Be sure your nonprofit is covered with Directors and Officers insurance
Directors and officers (D&O) insurance protects a nonprofit and its leaders against lawsuits for “wrongful acts.” While these suits are not common, even a single occurrence can sink an organization’s budget.
Consider these statistics from Susan Bradshaw, former vice president of marketing at the Nonprofits Insurance Alliance Group:
- Each year, about one in 100 nonprofits file a claim under D&O insurance
- The average cost of settling a D&O claim without going to court is $28,000
- The average cost of defending a claim is $35,000
- About 10 percent of these claims cost more than $100,000
Mistakes that leaders make
“Wrongful act” is a broad term. It’s defined in a variety of ways by state laws and the Internal Revenue Service.
In general, a wrongful act is any breach of fiduciary duty. Nonprofit board members have many such duties, including acting with reasonable care when making decisions and making sure that their organizations operate legally.
More specifically, D&O suits often involve claims related to:
- Unfair or excessive compensation packages
- Conflicts of interest
- Employee harassment and hostile work environments
- Failure to hire or promote
- Improper termination
- Discrimination on the basis of race, gender, ethnicity, or national origin
- Misleading or inaccurate statements
- Mismanagement of an organization’s funds or other assets
Remember that you and your nonprofit can be sued for such claims even if you’re innocent. A frivolous accusation is enough to land you in court — leading to legal costs and possible loss of reputation.
D&O claims can also be messy. Consider a disgruntled employee who claims that he or she was fired without reason. Key incidents in such cases can often be interpreted in different ways. And, the people involved have incentives to be less than candid.
More reasons to carry nonprofit D&O coverage
In short, D&O claims can lead to a substantial loss of time and money. That’s reason enough to own D&O insurance. But there are other reasons as well:
- General liability insurance does not apply to D&O claims. A general liability policy applies only to negligence — acts that are not intentional. For instance, you’d turn to general liability insurance if someone falls on a stairway in your office and sues for physical injury. In contrast, D&O claims result when someone claims an intentional breach of duty.
- Individual insurance coverage might not cover D&O claims. Do not assume that a board member’s personal liability insurance will apply. Such policies often exclude activities related to board membership.
- Strong D&O coverage makes it easier to attract qualified board members.If you do not have this coverage, your board members will be personally responsible for the cost of a D&O lawsuit. That’s a huge disincentive to work with your organization.
- D&O lawsuits can lead to tax penalties. Possibilities include fines, audits, and loss of tax-exempt status.
- Your organization can be sued even if you have no employees. For example, a vendor or landlord might sue for breach of contract.
Understand exactly what you’re buying
D&O insurance is challenging to buy. Unlike general liability policies — which often include standard language — D&O policies vary substantially from insurer to insurer.
Find an agent or broker who specializes in D&O insurance for nonprofits. Then ask the following questions:
- What does the policy cover? Make a complete list of your possible exposures to D&O claims and get coverage for each one. In addition to D&O insurance, you might need an employment practices policy to cover the risks.
- What is not covered? Look carefully at what’s included — and excluded — under the definition of “wrongful acts.” Avoid policies with a “failure to provide insurance” exclusion, which denies coverage if your organization does not have enough coverage in place. “Enough” can be defined in vague or arbitrary ways.
- Who is covered? Find out whether the policy covers employees and volunteers as well as executives and board members. Also see that the organization as a whole is covered.
- How will your organization be reimbursed? Make sure that the insurer will pay the costs of a lawsuit as they arise. Avoid contracts that require your organization to pay first and offer reimbursement.
Make sure that your insurance coverage is there when you need it
D&O insurance is sold on a “claims-made” basis: it applies only to incidents that occur while your policy is in force. The problem is that lawsuits can take many years to emerge. Your nonprofit could get sued for an incident that took place before you ever bought D&O coverage.
There are two ways to prevent this problem. First, get a D&O policy early on and keep it in force with adequate coverage limits. Second, look for a policy with coverage for prior acts.
Put risk management in place
The Nonprofits Insurance Alliance Group recommends that you prevent D&O claims by:
- Updating your policies, procedures, and employee handbook to comply with current laws — and following these documents to the letter
- Conducting thorough and candid performance reviews
- Clearly and promptly documenting any decision to discipline or warn an employee
- Stating in contracts that your organization and anyone it hires can terminate employment for any legal reason
- Revising your contracts and handbooks to remove any reference to a “permanent” employee
- Clearly and promptly investigating any claim of harassment or discrimination
- Getting legal advice before terminating any employee
Also review your D&O coverage regularly — especially when you want to recruit new board members. Approach this type of insurance as a way to keep your organization alive and thriving for years to come.
Blue Avocado: A Board Member's Guide to Nonprofit Insurance by Pamela Davis (2008)
Blue Avocado: Board Insurance: Do You Really Need It? by Susan Bradshaw (2011)
CIMA Volunteers Insurance: Insurance basics for nonprofit organizations (2012)