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