Help Your Board of Directors Help You: Protect Them With D&O; Coverage

If you run a business, you know that the key to growth is long-term planning, and the key to long-term planning is time, a precious commodity.

Successful business owners leverage their own planning time by recruiting working boards of directors--and they recruit working boards by protecting them with directors and officers insurance.

Common among publicly held corporations, D&O; coverage protects directors and officers against the personal liability that comes with serving on the board of an incorporated business. It is available to privately held businesses as well and at reasonable prices.

Many small businesses make do with boards of expediency, as it were, often consisting of family members who don’t understand business in general, not to mention the particular businesses they oversee.

The members of working boards, in contrast, make it their job to understand the businesses they direct and to prod their owners to follow fruitful strategies for growth. Often the members of such boards run their own companies, and they understand firsthand how to turn a small business into a big one.

Indeed, D&O; coverage can prove a potent force for growth. Without it, the owner of a privately held company often can’t recruit experienced board members at all. With it, the business owner creates a community of like-minded peers who help the owner clarify his or her vision of the future--and plot strategy to get there.

How does D&O; coverage work?

The typical corporate charter indemnifies directors and officers against personal liability for their actions on behalf of the business. In simple terms, this means that the corporation pledges its assets to protect directors and officers from legal assault by third parties--for example, family shareholders upset about the management of their interests, a creditor angry about alleged misrepresentations made in negotiating a credit line, and so on.

Given the readiness of Americans to take their disputes to court, any business with assets is a target, of course. And should the company’s assets not cover a claim, directors and officers may find themselves personally liable for the wrong.

D&O; coverage shifts the financial burden of this risk to an insurer. A number of insurers sell the coverage to small and middle-market businesses, including American International Group Inc., Chubb Corp., Travelers Group Inc., Reliance Insurance Co. and CNA Financial Corp. Premiums vary, of course; they start at $3,000 for $500,000 in coverage for low-risk companies.

“Corporate bylaws commonly offer directors and officers indemnity ‘to the extent provided by law,’ ” said Jerry F. Henderson, vice president of MDM Insurance Associates in downtown Los Angeles, who specializes in D&O; and other financial insurance coverage.

“This makes the corporation liable for the actions of its officers and directors--and the assets of the corporation are the wherewithal with which the business backs up this liability.

“But if a claim strips the corporation of its assets, the officers and directors are left bare, without protection.”

For the small to middle-market business, D&O; coverage often comes in a package with employment practices liability insurance, Henderson says. The upside is that the business owner covers both risks with one insurance policy. The downside is that a sexual harassment claim, for example, may exhaust your employment practices liability coverage, stripping you of your D&O; coverage.

The surer way is to buy separate policies covering the D&O; and employment practices liabilities, Henderson says, although the insurance costs more that way.

“The toughest question people ask is how much D&O; coverage they should buy,” Henderson said. “The problem is that a D&O; claim is potentially catastrophic--but a company with revenues of $10 million a year isn’t going to want to spend more than $20,000 or $30,000 on D&O; coverage.

“The average price for $1 million in coverage is $12,000 to $15,000. The average limits purchased by companies with fewer than 500 employees is probably $16 million. But how much coverage is appropriate is really a matter of the kind of business you run and the risks you face.”

However you choose to get the coverage, it’s important to insure both directors and officers and the corporation itself, Henderson says.

“This is really key because a claim puts the asset base of the corporation at risk,” Henderson said. “The coverage protects directors and officers for their personal liability--and the company for its obligation to indemnify directors and officers.

“If you don’t have coverage for the entity itself, a claim could easily outrun your assets.”

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Freelance writer Juan Hovey can be reached at (805) 492-7909 or via e-mail at jhovey@gte.net.