Guide to directors & officers liability insurance for financial institutions

Lloyd’s of London began writing Directors & Officers Liability (D&O) insurance in the 1930s following the Wall Street crash of 1929 and the introduction of U.S. securities laws in 1933 and 1934.  However, it remained a niche class of insurance until the 1960s when, as a result of new interpretations of corporate law in the United States, directors and officers themselves could more easily be held liable for the results of their actions.

D&O entered the mainstream of U.S. insurance in the late 1970s.  The U.K., Canada, South Africa, Australia, Ireland and Israel followed in the early 1980s, joined by France, Belgium, the Netherlands, Spain and Switzerland toward the end of the decade.  D&O spread to the rest of continental Europe and Japan in the early 1990s.

Nearly all publicly traded companies have some degree of D&O cover.

Today nearly all publicly traded companies in the above territories have some degree of D&O cover, while smaller companies and other organizations are also increasingly purchasing D&O insurance.

What is the Purpose Directors & Officers Liability Insurance?

D&O insurance policies offer liability coverage for company managers to protect them from claims that may arise from actual or alleged “wrongful acts” when acting in the scope of their managerial duties or while serving on the company’s board of directors.

Policies cover the personal liability of company directors and officers as individuals (Side A Coverage), and also the reimbursement of the insured company in case it has indemnified its managers in order to protect them (Side B or Company Reimbursement Coverage).

Publicly traded companies can also obtain coverage for claims against the company itself for a wrongful act in connection with the trading of its securities (Side C or Securities Entity Coverage).

The structure of D&O insurance:

Structure of D&O

Although large publicly traded companies have the highest risk of attracting D&O claims, any entity, whether publicly traded or not, as well as any non-profit organization, has potential D&O exposure.

What Risks are Covered

The core purpose of a D&O policy is to provide financial protection for managers and board members against the consequences of actual or alleged “wrongful acts” when acting in the scope of their managerial and director duties.  The D&O policy will pay for costs incurred in defending the matter as well as financial losses sustained by the covered individuals and the company.  In addition, extensions to many D&O policies cover managers’ costs generated by administrative and criminal proceedings or in the course of investigations by regulators or criminal prosecutors.

Shareholder activism and class-action lawsuits are common in the U.S. with shareholder claims on the rise, along with the general trend of increasing shareholder rights globally.

Common D&O Risk Scenarios:

Shareholder actions and derivative claims based on:

  • Restatement of financial results
  • Failure to comply with or violations of regulations or laws
  • Inaccurate or inadequate disclosure (financial statements, earnings calls, investor presentations)
  • Misrepresentation in a prospectus
  • Decisions surrounding the sale of the company or the acquisition of another firm

What Risks Are Not Covered?

A D&O policy does not cover fraudulent, criminal or intentional wrongful acts.  Nevertheless, innocent directors remain fully covered, even if the acts of their colleagues were intentional or fraudulent.  In addition, D&O will not cover cases where directors obtained illegal remuneration or acted for personal profit.

Common D&O exclusions:

  • Fraud
  • Intentional non-compliant acts
  • Illegal remuneration or personal profit
  • Property damage and bodily harm
  • Legal action already pending when the policy begins
  • Claims made under a previous D&O policy

All past, present, and future directors and officers of a company and its subsidiaries are covered under a D&O policy.  For securities claims, the policy covers claims against the company itself.  The policy is usually taken out and paid for by the company.

D&O insurance provides cover on a claims-made basis.  This means that claims are only covered if they are made against an insured during the policy period.  The “wrongful act” that gives rise to the claim can have occurred at any point prior to the claim being made.  However, if the policy contains a retroactive date, coverage extends back to that specific date.

Common D&O Exclusions

Market Characteristics

Capacity in the D&O marketplace is dynamic and varies due to prevailing macro- and microeconomic conditions.

The 2007-08 financial crisis was a material event in the D&O market for financial institutions.  Subprime losses, the Madoff scandal, loss provisions, and write-downs for securities in their portfolio caused immense losses to many financial institutions all around the world.  As a result, there was a spike in D&O loss payments.

Following the credit crisis, the amount of available D&O capacity shrank considerably as insurers evaluated their portfolios and sought to rationalize their exposure to certain insurance products and classes of business.

In subsequent years, the total available capacity in the D&O market has expanded as

  • Existing carriers became more comfortable with economic conditions and the stability of customers, leading to an increase of their available limits, and
  • New carriers entered the marketplace

Price Development

The premium for D&O insurance is calculated on the basis of the estimated claims frequency and severity. This means that in addition to the size of the company (consolidated assets, revenue, and market capitalization) there are a number of other risk factors that affect the pricing of an individual D&O risk.

Common Risk Factors That Affect Pricing:

  • Industry sector
  • Financial and stock price performance
  • Domicile and international activity
  • Corporate governance
  • Claims and loss history
  • M&A activity

Appropriate Limits

Program Limits – How D&O Programs are Structured

The policy limit is an “annual aggregate,” meaning that there is only one single limit of liability for all claims against all insureds during one policy year.  Unless regulated differently by law in the respective country, all defense expenses and other costs are part of this single limit.

Annual aggregate: There is only one single limit of liability for all claims against all insureds during one policy year

Larger D&O programs are typically built in layers from multiple insurance carriers. The primary carrier, which is the first on the tower to pay any covered losses above the deductible, is typically an experienced insurer able to handle the complex policy wording, claims handling, and international exposure, if necessary.  When the primary limit is exhausted by claims payments, it “erodes,” and then the first “excess layer” held by the next insurer on the tower will have to pay.  After that comes the second excess layer and so on. This type of structure – a tower of insurance built in layers – is the most common in D&O.

The lead insurer is the first to pay any program losses and usually carries the defense costs and smaller claims by itself. The primary layer is often the only one affected by a claim. Therefore, it receives a larger share of the premium than the excess carriers. The premiums for the excess layers decrease the higher each layer attaches, as the excess insurers are not affected by low severity losses and defense cost payments.

Another way to share the risk is proportional coinsurance. In this type of structure, multiple insurers share risk of a loss on a percentage basis. Accordingly, the premium is shared by the carriers on the same percentage basis. For example, if there is a $100 million limit insurance program with five carriers each taking an equal share of the risk, each carrier participates with a $20 million limit (20% of the overall limit) and pays loss simultaneously at the same rate. If the total insured loss is $50 million, each of the five carriers would contribute evenly and pay their participation of the claim. The five carriers would each pay $10 million.

Contrast that with the layered tower described above. Assume that the same $100 million layered tower of insurance has five carriers, each with a $20 million layer. A $50 million insured loss would be paid by

  • The primary carrier’s $20 million limit
  • The first excess carrier’s $20 million excess of $20 million limit, and
  • Half of the second excess carrier’s $20 million excess of $40 million limit.

The third and fourth excess carriers would not contribute to the loss.

Side A DIC

It is common for companies to buy additional insurance at the top of their D&O tower that is dedicated solely to the costs incurred by individual directors and officers.  This insurance, known as Side A, has two key coverage features.

  • First, it is available as excess side A dedicated solely to liability imposed on individuals for which there is no indemnification available from the company. For example, if a securities class action suit erodes the entire underlying D&O program limit, the Side A insurance will still be available to directors and officers for claims in which they are individually liable.
  • Second, most Side A policies feature a difference in conditions provision (“DIC”) in which the side A coverage will “drop down” on a first dollar basis to protect individual directors and officers in situations where the underlying D&O tower fails to respond to the claim.

Determination of Limits of Liability

Many of the common risk factors that determine the pricing of a D&O program also help drive the limit purchasing decision.  In conjunction with such individual risk factors (industry, financial size and performance, etc.), there are two common tools used to guide limit adequacy.

  • The first is the traditional method of benchmarking. Companies will ask their insurance broker, “How much D&O insurance are companies in the same industry and of similar size typically buying?”
  • The second, more cutting-edge, approach is to utilize advanced analytics to predict the average frequency and severity of a loss that the specific customer can expect in a given year. This data is then matched to the appropriate D&O limit of liability, ensuring the customer is buying adequate – but not unnecessary – program limits.


What If A Company Is Merged Or Acquired?

D&O policies include a “change in control” provision. If the company is merged or acquired during the policy term, the policy will stay in force for the remainder of the policy period—however only for claims based on wrongful acts that occurred before the change goes into legal effect.  After the legal close of the deal, the remainder of the policy period is solely for reporting claims based on wrongful acts that occurred before the deal close.

Clients that operate with subsidiaries all over the world need cover in all of their markets.

For an additional premium – usually represented as a percentage of the annual premium – this reporting period can be extended. It is common for an acquired company to purchase a six-year extended reporting period, which corresponds to the statute of limitations for securities claims in the United States. The merged or bought company will be integrated into the D&O program of the new parent company with coverage for new wrongful acts that occur after the financial close.

What About Companies Which Operate In More Than One Country?

Clients that operate with subsidiaries all over the world need cover in all of their markets, making an international insurance solution essential. Some countries such as Brazil, Russia, and China require companies to take out a local insurance policy from a locally admitted insurer. Other markets are liberalized and allow a master policy issued in another country to cover local exposure.

Only a few insurers and brokers are able to coordinate local policies worldwide. Coverage is typically provided by the use of a combination of locally admitted country-specific policies, plus a global master policy, which provides additional coverage to harmonize the protection as far as possible worldwide (unless for legal reasons completely stand-alone local policies need to be purchased).

Emerging issues


It is critical to have the most cutting-edge policy language that will respond in today’s evolving legal and regulatory landscape.

With regulators continually flexing their muscles, coupled with a changing, more aggressive regulatory environment, the D&O coverage of a financial institution has never attracted as much attention from their boards as they do today. It is critical to have the most cutting-edge policy language that will respond in today’s evolving legal and regulatory landscape.

Industry Consolidation

Prolonged low global interest rates have sparked a wave of merger and acquisition activity among insurance carriers.  Recent mergers include:

  • ACE-Chubb
  • XL-Catlin
  • Tokio Marine-HCC

While these tie-ups can result in the reduction of capacity available from the combined companies, there have been new market entrants coupled with expanded risk appetite by existing carriers to mitigate the effects of such carrier mergers.

This post was originally published April 28, 2016.


Ryan WenzelGuest blogger Ryan Wenzel is Willis Towers Watson’s Banking Industry Leader, based in New York. In this role, Ryan provides strategic advice on the management liability lines of coverage to Willis Towers Watson’s banking industry clients.

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