What Do You Know About D&O?
This issue of Risk Management Essentials is devoted to exploring nonprofit insurance policies and coverages. While there are many different policy types and forms with which risk leaders should be aware, one of the most talked-about and valued policies for nonprofits continues to be directors’ and officers’ liability insurance, commonly known as D&O.
Question #1: What are some of the biggest misconceptions about D&O?
Nonprofit leaders have significant responsibilities to the mission and stakeholders of the organization they serve. Since D&O insurance refers to directors and officers of the organization in its title, many people are confused about how far the coverage extends and assume that the coverage is limited to only those individuals. However, the vast majority of D&O policies purchased by nonprofits cover claims arising out of management decisions of the board members, officers, employees, and the organization itself. As noted by Peter Andrew, President and CEO of Council Services Plus, Inc., it is also important to understand that the coverage is limited to management decisions, and not all decisions made by an organization’s board.
Another common misconception is that the absence of “shareholders” substantially reduces the risk faced by nonprofits and therefore reduces the need for D&O coverage. However, lawsuits can still be brought by vendors, service providers, competitors, regulators, governmental litigators (state attorneys general), donors and beneficiaries of services. Yet the most likely claimant in a lawsuit covered by a nonprofit D&O policy is an aggrieved employee or former employee. And in practice, nonprofit D&O insurance is very often bundled with Employment Practices Liability (EPL) coverage, a type of policy that provides coverage for claims alleging wrongful employment actions. Experts suggest that the vast majority—perhaps 80 to 90 percent—of claims covered under D&O policies actually arise under the EPL portion of the coverage. Thus, obtaining coverage for employment-related claims is often a primary concern for many organizations purchasing D&O policies.
Question #2: What are the most common mistakes made in purchasing D&O insurance?
The board of a nonprofit comes into being when the organization is first incorporated. Thus, for many organizations, the first risk considered by the organization is the risk that the board members will be held personally liable for decisions they make on behalf of the nonprofit. This early taste of potential risk and liability may create a sense of urgency on the part of the board. A common mistake brought on by that urgency is the purchase of a policy based solely on consideration of the price. The coverage provided by D&O policies and their pricing vary substantially from insurer to insurer.
Choosing a policy based solely on the price can turn out to be a costly mistake when an expensive claim arises and coverage and claims handling are subpar. Remember that purchasing D&O insurance isn’t just about the peace of mind associated with having the policy; it’s really about the protection offered by the policy when a claim arises.
A second mistake stemming from the urgency associated with the newly formed board is the idea that D&O insurance will protect the board and cover potential liabilities wherever they arise. This thought can lead to confusion between the coverage offered by D&O insurance, and the coverage offered by General Liability (GL) insurance. Some nonprofits, particularly those that are newly incorporated with small budgets, may be surprised and dismayed to realize that the D&O coverage they purchased in their organization’s first week doesn’t extend to third party claims alleging bodily injury or property damage related to a fundraising activity or programmatic offering. For these exposures, General Liability insurance is required.
Another mistake that arises specifically when organizations change carriers—often to take advantage of better pricing—is not ensuring coverage continuity between the policies. Most D&O policies are written on a claims made basis, meaning that coverage only extends to those claims that are initiated during the term of the policy. If you change from a claims-made D&O policy to another, there is potential for a gap in coverage. Your prior insurer would not cover a claim reported after the expiration date of the policy, and your new carrier might only cover claims where the “event” giving rise to the claim—such as the termination of an employee—occurred during the new policy period. Assuming you changed carriers on January 1st, a lawsuit filed by an employee in January for a wrongful termination that occurred in December might not be covered by either policy.
There are two options for eliminating this potentially serious coverage gap. The first, and most cost effective option is to make sure the new policy either has no prior acts exclusion (a common exclusion onclaims-made policies) or has a “retroactive date” that confers coverage for events that took place prior to the new policy’s effective date. If these provisions aren’t available, a second option is to purchase an extended reporting period (ERP) from the old carrier. The ERP gives additional time to report a claim after the policy has expired.
Another important issue when changing insurers is to make certain that you have reported all claims and potential claims to your current carrier before your coverage with that company expires.
Question #3: What key questions should you ask to determine whether D&O is necessary for your organization?
D&O insurance provides coverage for claims by individuals and organizations alleging financial loss or seeking injunctive relief due to management decisions by the nonprofit organization and its paid or volunteer leaders. As discussed previously, the vast majority of claims covered by nonprofit D&O policies allege wrongful employment decisions, such as wrongful termination, employment discrimination, sexual harassment or illegal retaliation. Thus, the first question you should ask is whether your organization employs any paid staff.The hiring of a single staff member opens the door to employment-related claims. And although volunteers generally do not have standing to sue for wrongful termination or employment discrimination, the Center is aware of several instances when a D&O policy was helpful in defending a discrimination claim brought by a volunteer.
A second question to ask is whether your organization’s budget allows for the purchase of D&O insurance. In cases where an organization’s budget is inadequate to support the purchase of several policies, D&O may be a secondary priority after the purchase of General Liability. However, if your organization relies on staff and interacts with people on a regular basis, the purchase of a D&O policy should be an equally important priority.
Question #4: What are the most common reasons for the denial of a D&O claim?
Several of the Center’s go-to experts on the topic of D&O insurance, including David Szerlip, a nonprofit insurance specialist broker with Arthur J. Gallagher, provided similar insights about the common reasons for a claim denial.
A frequent reason that a claim is denied is because it simply isn’t reported in a timely manner. Most policies require that claims must be reported “as soon as practicable,” and in any event, within 30 to 60 days after the policy expires. Key personnel in your organization should be aware of the specific reporting requirements, and have a process for ensuring that these requirements are met. Claims are typically defined as “any written demand for monetary or non-monetary relief,” a definition that is quite broad. However, sometimes a claim isn’t reported by the staff member who receives it because that person believes that the claim will negatively affect the nonprofit’s reputation, the insurer will increase renewal premiums, or the claim is simply so far-fetched or ridiculous that it will never lead to a lawsuit. These reasons should not guide the determination about whether or not to report to your insurer. Err on the side of caution and report everything that falls within the definition of “claim” in your policy.
The second common reason for denial of a D&O claim is that the claim is excluded specifically within the policy. Because policies vary substantially between insurers, you should make sure to carefully read and understand all the particular coverages and exclusions in your policy. Some common exclusions under policies that frequently surprise nonprofit purchasers include claims alleging violation of the Fair Labor Standards Act (FLSA) and breach of contract claims. Although some policies may provide limited coverage for FLSA wage and hour claims, most insurers exclude these claims. Breach of contract claims were at one time uninsurable. In recent times, some insurers provide very limited coverage—typically for defense costs—associated with contract breach, but most insurers still don’t provide any coverage.
Question #5: What are some of the biggest differences in D&O policies written by different insurers?
As mentioned previously, each insurer creates their own D&O policy. Thus, the policies contain subtle as well as substantive variations, and also offer different approaches to claims handling. The following are several common differences:
- Insurance reimbursement versus “pay on behalf of”
For nonprofits with limited resources, this can be an especially important factor to consider. If the insurance policy indicates that the insurer will “pay on behalf of ” your nonprofit, you won’t be responsible for the up-front costs associated with a claim. On the other hand, if your policy indicates that the insurer will provide reimbursement, the cost of defending a claim must be paid by the nonprofit initially.
- Duty to defend versus no duty
If a policy indicates that the insurer has the duty to defend your organization from claims, this means that the insurer is obligated to assume control of the claim defense process, including selecting counsel and paying legal bills. The insurer must provide full defense even if a portion of the claim is not covered. The downside is that the insured usually has no control in choosing the defense counsel being assigned. If no duty exists, your organization will have more control of the claim including choosing counsel, but the insurer will allocate defense costs between covered and uncovered matters. Under some policies the insured will also be obligated to advance defense costs.
The lack of uniformity in D&O insurance policies extends to the amount you will be required to pay as a deductible. Comparing deductibles along with several other factors will help your nonprofit choose the most appropriate policy. As is true with any policy you purchase for your nonprofit, never elect a deductible that is beyond the financial means of the organization.
- Special situations
Remember that some policies may provide limited coverage for wage and hour claims and for breach of contract claims. Another major difference between policies is whether coverage extends to third-party sexual harassment claims. In these cases, a non-employee, such as a client, vendor, or business partner alleges sexual harassment (not sexual abuse or molestation) by a staff member or volunteer. Some policies will provide defense coverage for these claims, while others limit coverage to first-party sexual harassment, where an employee alleges harassment by a co-worker or supervisor.
- Settlement terms
Some policies specifically address whether the insured nonprofit can refuse to settle a lawsuit when an insurer would like to settle. In some cases, the insurer provides a benefit for organizations that agree to settle, such as a discount on the claim deductible. In other cases, a refusal to settle may limit the amount the insurer will pay if liability is imposed by a court in an amount greater than the insurer’s proposed settlement.
While differences abound in the substantive terms of D&O policies, one of the other biggest differences in the value of a policy is the claims-handling approach and expertise of the carrier issuing the policy. When comparing policies from two carriers, always ask your agent or broker about their experience with the claims-handling teams from each carrier.