Corporate directors and officers (D&O) have a duty to manage the company in their stockholders’ best interests. They are bound to use due care and to be diligent in respect of the management and administration of the corporation’s affairs and in the use of its property and assets. Accordingly, they are liable for losses or injuries that are caused by their breach or neglect of duty.
Recognizing the need to have competent directors and officers on executive boards, many corporations have put in their by-laws or charters certain resolutions undertaking to indemnify their directors and officers for legal expenses incurred by them in defending suits based on alleged wrongful acts in their capacities as directors and officers.
Such indemnification provisions are permitted by most states’ laws. Protection varies from state to state. In general, state statutes do not protect directors from claims brought by governmental agencies, or claims alleging violations of securities and exchange laws or other federal laws.
The Internal Revenue Service has ruled that premiums paid by a corporation for insurance policies indemnifying the corporation against damages sustained for the wrongful acts of its officers and directors in their official capacity and reimbursing the officers and directors for their expenses arising from such wrongful acts, are deductible by the corporation as ordinary and necessary business expenses.
Such expenses cannot be included in income of the officers and directors as noncompensatory fringe benefits. The premiums for Directors and Officers Liability coverage are thus considered as paid to meet an obligation of the corporation with respect to the employment of its officers and directors. The premium payments are considered noncompensatory fringe benefits, since the insurance protection afforded by the payment of the premiums allows officers and directors to make business decisions while minimizing the fear of unfavorable legal consequences. (Rev. Ruling 69-491.)
Per Internal Revenue Service rules, a business executive who pays his own liability insurance against corporate wrongful acts could claim that expense as a deductible business expense on his income tax return.
DIRECTORS AND OFFICERS LIABILITY POLICY
Most Directors and Officers Liability policies issued are written under a single policy cover, with the following two separate coverages:
- Directors and Officers Liability (Side A Coverage) – pays on behalf of any directors or officers for their liability arising out of wrongful acts.
- Company Reimbursement or Company Indemnification (Side B Coverage) – reimburses the insured company for payment made to its directors and officers. The payments must involve the director or officer’s expenses incurred by reason of claims made against them for wrongful acts, and to which they are entitled by the company’s by-laws.
Most Directors and Officer Liability are issued as stand-along policies consisting of the following:
- Directors and Officers Liability Declarations
- Directors And Officers Liability Insurance Coverage Form Analysis
- Policy Cover Page or Jacket. Individual insurance companies design this form for their own purposes. It may include a table of contents or index to meet the requirements of some states.
Every company will have its own set of available endorsements. These may enhance or restrict coverage based on the particular carrier’s appetite for coverage. It is important not to judge a policy based only its endorsement because a very broad policy may have a number of endorsements to restrict coverage while a very limited policy may have few endorsements because the policy is already very restricted.
Underwriting always begins with identifying hazards. With Directors and Officers coverage this means identifying the following:
- Types of wrongful acts that could be committed.
- Persons who could commit the wrongful acts.
- Potential impact of such wrongful acts.
- Processes or procedures in place to prevent the wrongful acts from taking place.
Directors and Officers Liability rates are dependent upon the selected limit of liability, the participation percentage, the Deductible, the entity’s size and assets, and the type of business or service provided by that entity. Rating procedures are likely to be significantly different between any two insurers that provide D&O liability coverage.