Never assume anything, goes the old proverb. Even though a former employee resigned from the Sacramento, Calif.-based Transitional Living & Community Support (TLCS), that employee sued the nonprofit for wrongful termination.
The organization’s directors and officers insurance came in handy when a $7,000 out-of-court settlement was reached.
“Our attorney told us the Department of Fair Employment and Housing (DFEH) wanted to make an example of us,” said Linda Wagoner, human resource manager for TLCS. “Even though we provided correspondence, we ended up settling out of court. The settlement seemed cheaper than a continuing trial, which would have been a burden on the organization.”
The TLCS case is just one example of litigation facing nonprofits. Specialized insurance, like directors and officers, or D&O, is a protection against a breach of “duty” by the directors and officers, according to most experts. Usually D&O insurance pays for actual or alleged wrong decisions, called “wrongful acts.” While each insurer describes coverage in separate ways, D&O generally includes actual or alleged acts or omissions, errors, misstatements, neglect or breach of duties.
Nonprofit managers often struggle with what level of insurance coverage is needed, and the exact types of clauses required in the coverage. These questions all exist within a series of misperceptions about D&O insurance.
“In the past, people thought that giving a reason for the termination was adequate,” Wagoner said. “Now we’re seeing we need to have information to back up that decision.”
For example, termination isn’t always a clear-cut decision. Just because a person resigns doesn’t mean they weren’t forced to resign. The nonprofit needs to show that a hostile work environment has not been present through such documentation. Nonprofit managers “have to be aware of changes in employment practices to avoid legal issues,” she said.
Before dealing with the specialized service offered from the Santa Cruz-based Nonprofits’ Insurance Alliance of California (NIAC), Wagoner tried to use another service not run by an attorney. “I received countless pieces of mistaken advice,” she said. “Nonprofits need a service that caters to giving specific details about personnel problems.”
Such a specialized knowledge helps a nonprofit to design handbooks dealing with employment practices. “Even though we just updated our handbook last July, we’re still in the process of changing details,” she said.
Roughly 90 percent of legal cases dealing with D&O issues happen with employment-related practices, said Pamela E. Davis, president and CEO for NIAC. “Around 40 percent happen in straight termination issues with others related to discrimination or harassment,” she said.
NIAC, with affiliates, provides a liability insurance pool exclusively for 7,500 tax-exempts in 20 states. The NIAC specializes in community-based nonprofits, such as Boys & Girls Clubs, homeless shelters or Meals-on-Wheels types of organizations, rather than national entities.
“The distinguishing factor of considering whether or not to absolutely obtain D&O is whether the nonprofit has employees,” Davis said. “Of those insured, one in 20 will have a claim any given year and about half of the claims will require defense costs.”
To give an example of the expense of human resources claims, NIAC’s average premium for $1 million of D&O with employment practice coverage is $2,500. If the nonprofit doesn’t have employees, the figure drops to a flat fee of $600, without employment practices coverage.
While policies are usually around $1 million, 50 percent of the time an action is settled without any payment, except defense costs. As many as 25 percent of the actions are ended with no payment at all. Another 25 percent will see a wrongful action costing around $80,000 or more, she said.
Unless the organization is sizable, the $1 million coverage is enough, according to Davis. “We have had one claim in our history, since 1989, that was in excess of $1 million,” she said. “The board acted egregiously and the claimant would have settled for less if we had known what that board had done.”
Davis further explained that altercations with discrimination involving federal laws become more complex. “Sometimes employee practices coverage is overlooked,” she said. “That box can always be missed on the form, but it’s important to look out for it.”
There’s no real formula that helps describe the appropriate limit of coverage, said Melanie Herman, executive director of The Nonprofit Risk Management Center in Washington, D.C. “One organization with a $1 million budget held a $5 million policy because one board member wouldn’t serve without that amount. He happened to be the largest donor. That was worth the premium.”
While there’s no single way to determine the appropriate D&O limits, certain questions can help:
- What can the organization afford? If the nonprofit is very small and is in a start-up mode, the organization might only be able to buy a policy with a $1 million limit.
- What is the organization worried about? “Besides employment related claims, you would be afraid of malfeasance or class actions,” she said.
Three criteria help decide what to worry about, according to Nancy Hall, senior adviser with the Baltimore-based Maryland Association of Nonprofits. Those are:
- Do you deal with fragile populations that put the organization at risk, such as children?
- Do you have enough assets that people would want to seize, like $20,000 plus? A piece of property could be another indicator.
- If you want to recruit members to the board who are accountants or lawyers, the insurance would be crucial.
“When shopping for insurance, remember the service is not just a commodity,” said Eric Johnson, assistant vice president for Aon Huntington Block Inc., in Washington, D.C. Johnson offers D&O as a managing general agent, underwriting and issuing policies for Hartford Insurance. “It’s not just the bottom line. People should compare apples-to-apples. If you’re not getting the same coverage, it isn’t really all the same.”
Then vs. now
In the process of comparing the apples-to-apples, insurers should know that most D&O policies are claims-made based. This requires the claim to be made during a policy year. On the other hand, an occurrence policy would pay based on the date of the accident or occurrence.
The problem of a claims-made policy develops if the policy is cancelled. For example, a policy in force for January 1, 2000, and renewed for 2001 and 2002 might discontinue in 2003. Should the organization be hit with a lawsuit for discrimination in hiring that took place in 2002, six months after the policy lapses no coverage would be in effect because the claim was made in 2003.
“The occurrence, or event trigger, will stay in force for even some years later so that the event that triggered that claim will have a defense as long as the event happened during the time that you had that policy in force,” Davis explained.
Another key clause in the policy, according to Johnson, is the defense outside of the limits ability. “Some unique defense costs hit above and beyond your liability,” he said. “Typically, without that clause, a figure like $250,000 would come out of the limit of the coverage, but this clause allows the defense cost to come outside of the limit of liability.”
You should also look for a clause dealing with outside directorship liabilities. This has an effect on a board member who serves on another board. A clause dealing with breach of contract from an outside employer is a related contract not covered under D&O. This covers an intentional act, such as dealing with a printing company where the nonprofit has to back out of the agreement. The policy would defend the action although it would not cover the payment of the settlement.
The extended reporting period clause extends the time for reporting claims that occur during the policy period. While this doesn’t extend the coverage, the clause extends the time and can offer two- to three-year options.
“If you’re replacing a claims-made with another claims-made policy, you can obtain a retro date,” Johnson said. “That retro date will exclude any previous incident, so you would want a longer extended reporting period.”
Misperceptions about the D&O insurance abound. “Certain homeowner policies offer a specialty, built-in defense for people serving on a nonprofit board,” said Marvin J. Klein, from McManus Serra & Klein, insurance brokers in Wyncote, Pa. “However, this is not an automatic coverage, and that coverage doesn’t help the other board members.”
When an organization goes out of business, it should always buy the tail coverage so when the coverage stops, the policy covers the officers and directors for a period of time. “The tail is usually fairly short, but you can usually buy a one-year tail to make sure no legal action is in the wind,” he said.
Because you’re a nonprofit doesn’t mean that you won’t be sued. Warned Davis, “You might see situations where the claimant is more tied to the organization emotionally. The action could be more costly because of the person’s emotion.” NPT
*** Tom Pope, a New York City-based journalist, writes on management issues.