The simple answer is that Directors and Officers (D&O) insurance protects individual board members and their personal assets from a lawsuit. Any allegations of mismanagement, neglect, or breach of duty in the course of managing the nonprofit can be directed at the board of directors both as a group and as individual members.
Usually, these allegations come in the form of a lawsuit. Here’s a recent example:
Members of an association filed a lawsuit alleging the recent election of the new Executive Director did not follow the correct procedures outlined in the association’s bylaws. Members argued that a majority vote required was not obtained and the bylaws were modified to suit the self-interest of the board. Defense and settlement costs were $75,000. Fortunately, the association had D&O insurance, so the board members did not have to pay these expenses out of their own pockets.
When I work with nonprofit clients, I always ask them if they have D&O insurance. Nonprofits in the United States are not required to have D&O insurance coverage unless dictated by state law. However, as a nonprofit organization, you face many risks. One of these risks is the potential for directors and officers of your organization to be sued for wrongful decisions or actions. D&O insurance is designed to protect directors and officers from these types of lawsuits.
A Common Misconception
It’s a common misconception that a homeowners insurance policy will cover any claim on an individual’s actions on behalf of the board. However, homeowners insurance is solely for property and general liability insurance. It does not extend to any actions on behalf of the nonprofit’s board. If a nonprofit does not have D&O insurance, and if the claim is against a board member, personal assets are on the line.
Allegations and claims can come from clients of the nonprofit, employees, and other third parties, including government agencies, funding organizations, etc. Claims can be frivolous or severe depending on the circumstances. Mismanagement of funds, conflicts of interest, breach of fiduciary duty, wrongful termination, and discrimination are some of the common reasons. All of these allegations can result in costly lawsuits against a nonprofit.
Nonprofits are often held to a higher standard than for-profits. This higher standard means that nonprofits may be more likely to be sued for wrongful decisions or actions. There is an assumption that nonprofit leaders are acting in the best interest of the public, rather than for private gain. But what happens if a donor, constituent, client, employee, volunteer, or court sees things differently? D&O insurance can help.
Many nonprofits have fewer financial resources than for-profit businesses. If a nonprofit is sued, it may have a harder time paying for legal defense and any damages that are awarded. This could lead to the organization shutting down. You need to protect the organization.
D&O insurance can help protect a nonprofit from some of these risks. It can pay for the costs of a legal defense and any damages that are awarded. This can help the nonprofit stay in operation.
Types of D&O Insurance policies
When it comes to D&O insurance coverages, there are three types: Side A, B, and C. Each type of coverage has its own distinct advantages and disadvantages, so it’s important to understand which one is right for your organization. Side C is for publicly traded companies and is used for securities claims only. Nonprofits will not have Side C coverage.
Side A coverage: Side A is the most important type of D&O insurance for directors and officers. Side A coverage protects directors and officers from personal financial losses arising out of claims made against them for wrongful acts. Side A coverage is typically written on a “claims-made” basis, which means that the policy will only cover claims that are made during the policy period.
Side B coverage: Side B is designed to reimburse the company for any amounts that it pays to settle a claim made against directors and officers. Side B coverage is typically written on a “claims-made” basis, which means that the policy will only cover claims that are made during the policy period.
What does D&O not cover?
D&O liability does not cover any physical injury claims, it only covers financial damages for directors and officers while fulfilling their organizational duties.
Additionally, D&O policies will not cover any illegal or fraudulent activities that the directors or officers knew about. If the D&O policyholder is convicted of a crime, the damages may not be covered.
Three Examples of D&O Claims
The long-time yacht club members had their privileges revoked. They alleged that some of the younger board members made false statements and coerced other club members into a biased voting position. They sued for defamation and non-monetary damages to restore their senior member club benefits. Through arbitration, a settlement was reached that exceeded $20,000.
The D&O insurance policy can help to cover the legal fees and settlement costs.
A nonprofit cooperative was attempting to merge with another because of financial difficulties. The surviving co-op requested membership information and the most recent balance sheet and income statement from the distressed co-op. Soon after the merger, it became apparent that the acquired co-op overstated its sales and membership enrollment. The board of the newly formed co-op felt misled and immediately sued the former Treasurer, alleging misrepresentation. The former co-op’s D&O insurance policy provided defense costs to the individual.
Misappropriation of Funds
A grant-making foundation receiving private donations was alleged to have used those funds for purposes not associated with the foundation’s underlying mission. A group of supporters sued the foundation’s board alleging misappropriation of funds and breach of duty. Defense costs exceeded $65,000.
The D&O insurance policy can help to cover the legal fees for defending the case.
There are many benefits to using a knowledgeable advisor when purchasing nonprofit D&O insurance, including access to multiple insurance carriers, expert advice, and assistance with claims. Access to multiple carriers means that you can compare rates and coverage options, and find the best policy for your needs.
Working with a knowledgeable Healy Group advisor can help you understand your options and make the best decision for your nonprofit. Assistance with claims can help you get the compensation you deserve if your nonprofit is ever sued.
Have questions? Let’s talk!
About the Author
John Kersey joined Healy Group in 2003 and has over 30 years of experience designing risk management programs for commercial clients. As a risk management advisor, John strives to build strong relationships with his clients and business partners to understand their needs better and provide the best risk management strategies for their unique situations.
Notes: Non-profit D & O claims examples, Philadelphia Insurance Companies