How to set limits for D&O insurance

Directors and Officers (D&O) insurance is a crucial component of the risk management plan for organizations, including not-for-profit, for-profit, and publicly traded corporations. This coverage protects the personal assets of directors and officers from potential lawsuits arising from their actions or decisions made on behalf of the organization. In this article, we’ll explore how to set appropriate limits for D&O insurance, considering each type of organization’s unique needs and considerations. In addition, we will also discuss the importance of considering employment practices’ liability limits and considerations for defense costs on policy limits. 

Not-for-Profit Organizations

Not-for-profit organizations often operate with limited resources, making it essential to balance adequate coverage and cost-effectiveness. When setting D&O insurance limits for a not-for-profit, consider the following factors: 

• Size and scope of the organization: Larger organizations with more employees and volunteers may require higher limits due to the increased exposure to potential claims. 
• Regulatory environment: Some not-for-profits may be subject to specific regulations impacting their D&O insurance needs. Be aware of any such requirements and adjust limits accordingly. 
• Board composition: A diverse board with members from various professional backgrounds may require higher limits, as they may bring different risks to the organization. 
• Past claims history: review the organization’s claims history to identify trends and potential areas of concern. This information can help inform your decision on appropriate limits.

For-Profit Corporations

For-profit corporations face unique risks and challenges when it comes to D&O insurance. Here are some factors to consider when setting limits for these organizations: 

• Industry and competition: Companies in highly competitive industries may be more susceptible to claims, necessitating higher limits.
• Financial stability: A financially stable company may withstand higher limits, while a struggling company may need to prioritize cost-effectiveness. 
• Growth stage: Rapidly growing companies may require higher limits to account for the increased risk associated with expansion. 
• Mergers and acquisitions: Companies involved in M&A activity may need to adjust their limits to account for the added risk and complexity. 

 Publicly Traded Corporations 

Publicly traded corporations face heightened scrutiny from shareholders, regulators, and the public, making D&O insurance a critical component of their risk management strategy.  

When setting limits for these organizations, consider the following factors: 

• Market capitalization: Larger companies with higher market capitalization may require higher limits due to increased exposure to shareholder lawsuits.
• Regulatory environment: Publicly traded corporations are subject to strict regulations such as the Sarbanes-Oxley Act, which can impact their D&O insurance needs.
• Shareholder activism: Companies with a history of shareholder activism may be more susceptible to claims, necessitating higher limits.
• International operations: Companies with global operations may need to consider higher limits to account for the increased risk associated with operating in multiple jurisdictions. Additionally, companies need to consider the regulatory environments in other jurisdictions and currency conversion rates for adequate coverage.

Employment Practices Liability Limits 

Employment practices liability (EPL) coverage is often included in D&O insurance policies, protecting against claims related to employment practices, such as discrimination, harassment, and wrongful termination. When setting D&O and EPL limits, consider whether you want them tied to an aggregate (total) limit or if each coverage should have its tower of coverage. Companies looking to purchase these valuable protections but also wanting fiscally conservative risk transfer-tied limits can provide an excellent step to better coverage without being too costly.

Defense Costs 

Another important consideration when setting D&O and EPL limits is whether defense costs are included within the policy limits (inside) or separate from the limits (outside). Inside limits are more cost-effective, but they could leave the organization with less coverage for actual damages if defense costs are high. Outside limits provide additional protection but may come at a higher premium. The option to purchase defense costs inside vs. outside the limits may not be up to the insured, and some companies may restrict what can be offered. It is important to consider the wordings carefully so that the limit is not too low. D&O, as well as EPL claims, can be costly to go through, so this is an important consideration. 

Additional Clauses for Consideration 

Limits are only one of many things to consider when purchasing D&O insurance. You should also consider: 

• Insured vs. Insured Exclusion: This clause prevents coverage for claims made by one insured party against another. It is designed in order to avoid collusion and discourage internal disputes from being covered by the policy. There are times, such as insolvency, when the D&O coverage should respond, so we look to carve out specific instances from the exclusion. 
• Hammer clause: Also known as the settlement clause, this provision allows the insurer to limit their liability if the insured refuses to accept a settlement offer recommended by the insurer. Because D&O claims can have significant reputational impacts some insureds prefer not to settle, and in these instances, it is good to know what portion you could be liable for.  
• Allocation Clause: This clause addresses the allocation of defense costs and indemnity payments between covered and non-covered claims or parties. It helps determine how much of the defense costs and settlement amounts are covered, and based on how costs are allocated, you might look at purchasing some excess side A only coverage for the directors. 
• Severability Clause: This provision needs to be provided on the policy, ensuring that the knowledge or actions of one insured party do not affect the coverage of other insured parties. One example is if a director engages in fraudulent activity, the severability clause would protect the other directors from losing their coverage due to the fraudulent director’s actions. 
• Third-Party coverage: This clause on the EPL side extends coverage to include claims made by third parties, such as customers or vendors, who allege harassment, discrimination, or other wrongful acts by the company’s employees. This can be an important addition to the policy, as it broadens the scope of protection. 
• Wage and Hour Exclusion: Many EPL policies exclude coverage for claims related to wage and hour disputes, such as unpaid overtime or minimum wage violations. It’s important to confirm whether your policy includes this exclusion, as wage and hour claims can be a significant source of liability for employers. If the exclusion is present, you may consider adding a separate endorsement to cover wage and hour claims. 

As you can see, setting appropriate limits for D&O insurance is a critical aspect of risk management for not-for-profit, for-profit, and publicly traded corporations. By considering each type of organization’s unique needs and risks and other factors like EPL coverage, Defense Costs, and other policy clauses, you can ensure that your organization is adequately protected against potential claims. Connect with us today to learn more about D&O coverage and to discuss your business insurance needs.