notably, however, this statement overlooks the holding-company structure of Berkshire Hathaway, auxiliary indemnification agreements with Buffett, and the individual operating companies may still purchase such insurance.