The Ultimate Guide to Directors and Officers Insurance
Directors and officers insurance turbocharges your business and nonprofit insurance. Here’s how it works.
It’s got a mysterious name and an even more mysterious purpose: What makes directors and officers so special that they need their own insurance? (You might feel extra-confused when you hear its even-more-mysterious nickname, D&O insurance.)
The truth is that directors and officers insurance is a critically important tool to keep your business or nonprofit solvent and thriving. It shields your organization from legal trouble and helps your leadership make smart, innovative decisions.
What Is Directors and Officers Insurance?
Directors and officers insurance covers legal fees and damages in case there’s a lawsuit against an organization’s board members, officers or other leadership. It’s purchased by an organization on behalf of those leaders, and kicks in whenever one or more of them is named in a suit.
The insurance company pays for legal representation and damages up to the insurance policy’s cap (usually in the millions range, like $5 million or $10 million).
Examples of groups that might sue include stockholders angry at plummeting prices, employees who feel their benefits were mismanaged, or victims of a sexual harasser who sat on your board.
Many insurance companies that offer directors and officers insurance provide other legal services to their customers, including free or reduced-cost legal advice that’s designed to help avoid D&O claims before they happen.
Directors and officers insurance helps you fulfill indemnification clauses. These are agreements that an organization will pay for any legal fees and damages incurred by a board member or high-level employee in the course of their job, and it’s usually part of a contract signed before movers and shakers come on board.
To fulfill this clause, a D&O insurance policy can be paid directly to the people dealing with the legal challenge, or it can be paid out to the organization, which in turn pays for the legal costs of its board members and employees.
In the past few years, these were the top reasons companies had to use their D&O insurance:
- Noncompliance with laws and regulations (34%)
- Negligence (21%)
- Maladministration or lack of controls (7%)
- Breach of trust or fiduciary duty (6%)
- Inadequate or inaccurate disclosure (2%)
- Other (30%)
Only a third of cases where directors and officers were sued had to do with laws and regulations. Illegal or shady deeds might be the first thing you think of when it comes to lawsuits against CEOs, but it’s definitely not the only reason this type of insurance comes in handy.
If directors or officers mismanage employee benefits like health insurance or 401(k) plans, that can be a cause for a D&O insurance claim. This scenario may also be covered under a related type of insurance often sold alongside D&O insurance, called fiduciary insurance.
This type of insurance covers legal fees and damages when a company fails in its financial responsibilities to employees, stockholders or other stakeholders.
Directors and officers insurance can be used to protect a company from the financial cost of a secret villain in its upper ranks—one who goes on a racist or sexist rant and does major damage to the company’s reputation, for example.
But it’s just as easily used to safeguard against more ordinary kinds of mistakes. Even a small misstep by a CEO or board member, like a cranky off-the-cuff remark to a reporter, can cause major headaches. D&O insurance is there to cover the legal fallout.
D&O insurance can be purchased for both nonprofits and for-profit businesses. Even churches and other religious organizations might choose to buy this insurance.
Who Needs Directors and Officers Insurance?
You should consider getting directors and officers insurance as soon as your nonprofit or business develops a leadership structure, especially one that includes a board of directors.
Even the tiniest nonprofits often have a board of directors right away, so it’s helpful for them to look into D&O insurance early, even if they wait until they have a steady stream of donations to buy it.
Businesses, on the other hand, may wait many years before buying D&O insurance. If you run a small local business with a handful of employees, directors and officers insurance is probably an unnecessary expense.
(It’s definitely an unnecessary expense for sole proprietorships!) It becomes a lot more important once you have more than a layer or two of management.
Directors and officers insurance is most crucial for mid-size businesses. As they take on new business and contracts and expand into new markets, leadership needs to make bigger and riskier decisions, exposing them to bigger and riskier, er, risks.
These companies don’t have the deep pockets of larger corporations to patch things up if things go south, so D&O insurance can be the deciding factor between solvency and bankruptcy in a crisis.
If you’re thinking about joining the board of an organization, whether it’s nonprofit or for-profit, you should ask to be covered by directors and officers insurance.
Otherwise that liability is on you or the organization, which might not have enough money to cover your costs in a worst-case scenario lawsuit. That could cost you millions of dollars, personally. Ouch.
Why Is Directors and Officers Insurance Important?
Directors and officers insurance doesn’t just protect the individual people listed in the policy. It protects the whole organization by ensuring that it won’t have to pay out a big indemnification clause settlement that could lead to bankruptcy.
It also preserves business relationships between the directors, officers and everybody else.
If you knew that any decision you made could cost you gobs of money if it went wrong—to the tune of millions of dollars—you’d probably be extremely cautious in your decision-making, right? Maybe you’d hesitate to make any decisions at all.
That’s what can happen without directors and officers insurance, and it’s not good for business. Some amount of risk is necessary for growth, and D&O insurance allows decision-makers to take that risk safely, without worrying about bankrupting the organization they work for.
Purchasing directors and officers insurance can also be required by the board, upper management or investors, meaning you’ll need to get it whether you want it or not.
How Much Does Directors and Officers Insurance Cost?
Smaller businesses and nonprofits looking to buy directors and officers insurance can expect to pay in the low thousands of dollars each year, usually starting around $2,000.
At the other extreme, mega-corporations like Disney and Walmart might pay more for their directors and officers insurance each year than mid-size companies earn in revenue. Most organizations can expect to pay in the upper thousands or tens of thousands each year.
The biggest factor in the cost of directors and officers insurance is the size of the organization. This includes the number of employees, stockholders and other stakeholders, as well as the amount of revenue it handles each year.
Operating in a field where there’s a lot of extra legal and financial risk, like the financial sector or an oil and energy company, can also make this insurance more expensive.
How To Save Money on Directors and Officers Insurance
The best way to save money on this type of insurance is to keep everyone’s noses squeaky-clean. You should have crystal clear guidelines for board and C-suite level behavior, including procedures for how to remove someone who’s become a loose cannon.
Do business as transparently as possible and avoid the kind of secretive dealings that make embarrassing gaffes or mistakes more likely.
It might seem a little wishy-washy, but that’s truly the best way to get directors and officers insurance discounts. Other factors that influence the cost of D&O insurance—like your company’s size and industry—aren’t easily changeable. (It would be pretty silly to limit the growth of your organization just to save on insurance.)
Another way to get a discount is by bundling your D&O insurance with other types of business or nonprofit insurance. Insurance companies want your business, so to motivate you to buy as many different types of insurance with them as possible, they’ll usually cut you a discount.
How To Get Directors and Officers Insurance
If you’re already working with an insurance agent for your nonprofit or business insurance, then shopping for directors and officers insurance is easy: Just ask your agent to start looking for quotes.
Ask if you can bundle your D&O insurance in with your existing business insurance, since many insurance companies offer both for a discount.
If you’re not working with an expert yet, here are a few good reasons to go indie:
- Agents work for you, not the insurance companies. They’ll round up quotes from multiple companies and help you shop for the coverage you want at the price you want.
- Agents are experts and specialists. They know their niche inside and out and can help advise you about the insurance choices similar organizations have made.
- They do the hard parts for you. You fill out an application and answer a few questions, they do all the math and shopping. That way you can focus on what’s important: running your organization.