This should not be construed as legal advice and is for general information purposes only.
Each year, hundreds of non-profit organizations search for liability insurance. This article will help those in search of liability insurance select the most appropriate coverage. A more detailed booklet is currently being written by the author and should be available in the spring of 1999.
What is risk management?
Risk management is the concept of managing potential risk that your organization may encounter. The most obvious risks are things such as theft or fires. Most organizations adopt a plan which includes both prevention and cure. For example, if an organization operates in an area of a city in which crime is prevalent, it will likely try to prevent theft by installing locks or bars on windows. It may also purchase theft insurance since the risk of theft is fairly high in that situation.
Other risks which are not as obvious are those resulting from the activities of an organization. The organization, its employees, and its volunteers may be sued by others for things they did while working for or volunteering for the organization. A particular risk that is becoming more and more real is the risk of liability of directors and officers.
The important thing is to assess the risk, try to prevent the risk related to the particular organization as much as possible and obtain insurance if needed.
There are four basic steps of risk management :
- Step 1. Identify potential risks and weigh each
- Step 2. Decide how to prevent risk
- Step 3. Decide how to "cure" risks
- Step 4. Balance the cost of insurance against the risk
Step 1. Identify Potential Risks and Weigh Each
The first step in risk management is to identify and weigh the risk. Since the law is constantly changing, it is best to speak to a lawyer or other expert about the risks to your organization. Most insurance companies will do a "risk assessment" before offering you insurance. Two of the main areas of risk are risks related to fiduciary duties and statute imposed risks.
A fiduciary duty is a duty to act in the best interest of the organization. Each director must act honestly and in good faith, in the best interest of the organization and in so doing, exercise the care, diligence, and skill of the reasonably prudent person. This duty is continually redefined by the courts as cases are brought before them.
Various statutes impose specific duties on directors and officers. Directors can be liable for such things as unpaid wages of employees and payroll deductions if they are not remitted to the government.
After identifying each risk, rank each of them in terms of severity (major or minor) and frequency. Obviously, those most likely to occur with the highest severity are treated differently than those at the other end of the spectrum.
Step 2. Preventing Risks
After identifying risks, set out to minimize or prevent them. It is a good idea to form a risk management team or appoint someone to be responsible for working through each risk. At the bare minimum, directors and officers must know the law relating to the organization and its activities, and know about duties relating to fiduciary and statutory obligations.
Step 3. The Cure for Risk: Indemnity or Insurance
After you identify potential risks and set up a plan to reduce or prevent these risks, there still may be a sense that more protection is needed. Every organization must consider how it might pay for claims if they arise. In many cases, corporate funds are in adequate. The following are things to consider.
Many organizations indemnify (pay back) board members if they are sued. This means, the organization will cover the expenses that a director or officer incurs to defend an action or the cost related to a settlement or a judgment of a claim. However, an agreement to indemnify a director is only as good as the financial resources available in an organization. In other words, indemnity may not be sufficient. Also, some statutes limit organizations from providing indemnity and an organization can decide not to indemnify an individual if the cost of litigation would push the organization into bankruptcy.
If you decide to purchase insurance, take the following into consideration.
Unfortunately, insurance policies are often written in language that is difficult to understand. Since an insurance policy is a contract between you and the insurer, its important that you understand what is being said and your commitments. If you do not meet the obligations set out in the contract, this may affect whether or not you are covered. When looking at insurance, look for four main things:
A. Who is covered?
Ensure that directors, officers and volunteers are covered You may also want to include higher level management staff such as the chief executive officer. Policies will either describe "insured" narrowly or broadly. In some narrow definitions, coverage is limited to current directors and officers of the organization only. Broadly defined policies will include the organization, all past, present and future directors, employees, committee members and volunteers. It is important to name as many people and organizations as possible in the definition of insured. Most litigation lawyers, when suing, will name all of these persons or organizations, regardless of who is ultimately responsible.
B. What is the definition of claim
Almost all directors and officers liability insurance is made on a "claims made" basis. This means that insurance must be in place when a claim is made in order for it to be covered. In other words, it doesn't matter when the actual event occurred. For example, if an organization has an insurance policy that lasts for all of 1998 and the organization fired an employee in 1997, if the employee decides to sue the organization in 1998, that claim will be covered. This is not very good for directors since they can be held liable for lawsuits about events that occurred years earlier.
C. What is the definition of wrongful act
The definition of wrongful act is fairly important since most policies limit their coverage only to wrongful acts that result in a claim. Most policies define wrongful act in a long series of paragraphs usually speaking about such things as errors, mistakes, or omissions that occur in the discharge of an officer's or director's duties. Wrongful act also usually includes those "causally connected errors" that are also called inter-related wrongful acts. In most situations, wrongful act will not include criminal activities such as false arrest or such things as libel, slander, infringement of copyright or trademark.
It is important to read the exclusions part of the contract very carefully because some claims that are included in the initial part of a policy are excluded in this section.
D. Policy Limits and deductibles
One of the most obvious parts of a policy is the limit that can be claimed under the policy. Limits are usually described in the dollar amount allowed per claim and the dollar amount allowed annually. So, for example, a $1,000,000/$1,000,000 policy means that any number of claims can be brought in a year but none can be greater than $1,000,000 and they can not total more than $1,000,000 in a year.
Other policy limits are related to defense costs. Defense costs are either included within the policy limits or in addition to policy limits. They will either be paid as incurred or paid at the end of the litigation.
Deductibles are the amount of the loss that the insured must pay. In some cases it must be paid up front when a claim is made. Many insurance policies charge different deductibles for individuals and organizations. Some insurance companies will pay for the loss and then ask for repayment of the deductible later. In many cases, this clause or term is negotiable in the contract.
Step 4. Balancing costs against risk
Not-for-profit directors and officers liability insurance typically costs from $200 to $50,000 year. The costs are based on the organization's annual revenues and on a risk assessment by the insurer. For not-for-profit organizations, it is important to realize that this cost can be lessened if its spread out among several organizations. Therefore, it is important to speak to other not for profit organizations and perhaps arrange for coverage which covers all of you.
The key question which every organization must ask itself is what is the probability that the board or senior staff will be sued. If it is very high, what is the likely reason and what loss prevention is currently being done? Weigh this risk against the cost of insurance and then decide what amount of insurance you need.
Some buying tips
- Solicit competitive bids every three to five years
- Allow sufficient time for a risk assessment by the insurer
- Locate an insurance advisor with expertise with not-for-profits
- Be extremely careful when filling out the application form (possibility of misstatements)
- Fully disclose the organizations prior losses and provide details on ways in which the organization can avoid future losses
- Negotiate for coverage and pricing
- Make sure that you report any prior incidences that might potentially give rise to a claim
- Ask each insurer to provide information on the insurance carriers' "financial strength"
Maureen F Fitzgerald is a lawyer at the law Society of British Columbia. She practices in the area of board governance, program planning, program evaluation, and legal education. These are her personal opinions and not those of the Law Society.
This article appeared previously in the newsletter of Volunteer Vancouver.