D&O insurance for nonprofits is an essential coverage for organisations of all shapes and sizes, however, it is not always well understood. It aims to protect an organisation and its management from claims made against them in the performance of their duties. Without such coverage in place, they may be exposed to significant financial loss.
In this article, we will explore D&O insurance for nonprofits, and understand why it is an important part of any comprehensive insurance programme.
D&O insurance for nonprofits: A definition
D&O insurance for nonprofits is a type of coverage purchased by an organisation to protect its management, and to some extent itself, from the consequences of managerial-related claims. In other words, it protects an organisation and its management from claims arising in the performance of managerial-related activities.
It is held by a wide variety of organisations, such as:
- Nonprofit organisations
- Religious organisations
- Universities and other academic institutions
- Government departments
By purchasing D&O insurance for nonprofits, an organisation can not only protect its own financial interests but also that of individual managers. When combined with appropriate risk management strategies, it can provide an organisation with the best possible opportunities for attracting talented individuals into the ranks of leadership.
How does it fit within an insurance programme?
D&O insurance for nonprofits typically forms part of a comprehensive insurance programme.
A policy will often be purchased alongside a range of general insurance coverages, such as:
- Property damage and business interruption insurance
- General liability insurance
- Marine transit insurance
- Motor vehicle insurance
- Corporate travel insurance
- Workers compensation insurance
Financial lines insurance
And it will complement any other financial lines insurance coverages that an organisation may purchase, such as:
- Cyber insurance
- Professional indemnity insurance
Within a broader programme, D&O insurance for nonprofits is often considered an auxiliary type of coverage. Its premiums can be relatively small when compared with other classes of insurance. However, from the perspective of an organisation’s management, it is arguably one of the most important, as it ultimately protects their personal assets from loss.
What are the key managerial risks?
The directors and officers of an organisation, known collectively as management, play an important role in governing its activities. But with this managerial responsibility comes many risks.
Common sources of claims
An organisation’s management have a fiduciary responsibility to place an organisation’s interests ahead of their own. However, while doing so they must also consider the consequences of their actions on others; specifically, an organisation’s stakeholders.
Common stakeholders of an organisation include:
- Shareholders and/or members
- Government and regulatory authorities
If a stakeholder becomes disgruntled with an organisation’s management they may wish to hold them accountable for their actions. To do so, any grievance may be formalised in a claim.
Common claims against management include:
- Negligent management of an organisation’s operations
- Inadequate disclosure in financial reports
- Misuse of an organisation’s funds
- False and misleading representation during fundraising activities
- Failure to comply with employment laws
- Theft of intellectual property and poaching of a competitor’s donors
- Breach of fiduciary duty resulting in financial loss or insolvency
- Inadequate or insufficient corporate governance
- Regulatory non-compliance
When a claim is made against an organisation or its management, it must be defended, no matter its merits. In this respect, a frivolous claim carries just as much weight as a genuine one and must be addressed with the same seriousness. With a little luck, a claim may be resolved through mediation. But if not, it may need to be defended before a court of law.
Common claim examples
To better understand what a directors and officers liability insurance claim might look like in practice, let’s take a look at a few claim examples.
Example 1 – Infringement of bylaws
An amateur sporting association disqualifies a competitor for suspected cheating in a race. At the tribunal hearing, the committee hands down a one-month suspension. In response, the competitor launches a legal claim against the committee, alleging that it did not act in accordance with its own bylaws, while also seeking reinstatement to active competition.
Legal counsel is appointed and defence costs of $10,000 are incurred – $5,000 of which exceeding the self-insured retention. Halfway through the claim, the competitor stops replying to all correspondence. No further update is received and the matter is eventually closed.
Example 2 – Breach of fiduciary duty
The director of a charity fails to disclose to the board that his family member has a financial interest in the building contractor who has been appointed to refurbish the charity’s new office. When this information comes to the attention of a key donor, they sue for a breach of fiduciary duty, demanding that he resign from his position.
The director makes a claim notification to the insurer, requesting indemnification under the terms of the policy. Panel counsel is appointed to prepare a defence on his behalf. Legal costs of $15,000 are incurred, and after some discussion, the director tenders his resignation.
Example 3 – Misleading and deceptive conduct
The chief executive of a social club is sued by a group of members after he made public comments that certain high-profile celebrities had joined the club. When this information was discovered to be false, the members that joined the club relying on his statements alleged that his behaviour was misleading and conducted in a deceptive way.
The insurer is notified of the claim, and legal counsel is appointed to defend the chief executive officer. Defence costs of $5,000 are incurred, and the chief executive officer is replaced shortly thereafter. The club agrees to refund the fees of the affected members.
How do managerial risks arise?
An organisation’s management is responsible for overseeing its operations and monitoring its ongoing performance. There are clear obligations imposed on them, and also potential consequences should these obligations not be fulfilled as expected.
The management of an organisation is required to satisfy a range of directors duties in the performance of their role. Directors duties vary between jurisdictions, but are typically articulated in statutory law (enacted by government), regulatory law (enacted by regulatory authorities), and case law (established by court precedent). These laws cover not only an individual’s behaviour, but also an organisation’s.
Board of directors liability
If directors duties are not performed as expected, it can result in board of directors liability. When a stakeholder believes that they have been adversely affected by the actions of organisation and its management, they may attempt to hold them accountable. By doing so, they will often seek compensation or some other remedy for the financial injury that they claim to have suffered.
What types of protection are available?
There are two common methods of protecting an organisation and its management from managerial-related claims.
Directors indemnification agreement
A directors indemnification agreement, also known as a deed of indemnity, is the first line of protection against board of directors liability. It is essentially a contract between an organisation and its management, whereby an organisation promises to protect them from any personal liability arising in the performance of their managerial duties.
D&O insurance for nonprofits
D&O insurance for nonprofits is the second (and final) line of defence for an organisation and its management. It can protect an organisation from the costs of indemnifying management, and in certain situations protect an organisation from its own liability. Importantly, it will also protect individuals in the event that an organisation cannot indemnify them.
Core policy coverages
Now that we understand the responsibilities of management and the types of risks they face, we can explore the insurance coverage designed to protect them.
A policy will typically include two core coverages:
Directors and officers liability coverage (Side A)
Side A coverage, also known as directors and officers liability coverage, protects management when a claim is made against them personally and the organisation which they represent cannot or will not indemnify them. In these situations, without insurance coverage, an individual would be responsible for financing their own defence, often at a great cost.
Organisation reimbursement coverage (Side B)
Side B coverage, also known as organisation reimbursement coverage, reimburses an organisation for the costs incurred when indemnifying management from a claim in accordance with its indemnification obligations. In these situations, without insurance coverage, an organisation would be responsible for financing a legal defence from its own balance sheet.
Optional entity coverages
In addition to its core coverages, a policy may also allow an organisation to insure its own liability in certain situations. This is generally known as entity coverage.
Organisation liability coverage
Organisation liability coverage protects an organisation from a broad range of civil liability claims. This coverage is often available to nonprofit organisations due to the fact that many are member-operated, and therefore the financial consequences of a claim against the organisation can be just as devastating as a claim made against an individual.
While this coverage is typically not economical for larger organisations, exceptions can be made for nonprofit organisations. An insurer’s intent is to provide protection for managerial-related claims against the entity, while excluding claims that may be considered commercial in nature or more appropriately covered under another class of insurance.
Employment practices liability insurance
Employment practices liability insurance protects an organisation from its own liability in employment-related claims. While directors and officers liability insurance typically includes coverage for claims made against an individual, employment practices liability insurance extends this coverage to include claims made against an organisation itself.
Commercial crime coverage
Commercial crime insurance, also known as fidelity insurance, protects an organisation from first-party losses incurred as a result of theft, fraud and misappropriation. More specifically, it provides coverage for the theft of its money, securities and property, as a result of misappropriation by its employees and also external parties.
Statutory liability coverage
Statutory liability insurance protects an organisation from claims made by government and regulatory authorities. While directors and officers liability insurance typically includes coverage for claims made against an individual, statutory liability insurance extends this coverage to include claims made against an organisation itself.
Superannuation trustee liability coverage
Superannuation trustee liability coverage, also known as fiduciary liability coverage, protects an organisation and its management from claims arising from the administration of retirement, superannuation or 401k schemes. In other words, it covers the liabilities that may arise when managing a pension plan on behalf of an organisation’s employees.
Who is insured by a policy?
A policy will be constructed to protect an organisation and its management in a deliberate manner, defining those who are considered to be an insured.
A policy will typically cover a principal insured organisation and any subsidiary of this entity. Collectively, these entities will often be referred to as the policyholder. The principal insured organisation will typically be listed on the policy schedule, and the definition of subsidiary will be located in the policy wording.
A subsidiary will typically be defined as any entity which the principal insured organisation owns or controls more than 50% of its shares or voting rights, directly or indirectly. If an organisation wishes to insure an entity that does not fulfil the definition of a subsidiary, it may be considered for inclusion as an additional insured organisation by endorsement.
A policy is likely to include a provision for automatically covering an organisation’s new and acquired subsidiaries throughout a policy period. The coverage for new and acquired subsidiaries often aligns closely with cessation of subsidiaries coverage, which will maintain coverage for any subsidiary that is wound up or divested during a policy period.
A policy will typically cover any insured person of the policyholder. The definition of insured person will be listed in the policy wording, and will be broadly defined to capture the types of individuals that are exposed to managerial-related risk.
An insured person is typically defined as any:
- Director, officer, or managing partner
- Chairman, secretary, or committee member
- Employee acting in a managerial capacity
Any past, present or future insured person will be covered as long as an organisation continues to purchase a current policy. This is certainly a great benefit, however, retiring individuals may be anxious that their ongoing coverage relies on an organisation continuing to purchase a policy. To address this risk, many policies will include some form of retired directors and officers coverage.
What type of acts are insured?
A policy intends to cover an organisation and its management for specific types of behaviour.
A policy will cover an organisation’s management in their insured capacity as directors, officers, and managers more broadly. This means that an insurer’s intent is to only cover managerial-related risks and not those arising in another capacity. As a result, an insured will not be covered for acting in a personal or professional capacity; other insurances are required to cover these risks.
A policy will cover an organisation’s management for any actual or alleged wrongful act while acting in their insured capacity.
The definition of a wrongful act will typically include any:
- Act, error, or omission that others perceive to be wrongful
- Misstatement or misleading statement
- Breach of directors duties
- Breach of fiduciary duty
- Breach of trust
A policy will also provide coverage for any actual or alleged employment-related wrongful act, such as:
- Unfair dismissal
- Failure to employ or promote
- Harassment, discrimination, or humiliation
- Defamation, including libel (written) and slander (verbal)
Management liability insurance will typically include entity coverage for employment-related claims as long as the employment practices liability coverage section of a policy has been selected.
What type of losses are insured?
A policy will define what types of loss incurred by an insured will be covered in the event of a claim.
The definition of loss will typically include:
- Defence costs, for legal representation by a solicitor or barrister
- Settlement costs, such as a negotiated claim payment or court-awarded judgement
- Formal investigation costs, incurred while preparing for an official inquiry
- Prosecution costs, for overturning undesirable judgements handed down in the course of a covered claim
- Fines and penalties, issued by regulatory authorities (where insurable by law)
However, not all types of loss that an organisation and its management may incur will be covered.
The definition of loss will not typically include:
- Fines and penalties that are not insurable by law
- The cost of complying with a court order or injunction
- Employment-related costs, such as wages, salaries, commissions, and other benefits
How is a policy wording structured?
A policy consists in its entirety of a policy schedule, policy wording, and endorsements. Of these, the policy wording plays a central role in defining the terms of coverage.
Insuring clauses, also known as operating agreements, are responsible for articulating the coverage afforded by a policy. They outline the promise of an insurer to pay for, or on behalf of, an insured for a covered loss. It is not unusual for a policy to include more than one insuring clause, each addressing a distinct risk that an insurer intends to provide coverage for.
Key term definitions
Key term definitions are contained throughout a policy wording and aim to facilitate a clear interpretation of its coverage. They are relied upon by all parties to reduce the ambiguity of important terms and are an essential link between a policy’s schedule, wording and endorsements. To aid identification, defined terms are often highlighted by bold, italic, underlined or capitalised text.
Extensions broaden a policy’s coverage from its insuring clauses and provide additional protection and/or benefits to the policyholder and any insured person. Many extensions will be automatically included, while some may be optional. An insurer will often use extensions to differentiate its product offering in the marketplace from that of its competitors.
Exclusions aim to eliminate an insurer’s exposure to undesirable risks faced by an organisation and its management. They are applied for many reasons; the risk of certain hazards may be too great for an insurer to bear, or be against the intention of coverage. Many exclusions will be included as standard, while some will be context-specific and applied by endorsement.
Conditions outline the various subjectivities that attach to a policy’s coverage. They explain how a policy is to be interpreted and what the obligations are of both an insured and insurer. Conditions will also carefully explain important processes that are essential to a policy’s operation; such as applying for coverage, notifying claims, and maintaining adequate disclosure.
How does coverage operate through time?
D&O insurance for nonprofits has a number of unique features that determines how a policy functions through time.
Claims made policy
A claims made policy requires that a claim be made against an insured and be notified to an insurer during the policy period, for any subsequent loss to be covered. For this reason, it is best to refer to such coverage as claims made and notified, to adequately account for the second condition of notification. Additionally, a policy will require the notification of any circumstance that may reasonably lead to a claim.
Prior acts coverage
The natural language of a claims made policy allows it to provide prior acts coverage. By prior acts, we mean any act or decision that has taken place at some time in the past, even before the commencement of a policy period. Insuring behaviour that occurred prior to the inception of coverage, as long as any subsequent claim is made in a policy period, is a unique aspect of a claims made policy.
A retroactive date, also known as a prior acts date, can be used to restrict a policy’s prior acts coverage. It is typically listed on the policy schedule and attaches to a retroactive exclusion. A retroactive exclusion will state that no claim will be covered if it arises as a result of an act that occurred prior to the retroactive date. Alternatively, it may state that only acts occurring after a retroactive date are covered.
Prior and pending litigation date
A policy may also include a prior and pending litigation date, which attaches to a prior and pending litigation exclusion. It aims to exclude claims that have commenced in any way prior to the date specified. It is an insurer’s way of excluding claims and circumstances that should have been most appropriately notified to, or covered by, a previous insurer.
How does an organisation acquire coverage?
To acquire coverage, an organisation and its management will need to follow a number of standardised procedures.
During the application process, an organisation is required to make a submission to a prospective insurer. A submission will typically include the following information:
- A proposal form
- Any supporting documents
- Its most recent financial statements
- An ownership structure diagram
Any financial statements should be audited, or third-party prepared at the very least. An internal accounting report is generally not sufficient because it is difficult to determine its integrity. For larger and more complex organisations, financial statements will be mandatory. For small and medium enterprises, however, there may be some flexibility to this requirement.
Duty of disclosure
An organisation is required to satisfy a duty of disclosure throughout the lifecycle of a policy. In practical terms, this means that it is under a strict duty to deal fully and frankly with an insurer, disclosing any material fact that is relevant to an insurer’s decision making. A failure to do so can result in severe consequences for all those who will rely on coverage.
An insurer will complete an underwriting process to analyse the risks faced by an organisation and consider its suitability for insurance. This aims to determine an adequate premium for accepting a risk and setting the terms of coverage. Once a quote is issued, it will typically remain valid for 30 days, subject to there being no material change to the underlying information.
Mid-term alterations to coverage
Once a policy in place, its terms will be set for the duration of a policy period. If an organisation would like to make alterations to its coverage mid-term, this will need to be completed by endorsement. Any changes to an organisation’s risk will need to be re-underwritten, and a signed no known loss letter will be required before any alterations are confirmed.
Expiry and replacement
As a policy period approaches expiry, a replacement policy will need to be arranged. In most situations, an organisation will need to complete a new proposal form and provide its most recent financial statements. Sometimes, an express or fast-track replacement process may be available; however, this is typically reserved for smaller and less risky organisations.
Selecting a limit of liability and self-insured retention
When an organisation and its management purchases D&O insurance for nonprofits, there are a couple of important points to consider.
Limit of liability
A limit of liability, also known as a limit of indemnity, is the maximum amount that an insurer is liable to an insured for covered claims in a policy period. It is typically separated into three key components; an any one loss limit, an aggregate limit, and sublimits. Selecting an adequate limit of liability plays an important role in protecting an organisation from large and significant claims.
A self-insured retention, also known as a deductible or excess, is the amount of loss that an insured must incur for a covered claim before a policy will respond. Once a self-insured retention has been paid or eroded, an insurer will commence its payments to an insured. Selecting an adequate self-insured retention ensures that a policy is reserved for claims that would otherwise impact an organisation.
How can a changes to an organisation effect its coverage?
Once a policy is in place, there are a number of situations that can effect the coverage of an organisation and its management.
Change in control
If an organisation is subject to a change in control during a policy period it will result in a conversion of coverage. When this occurs, a policy will no longer cover an organisation and its management for their future acts. Rather, only acts that occurred prior to a change in control will be covered. This phenomenon is generally described as coverage being in run off.
Run off insurance
Run off insurance is a term often used to describe the practice of purchasing insurance coverage for an organisation that has incurred a material change to its ownership or corporate structure, such as a change in control or winding up. It attempts to address the long-tail exposure of managerial-related claims, which remain long after individual managers have moved on.
Extended reporting period
An extended reporting period is a type of run off insurance made available to an organisation after a change in control. If an organisation and its management would like to maintain coverage for the notification of claims and circumstances arising from prior acts, an extended reporting period will allow them to do so; provided that it is willing to pay an additional premium for the privilege.
A discovery period may be made available to an organisation in the event that it decides not replace an expiring policy. This can provide an organisation and its management with the ability to notify claims and circumstances that materialise after a policy’s expiry date, but only for acts that occurred prior to the commencement of the discovery period.
How to notify and handle claims
D&O insurance for nonprofits is often purchased with the hope that it will never be required. However, for many organisations, it is only a matter of time before a claim arises requiring notification to an insurer.
Claim notification process
A claim notification describes the process that an organisation and its management must undertake to advise an insurer of a new claim or circumstance. It is an important aspect of protecting management, as it involves identifying any situation that is likely to trigger a policy’s coverage and then reporting this to an insurer according to its relevant procedures.
Who has the duty to defend?
A policy will include a duty to defend provision that outlines which party – an insured or insurer – has the right and obligation to defend an underlying claim. A policy with duty to defend language places this responsibility on an insurer, while non-duty to defend language (also known as duty to indemnify) places this responsibility on an insured.
Claim settlement process
An opportunity for claim settlement may arise throughout the defence of a claim. Claim settlement can describe the process of entering into negotiations with a claimant to bring a matter to conclusion, but also the process of an insurer discharging its obligation to an insured; by arranging payment to an organisation and its management for any covered loss.
D&O insurance for nonprofits is an essential coverage for organisations of all shapes and sizes, however, it is not always well understood. It aims to protect an organisation and its management from claims made against them in the performance of their duties. They may be exposed to significant financial loss without such coverage in place.