Private Equity: Top 9 Questions to Ask Before Applying for D&O Coverage

Since private equity firms have representatives serving on the boards of their portfolio companies, questions can arise when claims are made against the portfolio companies’ boards. Far too often, scenarios are not considered until after concerns have emerged. The best approach is for these issues to be considered early on when the coverage’s are first put in place. Here are the top nine questions you should ask about Directors and Officers (D&O) Liability coverage before you get in too deep.

1. When does a private portfolio company first need D&O insurance?

Historically, the newest private equity companies went without D&O insurance until becoming much larger businesses or just prior to going public. However, that is changing. Even many young companies with relatively small operations obtain some level of D&O coverage.

Why the change?

The coverage being offered by many reputable D&O carriers is better and less expensive than it used to be. This is due to a more competitive and better-developed marketplace. As well, because of the increased threat associated with sitting on a board, the directors of smaller portfolio companies now regularly seek increased protection from the threat of personal and professional liability. Lastly, private equity firms have begun to adopt risk management strategies that require, of companies in which they invest, to have some degree of D&O coverage. These private equity firms tend to monitor the levels, amounts of coverage, and the scope of D&O insurance coverage that is maintained by their portfolio companies, making sure the coverages are sufficient as the company’s portfolios evolve.

2. How much D&O coverage should a private equity company have?

While there is no formula to apply in determining D&O insurance requirements, the range is substantial. Ultimately, the answer for any company, in particular, depends on how much risk the board of directors is able to assume.

Key factors to consider before determining coverage amounts include;

  • Availability of the company’s assets to fully cover the indemnification obligations it owes to the D&O
  • Volatility and risk profile of the company’s industry
  • Scope or size of the firm’s operations
  • Prospects and expected future growth of the company
  • Likelihood of merger & acquisition activity, IPO, dissolution, or bankruptcy
  • History of the company’s relations with its stakeholders

3. How much does D&O insurance for a private equity company cost?

The cost of a private company’s D&O insurance will vary depending on the size. Insurance carriers underwriting the coverage base pricing on similar factors as those in Question 2, as well as on the unique coverages needed.

The pricing per million dollars of coverage may decrease with higher amounts of additional coverage since the likelihood of those will limit the risk of a claim.

4. What does D&O insurance actually cover?

This is a common but complex question many have had. Some confusion arises simply because of the of the name of the policy. The name “D&O insurance” might not seem to apply in the private company context. Most of the major insurance carriers offering this insurance now include policies extending beyond a company’s D&O.

As far as the actions which are covered under a policy, the following are most commonly covered. However, this is in no way an exhaustive list.

  • Breach of Fiduciary Duty
  • Breach of Investment Agreement
  • Shareholder Derivative Action
  • Inflation of Financial Results
  • Securities Class Action

Carefully consider the scope of your coverage and the consider the need to secure adequate protection for the directors, officers, and other covered individuals.

5. Can terms or coverages be negotiated?

Yes. D&O policies can be negotiated in order to improve the scope of your coverage. Coverage enhancements have become common in the competitive D&O insurance marketplace. Your insurance broker or legal counsel should have recommendations for modification to the standard benefits. Many times, the coverage enhancements can be negotiated without a higher premium.

6. How can we get the best D&O coverage possible?

Initially seek assistance from a qualified insurance broker bearing in mind that not all have expertise in negotiating D&O policies, even if they are experienced in business insurance.

7. How will D&O insurance impact rights to corporate or personal indemnification?

D&O insurance adds another layer of protection for directors. D&O insurance typically will respond first to pay for costs of defense, such as attorneys’ fees. The company usually is required to pay the policy deductible only. This is helpful in protecting the company’s assets and also helps protect the D&O when the company’s assets are not sufficient.

Board members who are private equity investors should consider stand-alone indemnification agreements. These agreements strengthen indemnification rights and clearly set payment procedures in the event of an indemnification claim.

8. Does a board member still have coverage after stepping off of a board?

Yes. Most policies have provisions that protect past and board members in case of latent or retroactive lawsuits. In the event that a company is being sold or dissolving its board, a multi-year runoff policy should be purchased.

9. Can private equity firms help their portfolio companies obtain better D&O coverage?

Yes. Private equity firms may employ their own insurance broker to develop a D&O insurance program.

Directors and officers liability (D&O) insurance coverage is needed to provide a critical layer of protection from risks of personal and professional liability for any employee representative serving on the board of a portfolio company. This insurance is especially necessary to those private equity firms which have individuals placed on multiple boards. It isn’t always easy to understand how D&O insurance actually works. To learn more about D&O Insurance for Private Equity firms seeking portfolio coverage, connect with us today or give us a call
at 619.980-8611.

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