Recently, the average cost of liability coverage has ballooned by about 30 percent all around the country. Naturally, some cost-conscious nonprofit leaders are looking for ways to save money. Some are asking: do we really need directors’ and officers’ coverage for our board of directors? To help answer this question, a peek at the factors and conditions that really influence the determination of risk and cost of coverage might prove useful.
Insurance is a commercial contract in which you pay a fixed amount of money (a premium), in order to avoid the possibility of paying out a much larger sum in the future. Because all organizations incur some degree of risk in the normal course of carrying out their missions and program objectives, budgeting for liability coverage—treating it as a necessary business expense—is sensible. Doing so eliminates the need for large cash reserves to cover unforeseen events. In a sense, your insurance policy is a rental agreement granting access to someone else’s capital against potential ruin—natural or man-made.
Though subject to state regulation, state-by-state variations in rate structures have relatively little impact on the way insurers actually price their product. Insurance companies are situated in the national (and increasingly global) economy; therefore, two market-driven questions, expressed in terms of access and cost, will generally govern the availability of insurance. The business cycle of the insurance industry is characteristically on a pendulum: it either makes its money from underwriting—that is, managing claims; or it profits from investing the money of policyholders before it has to pay out (or both). Thus, when the stock market is booming—as it was during most of the 1990s—underwriting profit was not foremost in the minds of the industry since investment promised far greater returns. Boom periods create a “soft market” where market opportunities motivate insurers to lower their prices in order to acquire new funds for investment.
Conversely, as the economy has slowed over the past year or so, the pendulum swung in the other direction, toward a “hard market,” where underwriting, if not recouping losses, at least minimizes lost profits. In an economic downturn, the incentive is to protect profits by raising premiums and cutting “under-performing areas”—limiting consumer access as fewer insurers are writing fewer policies at higher premium levels. The economics of insurance mitigate the usual effects of supply and demand—buying more insurance won’t drive the price-per-unit downward.
Finally, the primary insurers we deal with are like storefronts. The real decisions are not made at this “retail level,” but in the backroom, the realm of the reinsurance market, where insurers purchase their own insurance. Reinsurers are much larger, often transnational corporations, and the true drivers of global market behavior. They renegotiate their deals twice a year, and their agreements help determine the rates on your premium the next time you buy a year’s worth of insurance. Incidentally, you can be certain that the massive industry losses stemming from the terrorist attacks on the World Trade Center and the Pentagon figured prominently in last January’s renegotiation of rates and terms.
In addition to losses incurred as a result of disaster (natural or man-made), nonprofits are routinely exposed to risks in the form of claims and lawsuits against the organization and its staff, against property owned or controlled by the organization, and for employee health and safety. Your organization’s liability may already be covered by a variety of insurance types: worker’s compensation, employee health and life insurance, unemployment, property and casualty, professional liability, corporate auto, and surety bonds. In most instances, a general liability policy will cover civil judgments arising from acts of “negligence” committed by the corporation.
So, do boards of directors really need their own liability insurance? In my opinion, the answer is, reluctantly, yes. Many states have extended substantial statutory protections against liability for “civil wrongdoing” to the boards of public charities. However, just because nonprofits may enjoy a certain degree of charitable immunity under the law, doesn’t mean that they cannot be taken to court.
Directors’ and officers’ liability insurance, as the name implies, indemnifies corporate officers against claims alleging intentional harm attributable to the governance or management practices of the organization. Directors’ and officers’ insurance requires thoughtful attention to the needs of the insured. If you have liability insurance for your directors and officers, or if you are thinking about it, the main things you want from a D&O policy are a broad definition of who is insured, broad coverage for employment-related disputes, specific coverage for legal expenses, and language requiring the insurer to pay defense costs in advance or as incurred.
According to insurance industry insiders, one of the most common forms of legal exposure for nonprofit boards of directors is “wrongful discharge”—often brought by a terminated executive director. The second most common lawsuit involves “breach of contract”—often counter-filed by the board against the executive director. The obvious lesson for the prudent nonprofit board is that hiring—or firing—an executive director carries its own element of exposure to risk. A failed relationship here can cost you big time.
An organization’s insurance history literally tells its own story: wrongful discharge suits, breach of contract settlements and worker’s compensation claims are persuasive indicators of the quality of organizational management. I like to think of risk management (an unfortunate choice of words) as a quiet form of quality assurance, providing a unique window into an organization’s values, policies and inner workings.
Not to be overly general, well-managed organizations seem to offer a relatively low-risk environment for staff and clients alike—even in such risk-prone industries as childcare, youth programming and elder care. Such organizations pay close attention to the quality of staff and volunteer supervision, training needs and general working conditions—all factors conducive to reducing risk, improving program quality and achieving mission objectives.
As we’ve seen, some top factors in risk management—the selection of an executive director and general oversight of employment policies and procedures–are directly related to the traditional responsibilities of the board of directors. One way to improve your organization’s risk management profile is to examine your most likely areas of exposure and, rather than increasing your coverage, address the factors contributing to the risk—by investing in proper training for employees who must lift as part of their jobs, or in ergonomic workstations reducing the incidence of repetitive-stress injuries, for example.
An effective board of directors will establish the priority, pace and direction for risk management efforts. Board action should be both proactive and pre-emptive because defending the assets (people, property, income) and reputation of your organization from litigation can be a very expensive proposition. In the final analysis, insurance is neither a substitute for thoughtful risk management nor, more importantly, a shield from the board’s legal and moral obligations to the duties of corporate governance: obedience, loyalty and due care.
Thomas A. McLaughlin is a nonprofit management consultant with the Boston offices of Grant Thornton LLP. He is the author of Nonprofit Mergers and Alliances: A Strategic Planning Guide, Trade Secrets for Nonprofit Managers and the second edition of Street-Smart Financial Basics for Nonprofit Managers.