Buying an officers' liability policy? Pick one early, with adequate cover

insurance
Recently, the chairman of an Indian conglomerate was dragged to court by its erstwhile foreign partner, and narrowly escaped a jail term for non-payment of dues. The incident highlights the risk key personnel of companies face by virtue of the positions they hold, and the decisions they take. To safeguard them against this risk, companies nowadays buy a policy called directors and officers’ (D&O) liability insurance. At the Business Standard Insurance Round Table held recently, the chief executive officer of a general insurance company said that the demand for this cover has been rising.            

Growing risk: In their day-to-day work, directors and officers take decisions that affect the stakeholders of their company. Consider two examples. One, suppose that the directors decide to set up a new plant to double capacity. If all goes well and the new factory leads to the company garnering a higher market share, everyone is happy. But sometimes, in the two years that it takes to set up the plant, technology or customer preferences change. Aggrieved shareholders blame the directors for not anticipating these changes. Two, a company’s directors could decide to shut down a high-cost plant. The workers who lose their jobs would view this decision negatively. 

“Managerial decisions are about balancing competing interests. But those stakeholders who are affected negatively by a decision question it, and at times even bring a law suit against the company’s directors and officers. The D&O Liability Cover provides protection against such risks,” says Sushant Sarin, executive vice president & head–commercial lines & reinsurance, Tata AIG General Insurance. 

Adds Anurag Rastogi, member of executive management, HDFC ERGO General Insurance: “This is a management liability policy that protects the personal assets of directors and officers of an organisation and their spouses in the event they are sued for actual or alleged wrongful acts while managing a company.”

Nowadays, in a number of law suits, the aggrieved party names not just the company but also its officials. For instance, a supplier who offers 60 days’ credit may develop a grievance against the company if it does not pay up its dues for a much longer period. One option before the supplier is to file a suit against the company. In such a case, the litigation could go on for many years and the supplier may still not see his money. So instead, the suit names a company official, say, the purchase manager, alleging that he made false statements about the company’s financial health. Till the summons were going to the company, the lawyers of the two companies were handling it. But once the court summon goes in the name of the purchase manager and he finds himself at risk, the matter acquires a new-found urgency and he decides to pay up this creditor first.

The D&O cover pays for the legal cost of defending a company’s directors and officers. It also reimburses the company for any damages that it has to pay at the end of a legal proceeding. The premium for this policy is paid by the company. Some policies pay up after the case is over and the judgement has been passed. Other more advanced policies reimburse even while the court case is proceeding, and later, also pays any damage that has to be paid.

Suits are brought by investors, employees, creditors, suppliers, dealers and distributors. Regulators are another key source of risk.  

Even SMEs buy them: Nowadays even small and medium enterprises (SMEs) are opting for this cover. “They are more vulnerable and could be affected in a big way if they have to bear litigation costs,” says Kapil Mehta, co-founder and managing director, Secure Now Insurance Broker. An SME could be listed or non-listed. If it is listed, then its directors face the same obligations as those of any other listed company. If it not listed, then its directors and officers do not face risks from shareholders. But the other stakeholders mentioned above could bring law suits against them.

Know the exclusions: If a director or officer is found to be guilty of wilful misconduct, then this policy does not cover him. If a director himself admits misconduct, or if a court or arbitration tribunal determines that he has done something wrong intentionally, the policy will not pay any further costs. If damages are awarded, the policy will not pay for them.

There is even a provision in these policies which says that the insurer has the right to recover the defence cost if wilful wrongdoing is established. The money is recovered from the company. However, such disgorgements are rare, say industry insiders.

These policies come with a geographical boundary. “Law suits arising out of the country will not be covered unless specified in the policy,” says Bhawna Sharma, general manager, PolicyX.com.   

Retroactive date is another exclusion. “If a case pertains to an incident that took place before that date, it is excluded,” says Mehta. A suit brought by a major shareholder of the company could also be excluded, he adds.

Buy the right sum insured: One factor to keep in mind is the type of industry the company operates in. Old-economy industries with more settled business models tend to be less prone to litigation, while new-economy companies are at greater risk. Companies whose valuations depend on untested business models face greater risk. In the pharmaceutical sector, for instance, a lot of money is spent on research and development. If a new molecule is produced and is introduced successfully in markets, the company’s revenues and profits soar. But if research efforts fail despite spending billions, investors could become unhappy. Similarly, start-ups often burn capital in the initial years and recoup those investments only in the later years. If the business model fails, the directors and managers could be charged with not executing the business plan properly.

The size of the enterprise also needs to be considered when deciding the sum insured. A broker will be able to provide a ballpark figure of the sum insured that industry peers of a similar size have purchased. “Companies generally buy a sum insured equal to 10-20 per cent of their revenue, with 15 per cent being the average. Sometimes they buy more based on perceived risk,” says Sanjay S Chauhan, vice president-SME business, Policybazaar.com. The cost of the cover, he adds, is around 0.2-0.4 per cent of the sum insured.  

Do not go by price alone: Select an insurer with a track record of handling these claims. “Take into account the coverages offered, list of exclusions, the insurer’s understanding of such risks, claims payment appetite, and existence of a dedicated claims handling team,” says Rastogi. 

Adds Sarin: “Get professional advice. Brokers deal with a large number of insurers and will be able to tell you which company has written a large number of policies, and settled a high value of claims in the past.” 

Do not just decide based on lowest price. “Take into account the features and breadth of coverage offered by different insurers,” says Sharma.

Sometimes, companies buy this cover just because their foreign partners require them to. This policy should not be bought just to fulfil such obligations. Sometimes it come with deductibles (an amount that the insured has to pay out of his own pocket in case of a claim). A higher deductible leads to a lower premium. “Do not keep the deductible so high that you do not get any money in case of a claim,” says Chauhan.

Do not buy features that you do not need. For instance, if you are sure that you will not have an operation in international markets, then do not buy international coverage.  

Avoid procrastination in the purchase of this policy for key officials. “Remember that you can't buy a policy after a problem has arisen,” says Sarin.

Do’s and don’ts when buying a D&O Cover 
  • Buy this cover as soon as your company can afford it
  • Compare features as well as price, and not just the latter
  • Have someone who understands this policy go through the clauses to understand key exclusions
  • Do not keep the deductible too high just to reduce the premium
  • Do not buy features that you don’t need, such as an international coverage for a company that only has domestic operations

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