Do you understand your D&O policy? It has never been more critical for directors and officers to comprehend the scope of their coverage. These five questions will start the process.

• Author: Keogh, John W.
• Position: D&O Insurance - Directors' and officers'

THIS PAST JUNE, 1 addressed the topic of directors and officers liability (D&O) insurance issues for a group of corporate directors at the annual Stanford Law School Directors' College. During the session I asked the audience how many of them had read their D&O policy. Out of a group of 30, four raised their hands. When asked how many understood the policy, a single director raised his hand.

Why is D&O insurance such a mystery for so many officers and directors? The fundamental purpose of D&O insurance is to provide protection for the personal assets of individual directors and officers. However, over the last decade, D&O insurance has become more complex due to the evolution and expansion of the coverage and the increased rise in the frequency and severity of securities class actions and other complex commercial litigation.

With the actions of corporate management and boards under intense scrutiny, it has never been more important for directors and officers to understand their D&O policy. Directors and officers would be well served by seeking a coverage briefing with their firm's risk manager and/or legal counsel or insurance broker, and raising the following five questions.

Do I understand my D&O policy?

Since its origin, the D&O insurance policy has developed into an increasingly lengthy and complex legal contract. While there are many technical and legal concepts covered in the contract, an important issue facing the D&O policyholders is a concept referred to as "allocation."

Generally, allocation refers to the process of determining the portion of an insured loss that will be borne by the corporate entity versus the individual directors and officers covered by the policy. Historically, only individual directors and officers were insured under a D&O contract, requiring allocation negotiation between the D&O insurer and the corporation. In an effort to spare corporate assets, companies would take the position that the majority, if not all, of a loss should be allocated to the individuals, and thereby to the D&O policy. The D&O carrier, and sometimes the directors themselves, would disagree with this reasoning and negotiate against this position (since their policies were never written or priced with this exposure in mind).

In the mid-1990s, the insurance industry introduced the concept of entity coverage, which addressed the liability of the corporation. With the addition of entity coverage to the D&O policy, the D&O industry eliminated...