In the fast-changing business environment of today, Directors and Officers (D&O) insurance has become one of the most essential components in managing risk for private, public and not-for-profit organizations. However, to fully comprehend and clear misconceptions around the need for D&O insurance amongst Small and Medium Sized Enterprises (SMEs), one must revisit its historical evolution and its intent to protect board members, directors, officers and employers.
In the early 1930’s, organizations were not permitted to indemnify their directors and officers. The prevailing belief of directors and officers at the time was that the risk to their personal assets was negligible hence insurance was unnecessary. However, in the 1960s, the business trends in the United States led to increased mergers and acquisitions and laws were passed permitting organizations to indemnify their directors and officers which statutorily transferred the cost of defence on to the organizations. As litigation against organizations increased, executives recognized that the assets of their organizations were exposed to loss. At the same time, directors and officers became concerned about the threat to their personal assets in the event that indemnification from their own organization was not available. Both of these factors were instrumental in driving the desire for protection in the form of D&O insurance and led to the growth of this type of specialty insurance.
The history and growth of D&O liability teaches us two important lessons. Lawsuits against directors and officers are not limited to large organizations, hence the probability of small and medium sized businesses facing a lawsuit is not zero nor remote. Secondly, once bylaws obligated organizations to indemnify their directors and officers, legal expenses, and possibly settlement costs, transferred on to the organization could have a material impact on the finances of an organization.
In understanding the evolution of D&O insurance and the protection afforded by the coverage, one can appreciate how this coverage has applicability to all businesses, large or small.
SMEs run on small profit margins with limited cash flows and are therefore at a greater risk of bankruptcy or financial stress in comparison to larger organizations. If a legal or regulatory action is commenced against an SME, the costs involved in defending such actions and, if required, paying a settlement, can impose great strains on the finances of the organization. In the absence of D&O insurance, the costs to defend and settle can threaten the solvency of the organization. In addition, should the organization be unable to meet its financial obligations and declare bankruptcy and be unable to indemnify the directors and officers, the personal assets of these individuals could be exposed.
In such circumstances, the existence of D&O insurance would not only protect the organization from potentially crippling financial costs but would also protect the personal assets of the directors and officers in the event of bankruptcy.
In the case of family businesses, many chose not to purchase D&O insurance as owners believe they are insulated against loss as the majority, or all of the business, is controlled by family members. However there have been cases when third-parties have filed a lawsuit due to mismanagement of the business that holds all directors and officers, usually family members, responsible. Having D&O insurance in place would not only protect the business but also the assets of other family members and keep the family inheritance unharmed.
When considering the purchase of D&O insurance, it is important for SMEs to consider the business’s finances and structure, its relationship with investors and creditors, future business goals and susceptibility to litigation or regulatory investigation. With the help of an insurance broker familiar with D&O insurance, who understands the client’s business and corporate structure, D&O policies can be crafted effectively to match the coverage to the exposures presented by the client’s business.
For more information on Directors’ and Officers’ Insurance visit theguarantee.com, connect with us or consult your broker.
Chris Rebchuk is The Guarantee’s National D&O Product Manager responsible for the maintenance and development of underwriting standards, product innovation and supporting strategies for the Guarantee’s Directors’ and Officer and Fiduciary Insurance portfolios. Chris has over 34 years Commercial General Insurance brokerage and underwriting experience working with clients of all sizes in all the business sectors of Canada. He has been working in the area of Directors and Officers Liability insurance, in underwriting and management capacity, for 19 years.
This blog/article is intended to be used for informational purposes only and does not intend to replace legal, technical or other professional advice or to represent actual or potential coverage under any insurance contract. At all times, the specific issued policy in its entirety –including all definitions, conditions and exclusions – is to be used when determining the scope of potential coverage under The Guarantee’s insurance products. The Guarantee Company of North America disclaims all warranties whatsoever.