Understanding Directors & Officers Liability Insurance What Makes an Organization a Non-Profit? A non-profit is an organization that serves the public interest. Its mission and operations are charitable, educational, scientific, religious or literary in nature. A non-profit does not declare a profit but rather utilizes all revenue net of operating expenses. No part of the ownership or assets are assigned to benefit any one person or group of people. Non-profits can be unincorporated or incorporated entities, partnerships, or cooperatives, although most nonprofits are corporations. At a minimum, most states require a non-profit to have a board of directors, maintain a set of bylaws and hold an annual meeting. The definitive factor in determining an organization s non-profit status is its legal structure whether or not it was legally formed as a non-profit organization. Tax Exempt Status The U.S. tax code section 501(c) exempts certain organizations from federal corporate income tax, qualifies the organization for discounts on postal rates, and grants the organization access to government and private grants. In order to qualify for tax-exempt status, a non-profit organization must be incorporated and complete an application along with Form 1023 (a 3-year projected budget for a start-up). If the organization is accepted, it will receive a Determination Letter from the IRS. Tax-exempt organizations are required to complete and submit an annual 990 tax form to the IRS, as opposed to the 1120 form required of non-tax-exempt non-profits and for-profit organizations. The Corporate Structure of Non-Profits The corporate structure of non-profit organizations is becoming increasingly complex. The need to find alternative sources of revenue and the constant push to respond to member needs are prompting many non-profits to diversify their services and create new entities. Whether or not these entities take on the structure of a subsidiary, partnership, affiliate or chapter depends on the purpose and the tax and legal implications of the venture. Some of the entities that non-profits may create include: Subsidiaries - An entity in which the parent company owns greater than 50% of the voting shares of the entity. Partnerships - An entity in which the parent company owns 50% or fewer of the voting shares of the entity. Non-Profit Subsidiaries - An incorporated entity in which the parent company has control of the board and fiscal management and has the right to dissolve the organization. Affiliates - A partnership in which the non-profit owns 50% or fewer of the voting shares or contributes equally to the financial investment, has board representation, and does not retain the sole right to dissolve the organization. Chapters - An entity created or chartered by an international, national, regional or state organization that follows the same mission and bylaws. Chapters may or may not be incorporated and may have separate boards. Each chapter should have their own pay.
Classes of Non-Profit/Tax Exempt Business Charitable organizations 501(c)(3) Foundations Educational organizations Hospitals, clinics and healthcare organizations Literary organizations Museums Organizations to prevent cruelty to children or animals Organizations for public safety testing Scientific organizations YMCAs, YWCAs, boys and girls clubs Social Service Agencies/Social Welfare Organizations 501(c)(4) Civic leagues Homeless shelters Legal aid organizations (can also be assigned to 501(c)(20)) Veterans Associations 501(c)(23) Burial and Cemetery Associations 501(c)(13) Trade and Professional Associations 501(c)(6) Professional associations representing building and trade industries Bar associations Professional associations representing service industries Associations of sports professionals Chambers of commerce Business leagues Social Clubs 501(c)(7) Recreational clubs Golf and country clubs Dog club Yacht club Fraternal Beneficiary Societies 501(c)(8) or 501(c)(10) Fraternities and sororities Fraternal orders of police Non-Profit Cooperatives 501(c)(12) Mutual rural water or irrigation companies Mutual cooperative telephone companies Mutual cooperative electric/power companies Miscellaneous cooperatives
What You Should Know About Non-Profits When reviewing the applicant s website, the underwriter will review the following to get an understanding of the organization: History Most non-profits will indicate on their website that they are a non-profit organization. This information can usually be found in the About Us or History section of the organization s website. This section may also provide a list of the board of directors and a description of the organization s mission or purpose. Program & Services For social service organizations, determine what services they are providing to their clients - Job training - Job placement - Rehabilitation programs Depending on the organization s level of training, Schinnerer may be able to provide a stand-alone miscellaneous professional liability policy to cover this exposure. Programs for trade/professional organizations: - Accreditation - Certification - Standard Setting Depending on the level of the program, Schinnerer may be able to provide a sub limit for accreditation, certification and standard setting. Financials Non-profit organizations will post their recent financial report or tax returns on their website. This information is helpful to determine if their financial condition is acceptable. Subsidiaries It is common for a non-profit organization to have subsidiaries, such as a foundation or limited liability company (LLC). Knowing the structure of the non-profit is important (see next page). It is also important for the underwriter to gather exposure information; for example, is the subsidiary purchasing their own policy? Does the non-profit control at least 50% of the subsidiary? Does the subsidiary have its own financial statements? Do they have their own employees?
Questions You Should Ask About the Structure of Non-Profits 1. Do you have an organizational chart on which all your subsidiaries, affiliates and chapters are identified? This will assist in distinguishing between actual entities versus programs or activities. 2. Do the chapters, subsidiaries or affiliates have separate boards from the main entity? 3. Is the main entity separately incorporated? 4. Is the main entity a paper company or operating company? Why are these questions important? Consider the following examples: A low income housing development corporation typically has a non-profit parent who sets up several paper companies to hold the individual properties for which they will receive HUD funding and create individual limited partnerships for the financial management of each property. A professional medical association can have an affiliated non-profit foundation, a for-profit subsidiary that publishes its medical journal, a for-profit subsidiary that markets insurance products and manages the group insurance trust, a political action committee (PAC), and chapters in each state. A non-profit golf and country club can be owned by a for-profit parent company. A construction trade association could have a non-profit foundation, a non-profit subsidiary that manages a homeowners warranty fund, and a joint apprenticeship training fund in partnership with a union.
The Insurance Contract Generally, a non-profit D&O policy is intended to provide defense costs and indemnity coverage to the entity, its directors, officers, trustees, employees, volunteers and committee members for loss from lawsuits that allege internal mismanagement of the entity. It is not intended to provide coverage for loss from lawsuits that deal with the quality of professional services delivered. Gray areas include: Services provided by staff attorneys Referral services or consulting services provided by an association Social services provided by volunteers What is Covered? In most cases, the definition of insured and any endorsements naming any additional insureds define who is covered under the policy. Generally, independent contractors, members, outside consultants, and other companies who enter into contract with the insured are not covered because underwriters seek to cover only entities and individuals who are under the control of the entity. Coverage often depends on the capacity in which the defendant was acting when the alleged wrongful act was committed. Some carriers are unwilling to provide full coverage for the for-profit subsidiaries or partnerships. Who is Covered? The insuring clauses, definition of claim, definition of wrongful act and any additional coverage endorsements will outline what is intended to be covered under the contract. Excluded allegations are outlined in the exclusions section of the policy and in any additional exclusionary endorsements attached to the policy. Most common D&O exclusions: Fraudulent and criminal acts Bodily injury and property damage Fiduciary liability Prior or pending litigation Pollution Insured versus insured Breach of contract Professional services Sexual or physical abuse/molestation SEC claims Important Policy Issues to Review with a Policyholder Claims reporting requirements Hammer clauses or settlement provisions Retention and any coinsurance requirements Provisions relating to reporting of mergers and acquisitions Claims-made vs. occurrence policies - your clients should understand that under a claims-made policy, claims must be made during the policy period to be covered Defense provisions - if the policy is a duty to defend policy, the insured may not retain counsel and handle the case without the insurer if they seek coverage under the policy
The Underwriting Process The Underwriter s Perspective To properly evaluate a risk, the underwriter must understand the structure, nature of operations and activities, current financial condition, and loss history of an organization and its subsidiaries. At Schinnerer, our underwriters require the following: Minimum information required A complete application (with financials) Organization website Loss runs (5 years) Tax form 990 or audited finacials Supplemental information Bylaws and articles of Incorporation The employee handbook (if 25 or more employees) List of the board of directors The most common reasons an underwriter might decline a risk include loss history, financial condition or operations that fall outside of their defined underwriting guidelines. The Exposures a Non-Profit Faces Underwriters also consider whether or not the entity has a human resources manager, training for managers and employees on the employment policies and procedures, or a progressive discipline and grievance process, EPL loss history, trends of employment practices, and claims for the particular class of business. Evaluation of the following exposures involves review of the number of employees and volunteers, the entity s employment policies and procedures, and the employee handbook. Wrongful termination Discrimination (gender, age, sexual orientation, religion) Negligent supervision Sexual harassment Intentional infliction of emotional distress Underwriters review at least two years of annual financial data and look for positive trends in revenue growth and diversification, strong fund balance, low debt to equity ratio, strong working capital, appropriate percentage of expenditures on programs and services, net income trends that don t damage the fund balance, positive cash flow, reasonable debt repayment schedule and notes free from negative events. Evaluation of the following exposures involves a thorough review of the financial statements. Financial mismanagement and bankruptcy Breach of fiduciary duty Fraud Publication of medical journals, standards and specifications and technical journals carry the greatest exposure. Evaluation of the following exposures involve review of the insured s publications and website. Publishing liability Plagiarism Copyright infringement Misappropriation of ideas
Claims Examples Breach of Trust A non-profit organization held a fundraising event. The organization received a temporary operating fund or float from another organization which was to be repaid from the proceeds of the events. Unfortunately, the funds were inadvertently deposited into the insured organization s general account by an employee and used to pay general expenses. The organization subsequently filed for bankruptcy and was unable to return the float to the lending company. A lawsuit was commenced against the insured organization and the allegations made against the directors included negligence for failing to properly supervise the employee and breach of trust. The claim was ultimately resolved by way of a negotiated settlement in the amount of $75,000. The costs incurred to defend the claim were approximately $30,000. Breach of Duty, Abuse of Process The board of a professional association revoked an individual s membership due to allegations of unethical conduct. The member sued the association alleging the board of directors had targeted her and they had not followed the organization s bylaws. Although the facts did not appear to support the allegation that the board targeted the member, the bylaws were somewhat ambiguous, making it more difficult to defend the action. A settlement was negotiated to avoid any embarrassment or loss of reputation to the association. In addition to paying the amount of the settlement, the insurer also paid $100,000 in defense costs. Wrongful Dismissal Claim A senior executive s employment was terminated after several employees complained about the executive s behavior toward them, including alleged sexual misconduct and harassment. The executive sued the organization for wrongful termination, and the directors and officers for alleged interference with contractual relations. Although the executive succeeded at trial, the insurer appealed the decision of the trial judge and won the appeal with the result that no damages were paid to the executive. The total defense costs incurred were approximately $250,000. Discrimination A woman enrolled in an educational program offered by a non-profit organization. During the course of the educational program, the woman became romantically involved with the leader of the program. The relationship ended before the completion of the program and problems developed between the participant and the leader of the program. The participant filed a human rights complaint alleging that she was being discriminated against and had been denied the services offered through the educational program. The insurer defended the complaint by retaining counsel to file an application to dismiss the complaint which was successful. The insurer paid approximately $36,000 in defense costs. Service Club - Breach of Bylaws The volunteer board of a small service club voted unanimously to expel a member of the club after several incidents of disruptive behavior, many of which occurred after the member had consumer several alcoholic beverages. On one occasion, the member became verbally and physically abusive toward another member. Upon receiving the news of the expulsion, the member commenced legal action against the club, alleging they had acted in breach of the club s bylaws. The insurer retained counsel to defend the action which was subsequently dismissed. The insurer incurred approximately $15,000 in defense costs. Wrongful Dismissal and Defamation As part of a corporate reorganization, a large non-profit organization terminated the employment of an employee who had been with the organization for more than 15 years. The employee sued the organization alleging wrongful termination. The employee also alleged that she had been defamed as a result of a written communication that found its way into the hands of individuals outside the board of directors of the organization. Although many of the facts were in dispute, the claim was ultimately settled by way of a negotiated settlement. The defense costs incurred were approximately $50,000.
8 Compelling Reasons to Insure Your Non-Profit Organization When times are tough, companies examine their expenses more carefully. Some non-profit organizations may even consider going without directors & officers and employment practices coverage to save money. However, dropping your coverage can cost you more than you think. Here s why: 1 2 3 4 5 6 7 8 If you drop coverage now, it will be as though it never existed. Directors & Officers and Employment Practices policies are written on claims-made policies, meaning that coverage must be in force at the time of the claim to be covered. So consider carefully the services or issues you ve recently been involved with. Even if your policy was active at the time, if a claim is brought against you after you ve let your coverage lapse, it won t be covered by that policy. Keeping your coverage is the best way to protect yourself against future claims. Insurance protects your organization s assets, as well as the personal assets of people that sit on the board. Remember, even frivolous claims cost you time and money to defend yourself. Who will be with you if a claim is brought against your firm? When you re a Schinnerer policyholder and a lawsuit is brought against you, we ll match you with an experienced defense attorney who will fight for your organization. Staying continuously insured could reduce your costs. Firms that renew their coverage may be eligible to receive longevity credits for staying continuously insured in our program. Buying and keeping Directors & Officers coverage is a much better option than relying on the Volunteer Protection Act for help. The Act/Law does not prevent a volunteer from being sued. In addition, compensated individuals (the most obvious being compensated employees and directors or officers) are not provided protection under the law. You get easy access on the web to our risk management library. When you re insured with Schinnerer, you get access to our risk management resources which are full of important information to help you take control of your risks. We provide valuable tools that help you improve your employment practices procedures. Non-Profit D&O coverage can provide added protection that is beneficial for the organization s professional employees, and the organization itself. Some ancillary coverages may include protection against anti-trust allegations, and claims stemming from services provided such as certification, standard setting, peer review, accreditation, and the publishing of newsletters and trade journals. Schinnerer has provided non-profit Directors & Officers and Employment Practices coverage for 16 years. Here are a few reasons to get your Directors & Officers coverage through Schinnerer: Our underwriters are some of the best-trained in the industry, they understand the non-profit industry. If you have a claim, you ll work with one of our expert claims specialists. We also provide 24-hour turnaround for online quotes and a wide range of risk management resources to help you avoid risk.
Risk Management and Resources for Non-Profits Below is a short list of best practices. This is by no means a complete list, but rather a baseline for good risk management practices. Board members should participate in and document meetings. Non-profits should establish, publish and enforce policies and procedures for employment issues, and provide regular training to staff and managers. When faced with threat of litigation, or a situation that may lead to litigation, a non-profit should consult experts like attorneys, human resources consultants and claims experts. A non-profit should establish financial oversight committees and conduct frequent audits. It is a good idea to engage a CPA to conduct a full annual audit and a review of internal controls. Non-profits should take advantage of the growing number of resources available to assist them with corporate governance and risk management issues. Subject Matter Experts - Your Managment Liability Underwriting Team Ana Recuero Ana.B.Recuero@Schinnerer.com 301-951-6930 Jessica Smith Jessica.Smith@Schinnerer.com 301-951-6916 Steve Cohen Steven.E.Cohen@Schinnerer.com 301-961-9851 Jose Gonzalez Jose.Gonzalez@Schinnerer.com 301-951-5452 Sarah Katz Sarah.J.Katz@Schinnerer.com 301-961-9898 This information is for illustrative purposes only and is not a contract. It is intended to provide a general overview of the policy described. Nothing contained herein should be construed as an acknowledgement by Schinnerer that a given situation may be covered under a particular policy. 2014 Victor O. Schinnerer & Company, Inc. In CA, dba Schinnerer Insurance Services CA Ins. Lic. # 0156109 Victor O. Schinnerer & Co., Inc. Two Wisconsin Circle Chevy Chase, MD 20815 Phone: 301-961-9800 Fax: 301-951-5444 www.schinnerer.com vos.info@schinnerer.com