Words of wisdom from our business insurance experts.
The Short Answer: it's the best way for an insurance company to understand the stability of a business. One of primary goals of a director or officer is to manage the financial health of a company. Are they burning cash? Are they going bankrupt? Are they making a profit? Remember, a Directors and Officers Policy protects the board, investors, and other executives if they are personally sued. When a business goes bankrupt, for example, investors may sue other individuals for mismanaging their money. Therefor, a company with a strong financial background are generally more favorable, and a company burning cash faster than it's making is more risky.
The Long Answer: a business looking to purchase Directors & Officers Insurance will be required to fill out a Management Liability Application, and submit a copy of the Capitalization Table and Company Financials. Company financials include the following:
- 12 Month Balance Sheet
- 12 Month Income Statement
- 12 Month Cash Flow Statement
Underwriters at top rated insurance providers will need to understand an organizations financial position, which requires an examination and analysis of the items above. A businesses financial background and trajectory paints the financial picture of a business. It uncovers things like their revenue, expenses, liquidity risk, and expense ratios. Some of the key sections they will review are the following:
- Net Income
- Burnt Rate
- Expected Revenue
- Asset Size
The money flowing in and out of a business can help an underwriter predict the future of a business and get them comfortable, or uncomfortable, with offering terms. Businesses that are burning cash quick or are losing money, are historically more risky than a business with strong run-rates and expense ratios. Often, if a business has strong financials it opens the marketplace and reduces rates. The more insurers interested in offering terms, the more negotiating power your insurance advisor will have.
If a company is pre-revenue or has raised capital, then underwriters look at the business a bit differently. The larger the investment can often create a riskier profile as more people are typically involved with large raises. Hence why a Capitalization Table is also required when applying for D&O insurance. In some cases, underwriting may ask for biography and descriptions of the entire management team.
The most common questions underwriters ask while reviewing your financials are the following:
- Do the people behind the organization manage their financials well?
- Does the business have enough money to sustain the next 1 year? 2 year? etc.
- Are there are undisclosed exposures hidden inside the financials?
- Can the company afford the proper risk controls?
- How fast is the business burning money?
Directors and Officers Insurance is one of the most vital lines of insurance for a startup, growing business, or established business. It can be the lifeline if things go south with the business, investors, executive team, and board of directors. Learn more about D&O Insurance and speak to a Fullsteam Advisor today.